The important question for companies is that should they be chasing TSI or ESG for its own sake or are their more tangible benefits? And the fear that investors have is whether they will underperform the benchmarks if they shift their gaze from shareholder returns to sustainability?
Cyril Amarchand Mangaldas, a leading law firm, organized a day-long seminar in the first week of November to deliberate on the SEBI Committee on Corporate Governance’s Report aka the Kotak Committee Report. Borrowing the expression raja-praja from Uday Kotak’s foreword to the Report, the first session was provocatively titled “Moving from the raja-praja model to the custodian model.” In keeping with the spirit of the seminar - Corporate Governance: the Sushasan Way, Ishaat Hussain, who has recently retired from the board of Tata Sons, spoke about ram rajya. Translating and contextualizing this - for a member of the audience, the conversation quickly veered to “Total Societal Returns,” a concept that BCG, a global consultancy firm, is now championing.
The starting point is the boards are rethinking the role of business in society. The BCG study, published on 25 October finds three factors explain this shift. One, governments, customers, employees all three are pushing companies to play a more significant role to help deal with issues such as financial inclusion and climate change. There is an acceptance that the UN Sustainable Development Goals will be achieved only if there is a strong buy-in from the private corporate sector. Second investors are pushing companies as they gather mounting evidence that social and environmental practices improves long-term returns. And three, as ESG (environment, social and governance) measures get quantified, stakeholders are measuring, comparing, commenting and pushing companies to improve.
Total Societal Impact (TSI) is the total benefit to society from a company’s products, services, operations, core capabilities, and activities. It is not a single measure, but a collection of measures to capture the economic, social and environmental impact (whether negative or positive). As it has a greater focus on aspects such as job creation, greater agricultural productivity (- for agri linked industries), financial inclusion for banks, or drawing tourist traffic to an area where it may not otherwise have gone (- Airbnb). TSI helps move the discussion beyond ESG.
For fund managers, the challenge is that they are judged daily, but TSI will have an impact over the longer term. The questions are also hard to answer: If you do not want to invest in coal, then what about companies which manufacture wagons in which this coal is transported? Or cigarettes versus bottlers of sugary water? In this context investors need to integrate the investment teams with the ESG team, and then drive the agenda for their meeting with companies i.e. to discuss the indicators they will use to measure company performance – in additional to the financial numbers, and discuss these in management meetings and quarterly calls. They must insist on greater transparency on matters other than financial numbers, as this alone may result in companies competing to outdo each other for the greater good. Eventually they must hold senior management accountable for these benchmarks.
For managements focused on delivering on the financial parameters, this can be equally vexing. They now need to focus on more than just shareholder returns. The guidance the study provides is very helpful. First companies need to recognize the impact they can have, and then take a call on where they are today, and what they want to achieve. These could be for the entire business or a division. It is important for companies to engage with their stakeholders to understand what matters to them, and ideally should be baked into the strategy. Two, spell out the parameters that will define success. Three, recognize external help might be needed – and in this context NGO’s can play a key role (- companies in India have gained through such partnerships as they have rolled out their CSR initiatives). Three, build this narrative into the company strategy and articulate it clearly. Four, disclosure on TSI activities should be integral to investor engagement be it calls, meetings or financial statements and finally, the governance structure and incentives should be aligned to achieving these goals.
The important question for companies is that should they be chasing TSI for its own sake or are their more tangible benefits? And the fear that investors have is whether they will underperform the benchmarks if they shift their gaze from shareholder returns to sustainability? The evidence overwhelmingly suggests that companies focusing on sustainability enjoy higher margins and that these investments are financially rewarding. The study evidenced that the valuation multiple premiums on select indicators related to downside and risk, was 3% for banking, 12% for bio-pharmaceuticals, 11% for consumer-packaged goods and 19% for oil and gas. Other studies like that by the Oxford University and Arabesque Asset Management too have found correlation between responsible investment and performance. As regards firm level data, the BCG study, like others, has evidenced higher EBITDA margins for companies focused on sustainability. Companies, investors, society, all benefit.
Evidence and pressure is mounting on companies to move beyond a strategy that delivers on just the financial numbers, which I have no doubt they will. And some investors no doubt will need more convincing, but in the aggregate, they will be the force for change.
A modified version of this column by Amit Tandon, was published in Business Standard on 30 November 2017. Click on this link to read the column or type the following url: