Corporate social responsibility
Boards of directors should leverage CSR initiatives to mitigate legal, reputational, operational and financial risks, and improve their bottom line. While some may perceive CSR efforts primarily as public relations efforts, community engagement or corporate philanthropy, more and more companies have developed systemic and effective programs to successfully meet key environmental, social and governance (ESG) standards as an integral part of their comprehensive risk assessment and mitigation programs. In fact, Boston Consulting Group analyzed some of the world’s largest consumer goods, biopharmaceuticals, oil and gas, retail and business banking, and technology companies, and concluded that those with better ESG standards were more profitable and traded at a higher value than their competitors. According to a 2017 study by Bank of America Merrill Lynch, companies with strong CSR practices are less likely to suffer large price declines, and they tend to have better three- to five- year returns on equity, as well as a greater chance of long-term success. These trends have not gone unnoticed. Investors are increasingly interested in the CSR performance of target firms as a way to identify economic performance potential and flag potential risks. As such, directors should now consider CSR performance critical to the bottom line.
From a risk assessment and mitigation standpoint, comprehensive CSR programs can help companies identify problems early and respond effectively. Whether the potential liability is legal (e.g., forced labor legislation or environmental regulations), financial, operational or reputational, firms that are not adequately prepared to recognize and resolve issues see their bottom line affected. A comprehensive CSR program can include risk assessments through internal investigations and audits, stakeholder engagement to identify issues and generate potential resolutions, and clear policies to resolve and address ESG risks in the future.
Private equity firms now often consider ESG risks in the due diligence of potential investments and are increasingly imposing ESG reporting requirements on portfolio companies. When companies lack a cohesive and proactive CSR program, ESG-related diligence can reveal unmitigated risks that may affect the value of the entity. In the absence of a comprehensive CSR program, reporting on ESG risks can be burdensome and may inadvertently divert resources from other key initiatives. For companies with developed CSR programs that involve voluntary reporting, however, portfolio companies may be able to satisfy reporting requirements by simply referencing their existing CSR reports.
Such voluntary reporting is a prominent way in which companies communicate their CSR commitments to a variety of stakeholders. These reports, which can range from one-page mission statements to flashy, interactive webpages, serve many purposes. In addition to satisfying investor requirements, increasingly, shareholders have demanded the inclusion of ESG factors in a company’s reporting, which reflects a growing consensus that CSR factors are material in a corporation’s health and potential growth. Additionally, through CSR reporting, a company can communicate with its consumers and other key stakeholders about the steps it is undertaking to increase awareness about ESG initiatives and compliance throughout its operations.
Embedding CSR considerations into day-to-day operational decisions has resulted in cost reductions for a number of leading corporations. While it is difficult to quantify savings based on risks that are mitigated through the implementation of social and governance standards, evaluating the impact of more stringent environmental standards has now become more common. For instance, by the end of 2013, GE had reduced greenhouse gas emissions by 32 percent compared to its 2004 baseline, and water use by 45 percent compared to its 2006 baseline, resulting in $300 million in savings. Similarly, in 2011, Dow Chemical reported that, by investing less than $2 billion dollars since 1994 to improve resource efficiency, the company saved more than $9.8 billion from reduced energy consumption and water waste.
ESG risks, including those that may not produce legal liability, are of growing importance to investors, shareholders and consumers. How an entity identifies and mitigates these risks, whether through proactive CSR initiatives or reactive ad hoc responses to specific incidents, can have an impact on its bottom line. Boards should therefore consider investing in CSR initiatives that proactively address these risks, treating these initiatives as an integral part of the entity’s compliance program and leveraging voluntary reporting frameworks to ensure that these initiatives are more visible to stakeholders.
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