The importance of ESG has grown over the past few years, mostly driven by the need for greater transparency, growing demand for action to tackle climate change and increasing new regulations.
When looking at how the ESG movement is influencing business behavior, industry experts tend to consider what larger companies are doing, how they are integrating ESG into their strategies, how are they reacting to newly implemented regulatory frameworks and what investors are asking of them. But what about small and mid-cap firms?
A new study conducted by UK investment banking specialist Peel Hunt, in collaboration with ESG consultancy SIFA Strategy, looks at the extent to which ESG and executive management compensation are tied at smaller firms. It also considers ESG best practices and what impact they have on shareholder returns.
The 2022 UK Company SIFA ESG Review surveyed more than 70 small and mid-cap companies across 17 different sectors listed on the London Stock Exchange.
It finds that 86 percent of UK small and mid-cap companies now see some form of direct connection between boardroom remuneration and ESG performance. This is more than three times higher than 2021 when only 25 percent of companies in this market cap noted a link between the two.
A strong link between ESG and remuneration is a ‘key indicator’ of how well ESG is embedded in a business, notes the report.
The data shows that in 2022 only 14 percent of companies consider ESG and remuneration unrelated, compared with 75 percent last year. This may appear comforting but there is a significant discrepancy between where companies say they are at in linking ESG to management pay and the work they are doing to get there. The report concludes that more work needs to be done to ensure ESG targets are measurable, achievable and linked to realistic dates.
For example, only 13 percent of companies surveyed describe ESG as fully embedded in their business operations, even though more than half of them say they have processes in place to reduce risk and identify opportunities.
‘Linking ESG to pay is seen as a way to hold corporates and their senior executives to account for the commitments they make,’ notes the report. ‘There are, however, challenges in ensuring that metrics and the focus of remuneration policies are there to support wider ESG objectives.’
Looking at the next 12 months, 71 percent of UK-based small and mid-cap businesses expect to invest more in developing ESG, despite expectations that market volatility will continue over the next year.
‘Despite concerns around macroeconomic issues, ESG is still an important consideration for boards. The findings of the research show that the overwhelming majority of small and mid-cap UK company boards are more concerned about ESG issues than ever,’ says Sunil Dhall, chief financial and operating officer at Peel Hunt.
‘Moreover, boards are taking action to ensure ESG is at the heart of strategy, with increased investment planned for next year and a focus on ESG-linked remuneration for executives.’
‘ESG will remain important because the question of what makes this a business I want to hold shares in for 10 years is still what you have to answer – and increasingly ESG is part of that response,’ says one survey respondent.
According to the research, in the UK, four in five executives at small and mid-cap firms see ESG as ‘positively aligned’ with shareholder returns, either as a factor of value creation or in driving higher resilience.
Nearly 40 percent of companies consider their ESG efforts to be mostly aligned with maximizing shareholder returns, compared with 17 percent who agree they view ESG as fully aligned with shareholder returns, up from 3 percent in 2021.
‘You need to think about the cost of doing business with carbon tax and other things like that,’ notes one surveyed company. ‘If you don’t think about these things, frankly, your stock will be less attractive and marketable.’
It is in companies’ interest to understand how investors consider ESG in their investment processes and this creates more than a few challenges for corporates involved in a balancing act of showcasing that their business is both responsible and profitable.
Looking at value drivers for the next decade, 83 percent of companies agree that a commitment to tackle social issues is going to be a strong driver of value.
This compares with 59 percent of firms that believe environmental strategies in place will have a noticeable, significant or very significant impact on valuation and performance, and 51 percent that consider governance issues as increasingly important.