The G in ESG: Why governance matters to investors

Environmental, social and governance (ESG) factors are being used more and more by investors looking to assess the sustainability and risk profile of companies. ESG considerations can have both positive and negative impacts on a company's financial performance and on shareholder value. A growing body of research also points to a positive link between financial performance and strong corporate ESG policies and practices.1

This article is the last in a three-part series looking at each of the ESG components and how they help investors better manage risk and generate sustainable, long-term returns. Here, we're looking at how a company's governance structure, policies and procedures can help create value for investors and benefit society at the same time.

Good corporate governance promotes investor confidence

Governance covers a broad range of corporate activities including board and management structures as well as a company's policies, standards, information disclosure, auditing and compliance. For example, investors want to know that a company's accounting is both accurate and transparent and that its business practices are ethical. They also like to see policies that encourage shareholder engagement and to invest in companies with a board of directors that is both accountable and diverse.

Investors can screen for governance practices, as they would for environmental and social factors. Negative screens can be used to rule out companies whose governance policies and practices expose them to unacceptable levels of risk. It can be a company that is involved in legally or ethically questionable practices, or one that doesn't adequately address long-term risks to its business, such as the risks presented by climate change. Positive screens can be used to identify companies with strong and transparent governance policies and practices.

If you follow the markets, you'll find that corporate governance issues make headlines on a regular basis.

Volkswagen Group provided a lurid example of the negative consequences of poor governance in 2015, when it was revealed that the company had programmed 11 million diesel cars to cheat emissions tests. Volkswagen has paid billions in criminal and civil penalties related to the scandal and its stock price has yet to fully recover.

Executive compensation is an ongoing hot-button issue in corporate governance. Securities regulators in many countries, including the U.S. and the U.K. — but not Canada — require publicly traded companies to allow shareholders to vote on executive compensation packages at regular intervals. Recently, Norway's influential US$900 billion sovereign wealth fund announced it would focus on curbing excessively high executive salaries at companies in which it invests, arguing that certain compensation structures work against the long-term interest of shareholders.2

Gender diversity and gender equity are another high-profile governance issue, with many institutional shareholders demanding better representation of women on corporate boards and in executive ranks, and equal compensation and career promotion access for women. Research from Morgan Stanley shows that a better balance of men and women in the workplace can deliver returns with less volatility, making gender diversity profitable for companies and investors.3

Canada has a long way to go when it comes to advancing women in the workplace. Only 12 per cent of corporate board seats are held by women while 45 per cent of Canadian companies have all-male boards.4 And women working full time earn 74 cents for every dollar that full-time working men make, according to Statistics Canada.5

At the June 2017 annual meeting of Restaurant Brands International (RBI) — the parent of Tim Hortons and Burger King — independent shareholders strongly backed a shareholder proposal calling on the company to improve gender diversity on its board and in its executive ranks.

The resolution, which was tabled by Qtrade Investor's sister company OceanRock Investments Inc., received nearly 23% of the vote overall, but was supported by 64% of independent shareholders (RBI is majority owned by 3G Capital of Brazil).

The ESG advantage

More investors are seeing the connection between ESG performance, value creation, and risk reduction. It stands to reason that companies with strong ESG performance tend to be more efficient and less wasteful. They enjoy greater employee commitment and higher productivity. They are more respected and better able to build brand equity. All of that reduces operational and reputational risks.

Catch up on this series

In case you missed them, here are the 'E' and 'S' articles in this series:

The 'E' in ESG: Why investors are weighing environmental criteria in their portfolios
The 'S' in ESG: Why investors should care about a company's social impact

Resources for investors

If you are interested in discovering companies that are deemed to be leaders when it comes to ESG performance, here are a few resources to check out:

Jantzi Social Index, from Sustainalytics, is a socially screened stock index modeled on the S&P TSX 60, consisting of 50 companies that pass a broad set of ESG criteria.

Dow Jones Sustainability Index, from S&P Dow Jones Indices and RobecoSAM, which includes companies based on ESG factors.

2017 Global 100 Most Sustainable Corporations in the World index, from Corporate Knights

 

  1. Clark, G.L., Feiner, A., and M. Viehs. "From the Stockholder to the Stakeholder: How Sustainability Can Drive Financial Outperformance," 2014. SSEE Research Report sponsored by Arabesque Asset Management. This research examined more than 200 academic studies, industry reports, newspaper article and books. It found that 80% of the studies shows that stock price performance of companies is positively influenced by good sustainability practices.
  2. Hikael Holter and Sveinung Sleire, "Biggest Sovereign Wealth Fund Proposes to Curb CEO Bonus Plans," Bloomberg Markets, April 7, 2017. https://www.bloomberg.com/news/articles/2017-04-07/norway-s-wealth-fund-proposes-to-rein-in-executive-pay-plans
  3. "Why It Pays to Invest in Gender Diversity," 2016. https://www.morganstanley.com/ideas/gender-diversity-investment-framework
  4. Ontario Securities Commission. "Regulators Release New Results on Women on Boards and in Executive Officer Positions," September 2016. http://www.osc.gov.on.ca/en/NewsEvents_nr_20160928_new-results-women-on-boards.htm
  5. Statistics Canada. "Women and Paid Work," March 2017. http://www.statcan.gc.ca/pub/89-503-x/2015001/article/14694-eng.htm