Environmental, social and governance (ESG) is quickly making it to the top of boardroom agendas, but why is it so important for companies and investors?

Against a complex backdrop of a rapidly changing legal and compliance framework, heightened disclosure and reporting requirements, increasing interest and pressure from stakeholders (including investors, suppliers, employees, and consumers) and a greater focus on the protection of company and brand reputation, it is vital that companies address the risks and rewards associated with the management of environmental and social issues.

In this instalment of our ESG in the Boardroom series, we highlight some of the key reasons why ESG is so important for companies and investors.

Attracting investment / financing

Many investors and financial institutions use ESG criteria to assess and select potential investments and funding. They recognise that companies which have identified their key ESG risks and developed an ESG strategy can increase returns through long term strategic and sustainable growth and value creation. They can also actively address identified risk issues.

Evaluating ESG activities and their impacts has become an indicator of good performance. Companies can be benchmarked against competitors, with evidence suggesting that those companies with higher ESG "scores" attract a value premium and higher multiples on sale. Conversely, companies that perform poorly on ESG are at greater risk of cost and value leakage, as well as increased litigation and enforcement actions. However, assessing an organisation’s ESG credentials, using these ESG Ratings, is not a simple exercise. There is no industry standard, leading to different approaches and frameworks, making it challenging for investors or funders to compare organisations. It is also difficult to gather the necessary depth, detail and accuracy of data, not least because so many factors fall within the scope of E, S and G.

Scoring could also be carried out based on publicly available information – meaning that some organisations fare better than others (who could be undertaking valuable initiatives but not be so good at communicating it on their website, for example). Although ESG Ratings are not considered perfect, they are still widely used to evaluate a company’s ESG performance, pending more formal regulation which is expected but unlikely to be soon.

Values and purpose

The way a company’s directors approach ESG, both at board level and throughout the business, serves as a valuable indicator of their approach to governance, risk management, value creation and company culture. Investors and funders will look for a clear strategy, along with policies and processes embedded throughout the business from top to bottom. These should create a strong culture of ESG awareness, training and compliance, as well as an open environment where employees can suggest ideas and raise concerns about day-to-day operations. In the UK, directors are required to act in a way which they believe will promote the success of the company for their shareholders, having taken into account (amongst other things) the interests of the company’s employees, business relationships with suppliers and customers and any impact on the environment, communities, or reputation. Failing to act in this way puts the directors at direct personal risk, and investment and funding will be difficult to obtain for a company whose governance is not purposeful, accountable, transparent, and well considered.

Litigation risk

The growth in ESG-related law is creating new litigation and enforcement risks. Navigating the rapidly evolving and varied legal requirements developing in the jurisdictions where the business operates is a complex task. Failing to keep pace with this can leave businesses exposed. There are, for example, an increasing number of claims being issued against UK-based companies for alleged anti-bribery, modern slavery and human rights infringements or adverse environmental impacts by members of their supply chain. There are also a rising number of greenwashing allegations. We will be looking at both these risks in future insights. For directors, the issue isn’t just the impact that claims could have on the value of the business – they could also be liable to compensate a company for loss suffered because of a misstatement or omission in certain director reports which they know to be untrue or misleading or dishonestly concealed.

Physical risks

Inadequately managing environmental and social impacts, such as flooding, contamination, and worker injuries, within a company, or its supply chain, can cause significant disruption, losses, and damage to the business, including reputational harm.

Brand and reputation

Consumers often use smart phones and social media platforms to promote concerns, support products, inflict reputational damage and allege infringements against companies. It is therefore vital for a company to mitigate reputational risk by focusing on compliance, messaging and implementing ESG values as part of its overall strategy. Any litigation or enforcement action (whether successful or not) can also inflict a reputational blow that is difficult to recover from, causes significant costs and affects company value or future growth. For many investors and funders, the brand and reputation of the company or group they are looking to support is key. Even where the financial information and growth of the business look positive, a branding or reputational issue can block the investment going ahead.

Consumer preference

Research confirms that many consumers are willing to pay a premium for more sustainable goods, products, and practices. Ensuring a clear and well publicised ESG strategy for the business can drive value and increase consumer purchasing.

Talent attraction and retention

Recent studies suggest that companies with strong ESG values and initiatives attract and retain quality employees, enhance employee job satisfaction, and increase productivity. Employee satisfaction is positively correlated with shareholder returns. By providing their workforce with a clear ESG strategy and credentials, companies can inspire their employees to perform better, drive revenue and shareholder returns and increase long term sustainable growth. Investors will be particularly interested in a company’s employees to understand their views and approach to ESG to ensure their retention after any investment.

These are all reasons why ESG is important for investors and funders. Much of this is also relevant in reverse – when a board of directors and their shareholders are seeking an investor or funder for their next growth phase. When a company’s mission and branding are rooted in strong ESG values, and its people closely identify with those ESG principles, it’s crucial to assess the ESG credentials and approach of any potential investor or funder.

In summary

ESG plays a significant role in how companies are assessed by investors, funders, consumers, suppliers, and employees. 

There are multiple ways that ESG activities can create value, but each business is different and should focus on the areas of ESG most relevant to them and their stakeholders. Even within the same sectors, different companies will have different ESG priorities, risks, and opportunities. The key should be to focus on progress, and not perfection. Our article here provides a useful starting point for businesses putting together an ESG agenda and sets out some of the ESG frameworks which can support a business in identifying ESG issues most relevant to their industry.

There is increasing awareness that ESG may soon become compulsory for all companies and embedding ESG principles now within their core purpose will prepare them well for the future and ensure their business remains competitive. We regularly work with clients on their corporate governance frameworks, whether as part of a recognised code, to comply with disclosure obligations, or simply because the company recognises that establishing a framework is the right thing to do as a matter of best practice. If you would like to know more, please get in touch.

This publication is intended for general guidance and represents our understanding of the relevant law and practice as at January 2025. Specific advice should be sought for specific cases. For more information see our terms and conditions.

Date published

16 January 2025

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