Director, Social Impact
For decades, most companies have oriented their strategies toward maximizing total shareholder return (TSR). This focus, the thinking has been, creates high-performing companies that produce the goods and services society needs and that power economic growth around the world. According to this view, explicit efforts to address societal challenges, including those created by corporate activity, are best left to government and NGOs.
Now, however, corporate leaders are rethinking the role of business in society. Several trends are behind the shift. First, stakeholders, including employees, customers, and governments, are pressuring companies to play a more prominent role in addressing critical challenges such as economic inclusion and climate change. In particular, there is recognition that meeting the UN’s Sustainable Development Goals (SDGs) will not be possible without the private sector’s involvement. Second, investors are increasingly focusing on companies’ social and environmental practices as evidence mounts that performance in those areas affects returns over the long term. Third, standards are being developed for which environmental, social, and governance (commonly referred to as ESG) topics are financially material by industry, and data on company performance in these areas is becoming more available and reliable, increasing transparency and drawing more scrutiny from investors and others.
As these trends gain momentum, companies need to add a lens to strategy setting, one that considers what we call total societal impact. TSI is the total benefit to society from a company’s products, services, operations, core capabilities, and activities. (See “What Is Total Societal Impact?”) The most powerful—and most challenging—way to enhance TSI is to leverage the core business, an approach that yields scalable and sustainable initiatives. If well executed, this approach enhances TSR over the long term by reducing the risk of negative events and opening up new opportunities. In the end, such an approach allows the company to survive and thrive.
Every company has positive and negative economic, social, and environmental effects on the world. We refer to the aggregate of these as its total societal impact. TSI is a collection of measures and assessments, not a single metric. Companies should use TSI to help shape strategy.
A company’s TSI includes the impact of its products and services, its operations, and its corporate social responsibility initiatives. It also includes the result of explicit decisions the company makes to adjust its core business to create positive societal benefits. Activities related to TSI often have a material impact on total shareholder return (TSR)—but not always.
TSI encompasses numerous elements. Examples include:
Impact is not an easy thing to measure. It is topic- and industry-specific and often requires data from outside the company. Many companies measure the outcomes of their efforts—but have difficulty measuring the ultimate societal impact. In the case of efforts aimed at expanding financial inclusion for women, for example, it may be fairly easy to measure an outcome, such as the number of women who join the banking system. The impact, on the other hand, which may be a decrease in gender income inequality, may be more difficult to measure.
No doubt, companies will make progress in identifying and tracking impact in the future. The objective, however, is not to come up with a single metric like TSR but to understand how a company’s actions connect to impact and to adjust strategy to maximize TSI for the benefit of TSR.
Evidence of the power of this approach is mounting. Much of the research to date has focused on demonstrating the link between a company’s overall ESG performance and its financial performance. However, CEOs tell us that it is unclear where they should put their energy. Which areas in their industry provide the best opportunities to create both societal benefits and financial returns? To help answer that question, we have gone deeper and identified the link between individual ESG topics and financials in specific industries. Our study encompassed five industries: consumer packaged goods, biopharmaceuticals, oil and gas, retail and business banking, and technology.1
For individual industries, we looked at the link between performance in specific ESG topics (such as ensuring a responsible environmental footprint or promoting equal opportunity) and market valuation multiples and margins, both contributors to TSR.2 Our key findings:
ESG data is currently the best way to quantify a company’s societal impact. However, it is important to note that ESG measures are not designed to measure a company’s TSI. In particular, ESG provides a limited window onto the largest impact of a corporation: the intrinsic societal value created by its core products or services. The ESG measures that do relate to a company’s products or services tend to focus on the incremental ways a company improves its products or makes those products more accessible. In banking, for example, ESG data is not designed to capture the full economic benefit of a bank’s lending activities—but it does track the degree to which banks are lending in underserved markets. Consequently, most of our findings relate to how companies operate their business, not to the actual product or service they create.
Still, the clear links in each industry between performance in specific ESG topics and financial performance point business leaders to opportunities to enhance both TSI and TSR. Notably, we found just two negative correlations in our analysis of 65 topics (we studied 35 topics, 10 of which applied to all four industries)—suggesting that a well-executed investment in material ESG issues does not hurt financial performance.
Of course, many companies have already developed programs that aim to address various societal issues and generate business benefits. Examples include efforts to reduce greenhouse gas emissions, programs aimed at eradicating major diseases in developing countries, and initiatives that provide opportunities that can lift people out of poverty. But too often, the results are fragmented and lack scale. Moreover, even companies that have an effective, large-scale effort intended to increase both societal impact and TSR frequently fail to measure and communicate the results to investors, their employees, and the wider public. This diminishes the benefits to the brand, to employees, and to stock market performance that companies could realize from such efforts.
Based on extensive work with clients and numerous interviews, we have identified the key success factors for integrating TSI efforts into a company’s strategy, organization, and business model. Companies that do this well will find they can not only create value for shareholders—but also make a real difference in the world.
The business community has, of course, played a role in addressing societal challenges for many decades. Companies have long run their own foundations, for instance, and have established major corporate social responsibility programs.
Today, it’s not enough for companies to pursue societal issues as a side activity. Instead, they must use their core business—and the scale advantages it offers—to create both positive societal impact and business benefits. The result can be a more reliable growth path, a reduced risk of negative, even cataclysmic, events, and, most likely, increased longevity. (See Exhibit 1.)
BCG conducted a comprehensive study of how this approach is being adopted in five industries. In addition to our quantitative analysis and a review of external studies, we spoke with in excess of 200 people at more than 20 companies both within and outside our five industries. We also spoke with dozens of investment professionals at pension funds, foundations, sovereign wealth funds, asset managers, private equity firms, and financial advisors to understand how the investment community is assessing ESG performance and incorporating it into their decisions—and what those views mean for corporate leaders. Lastly, we spoke with international development organizations and NGOs to get their perspective on partnerships with the private sector.
A company’s significant activities ultimately have an impact both on society and on shareholder value. Company activities are often presented in a 2x2 matrix to illustrate how much they contribute to each. Following the example of others who have conducted research in this area, we have created a matrix that shows the positive and negative impacts of business practices and activities on society and on financial performance. (See Exhibit 2.)
Assessing How Business Practices and Activities Contribute to TSI and TSR. A company’s business practices and activities ideally boost both TSR and TSI, falling in the upper-right quadrant. But placement within that quadrant—which reflects just how much these activities actually increase TSR and TSI—varies.
Philanthropy and donations, for example, can benefit society. But the impact on TSR, typically in the form of brand enhancement or employee engagement, is more variable. Some of these activities can enhance both TSI and TSR, putting them in the upper-right quadrant. But when these activities are not done well (or are done to excess), they can actually be a drag on TSR, putting them in the upper-left quadrant. A company may make donations that help society, for example, but do little to burnish its brand or engage employees.
The real question is how companies can identify activities that would fall farther up and to the right in that quadrant—business opportunities that generate significant shareholder returns as well as societal impact that goes well beyond the intrinsic benefit of a product or service. This requires explicitly identifying ways to leverage the core business to address social and environmental goals. How best to do so will vary by industry but can include changes to the supply chain, leveraging core capabilities of the business, and enhancements to existing products or services or the development of new ones.
Such activities can have a greater impact than most philanthropic efforts for a simple reason: they are scalable. In addition, while charitable giving can be among the first things on the chopping block in an economic downturn, a strategy built around enhancing TSI and TSR together is likely to be more sustainable because of the business benefits it aims to create.
Certainly, some activities fall in the other three quadrants, dragging down TSR, TSI, or both. For example, companies that have focused almost exclusively on delivering solid returns to shareholders have at times failed to invest in the best environmental practices or safety disciplines. However, societal expectations, regulations, and investors’ attention to social and environmental issues have evolved, making many previously permitted activities untenable.
Consequently, companies find that activities that previously boosted TSR in the short term, but had a negative impact on society, ultimately become a drag on TSR. As a result, those activities move from the lower-right quadrant to the lower left, often damaging the brand in lasting ways and even threatening the company’s survival.
The degree to which management has focused—and continues to focus—on TSR as the primary objective varies by region. In continental Europe, companies have long subscribed to the “stakeholder model,” in which employee, community, and environmental interests are all considered in addition to shareholder interests. This culture has its roots in an industrial structure dominated by family-owned enterprises and a regulatory environment for large companies that is more alert to maintaining the balance among these constituencies than in the US. In Asia, the prevalence of state-owned enterprises and family-owned, publicly listed companies creates an environment in which companies are generally focused on a broader set of objectives than simply maximizing TSR. These objectives can include, for example, supporting a country’s industrial policy.
The Trends Driving an Increased Focus on TSI. Several trends are converging that make it critical for all companies to expand their view to include both TSR and TSI.
First, companies are under mounting pressure from a range of stakeholders to play a more active role in addressing social and environmental issues such as global health challenges, climate change, and gender inequality. Employees—millennials, in particular—not only want their employers to have a greater sense of purpose but also seek an active role in companies’ societal impact efforts. In addition, customers are increasingly attuned to information related to a company’s social and environmental impact—information that can shape their buying decisions. Some governments, meanwhile, expect companies to do more to solve economic and social problems and are looking to collaborate with companies in such initiatives. The need for greater private-sector involvement in these efforts is clear: the annual gap between the cost of achieving the SDGs and the available public funding is projected to be as much as $2.5 trillion—a shortfall that many believe the private sector must largely address.3
Second, the investment community is increasingly focused on companies’ social and environmental performance. A decade or so ago, socially responsible investing (SRI) encompassed two primary approaches. The first was negative screening, in which investors in public markets avoided stocks of companies whose products or services were deemed to have a negative impact on society. The second was impact investing, which involved relatively small investments in the private markets that would support an explicit social or environmental objective. These two approaches represented a relatively small slice of the overall investment market.
Global figures reflect the shift. In 2016, global SRI assets hit nearly $23 trillion, accounting for more than one-quarter of total managed assets and up from $18 trillion two years earlier. The overall share of SRI investing varies quite a bit regionally. In Europe and Australia and New Zealand, roughly half of all managed assets fell into the SRI category in 2016; in Canada, the share was nearly 40%. In the US, the percentage was just over 20%, but it grew at a compound annual rate of 15% from 2014 to 2016. SRI investing has not yet taken off in Asia, where the share was close to zero.4
Asset owners and asset managers, particularly those with a long investment horizon, are paying close attention to environmental and social factors for a simple reason: evidence is mounting that company performance in ESG areas has an impact on long-term shareholder returns.
A third trend that’s moving TSI front and center is the growing availability and reliability of ever-more detailed data on company performance in ESG areas. A variety of standard-setting organizations and data vendors are behind this trend. Certainly, data challenges remain. For one thing, consensus is still emerging on which ESG topics are material for specific industries and on the appropriate ways to measure performance in those topics. And data quality and completeness need improvement. But information today is largely available and is rapidly becoming more reliable. As a result, companies will find their performance on social and environmental issues increasingly under scrutiny.
However, even if a company and many investors believe that societal and business benefits go hand in hand, several realities may make it difficult for CEOs to take this long view. These include the need to meet quarterly earnings as well as the increasing prevalence of activist investors, who may pressure the company to boost near-term shareholder returns at the expense of long-term value creation. In addition, some obstacles prevent companies from being fully rewarded by the investment community for their ESG efforts, such as the way companies and investors communicate about these issues. (See “Bridging the Investor Divide.”)
There are two main barriers that prevent publicly listed companies from getting full credit in the capital markets for their social and environmental efforts.
The first is the way companies and investors communicate with each other, which reflects the bifurcation between ESG and financial experts within companies, asset managers, and asset owners.
In a company, CFOs are focused on financial results described in well-defined metrics based on accounting standards. Consequently, they communicate less about ESG performance and how that performance affects the company’s financial results. As a result, conversations with portfolio managers within the asset managers and asset owners tend not to involve ESG in a major way, focusing instead on the company’s financial performance and plans.
Those portfolio managers, meanwhile, do not typically have ESG expertise. While a separate group of ESG experts does communicate directly with companies on issues these specialists believe are significant, such conversations do not generally happen in a regular and scheduled fashion.
The second barrier is that asset managers are typically hired and judged over a relatively short time frame by asset owners.1 That creates less of an incentive to factor in ESG issues, where benefits often accrue over a long period.
These two barriers can create a vicious cycle. Many CFOs and investor relations leaders at companies say investors generally do not ask about ESG factors, giving them less impetus to develop detailed information and messages about them. Investors that do care about ESG, in turn, are often frustrated, arguing that the information they receive about social and environmental efforts and their contribution to financial performance are short on details and clear measures of success.
Both barriers can be surmounted. For the first barrier, ESG expertise needs to be integrated into the company’s finance function and into investors’ portfolio management activities. That said, because companies set the agenda for communications with their investors, it is their responsibility to include ESG issues in those conversations. The second barrier needs to be addressed by asset owners. They must extend the time frames under which they measure asset managers’ performance.
The barriers are not a major issue in the private market, however. Private equity firms typically hold their investments for a fairly long period, usually five years or more. In addition, they often get board seats at the companies in which they invest, giving them significant influence over company strategy and the reporting of ESG performance.
No surprise, then, that a number of private equity firms we spoke with are integrating environmental and social factors into the life cycle of their investing strategy, making ESG a factor in due diligence and setting out ESG targets for companies in their portfolio. This reflects a belief among both general and limited partners that an ESG focus can ultimately help increase exit valuations. And it can help private equity firms attract more socially minded limited partners, such as development finance organizations and foundations.
In the end, the goal for companies is the same whether their shares are held in the public or private market: to receive full value for their ESG performance. That will not be possible unless companies effectively integrate that information in their communications with investors.
1. See R. Eccles and M. Kastrapeli, The Investing Enlightenment: How Principle and Pragmatism Can Create Sustainable Value Through ESG, State Street, 2017.
Companies that recognize these shifts and actively rethink how to improve their TSI stand to reap concrete business rewards. First, adding the TSI lens drives them to identify and address activities that will ultimately destroy TSR, activities that over time can undermine a company’s performance and ultimately even threaten its survival.
Second, the TSI lens leads companies to spot completely new opportunities—both internal and external. The most prominent include the following:
Companies that are able to seize such opportunities while addressing potentially TSR-destroying activities increase the likelihood that they will grow and thrive over the long term. Such sustained success is increasingly difficult to achieve. BCG research has found that corporate longevity has plummeted. Public companies have a one in three chance of being delisted in the next five years, whether because of bankruptcy, liquidation, M&A, or other causes. That’s six times the delisting rate of companies 40 years ago. (See “Die Another Day: What Leaders Can Do About the Shrinking Life Expectancy of Corporations,” BCG Perspective, December 2015.)