There is evidence to show that companies that have strong ESG characteristics can also deliver superior investment returns over the long term. This article examines the relationship between financial productivity and a set of ESG characteristics, namely carbon intensity and governance.
The research found a strong relationship between financial productivity and environmental and governance ratings, as well as a positive correlation with equity returns. This is a review of some research conducted by Lazard Asset Mgt (reference to paper at the end).
Financial productivity
For this paper, the authors concluded that the best approach was to use CFROI (Cash Flow Return on Investment) for non-financial companies and RoE (Return on Equity) for financial companies.
Note that CFROI measures a company’s ability to generate cash flow. It is an internal rate of return that equates the cash a business generates today with the cash (expressed in present value terms) that has been invested in the business. Essentially this means CFROI is a better measure of “economic profit” than “accounting profit”. It can thus be used to compare companies with differing leverage, across sectors and regions.
Carbon intensity and financial performance
The article argues that the strong relationship between a company’s financial productivity and its carbon footprint can be explained by the company’s asset intensity. Companies with asset-light businesses tend to be more adaptable to changing market conditions and are usually easily scaled. In addition, they generally have lower operating costs and a stronger focus on innovation and brand building, resulting in relatively heavier investment in technology, research and development, and marketing. This creates sustainable competitive advantages, which is critical to a business, not only generating high levels of financial productivity, but also, sustaining it.
Governance and financial productivity
Companies with strong governance should create value for shareholders and investors over the long term as strong corporate governance tends to increase management’s accountability and transparency and reduce excessive risk-taking. This can potentially drive more efficient use of capital and increase returns on assets over the long term.
Reference / source:
The Link between ESG and Financial Productivity, by Lazard Asset Mgt (accessed on 9/9/2023).
Link: chrome-extension://efaidnbmnnnibpcajpcglclefindmkaj/https://www.lazardassetmanagement.com/docs/-sp1-/68744/TheLinkBetweenESGAndFinancial_LazardPerspectives_en.pdf
Comments