The public company readiness checklist for any business working toward an initial public offering (IPO) is long and complicated. And now, there are signs in the marketplace that for many companies aiming for an IPO, this checklist may need to include an analysis of environmental, social and governance (ESG) performance and reporting. Demonstrating meaningful effort and progress with ESG issues could potentially impact IPO valuation — and long-term market value.
Here’s a look at some of the dynamics that suggest ESG reporting, along with measurable progress toward ESG goals, could move over time from being a “nice to have” competitive differentiator to becoming a must-have for meeting the expectations of shareholders and other key stakeholders.
Pension Funds’ Intensifying Focus on ESG Performance
Pension funds aren’t the only investors in the marketplace, of course, but they are certainly major players that pre-IPO and public companies don’t want to dismiss. And pension funds around the globe have been leading the way in ESG investing, with a growing number of asset managers heavily weighing ESG criteria in their screening analysis and decision-making.
In the United States, for example, the California Public Employees’ Retirement System (CalPERS) closely monitors how companies in its portfolio are addressing issues such as corporate board diversity and climate change. TIAA meets directly with company CEOs, senior management and boards of directors to communicate the fund’s expectations on ESG best practices. And the New York State Common Retirement Fund, which is the third-largest U.S. public pension fund, just hired its first director of sustainable investments.
The desire to satisfy shareholders who care about socially responsible investing is, of course, a top driver for pension funds’ increasing interest in companies’ ESG performance. But there is also a general — and growing — view in the investor community at large that businesses serious about ESG issues are better positioned to handle related risks that could impact their ability to operate, attract and retain in-demand talent, maintain a good reputation, avoid legal quagmires and more. As a result, these businesses are more likely to generate attractive returns over the long term than businesses that are either indifferent to ESG matters or lack compelling disclosures regarding how they are dealing with such matters.
Industry and Regulatory Pressures — and a New Purpose
Companies in the technology sector are among the many businesses now recognizing the need to make ESG performance a higher and ongoing priority. As we discussed in a previous blog post, government scrutiny is only intensifying for these companies around issues such as data privacy and diversity.
On the data privacy front, there are stringent and rapidly multiplying regulations, such as the European Union’s General Data Protection Regulation (GDPR) and the California Consumer Privacy Act (CCPA). And as for diversity — an issue many tech firms have long struggled with — we see California leading the charge in mandating gender diversity in the boardroom. The state recently passed a law requiring publicly traded companies in the state to have at least one woman on their corporate board of directors.
To show a commitment to making progress on the diversity issue, in particular, look for more tech businesses to take a proactive approach to ESG reporting. As the focus on ESG performance becomes more mainstream in the tech sector, it will grow in importance for investors as well. And the more investors that value ESG performance, the more it can impact a company’s market value.
Most of the S&P 500 (86%) already publish sustainability and corporate responsibility reports. So, a time will come where not offering such transparency will leave the investor community wondering why. Also, keep in mind that the purpose of the corporation itself is shifting, with a view toward delivering value not only to shareholders, but all respective stakeholders. ESG reporting plays a role in companies disclosing how they are delivering that value, although, as noted in a recent issue of The Bulletin from Protiviti, the quality and consistency of such reporting needs to improve. Therefore, there is plenty of opportunity for late entrants to the ESG reporting game to make their mark.
The Need for a Standard Framework for Measuring ESG Success
While there is no clear evidence — yet — that ESG performance can significantly impact a company’s market valuation, it’s hard to see how it won’t become a factor, given the current trends. ESG is likely to be a hot topic for many CEOs and CFOs to address with investors in IPO roadshows this year. In fact, CEOs of already public companies heard this week from BlackRock regarding its intent to oppose voting for boards of investee companies until seeing quality ESG reporting. For many pre-IPO firms, ESG will be an important element of efforts designed to generate interest in the company’s stock issuance.
One major question mark in just how much ESG performance will impact a company’s valuation is measurement. Right now, there is no standard approach to rating companies’ ESG performance. When a unified framework emerges that becomes the accepted standard, look for the investing public to consider ESG performance much more heavily in their decision-making. Meanwhile, standards from the Sustainability Accounting Standards Board (SASB) can be useful in helping many companies, including tech firms, to be more transparent about business practices that impact the environment and society. In fact, BlackRock’s letter to CEOs recommended the use of SASB standards in reporting on material ESG considerations.
Even though first-mover advantage in this area remains to be seen, there are already indications that a concerted effort to prioritize ESG can benefit the business in many ways even before the IPO — and well beyond. No reasonable investor is expecting perfection when it comes to ESG performance, especially for a fast-growing company in the early stages of its life cycle. However, it’s hard to say that investors eager to make a smart investment won’t look favorably on a company’s efforts to do the right thing, even if the initial motivation is primarily a financial one.
For detailed insight on the steps toward achieving public company readiness, download the latest edition of Protiviti’s Guide to Public Company Transformation.
