ESG Metrics

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= environmental, social and governance metrics

Discussion

By AL GORE AND DAVID BLOOD:

"ESG metrics directly affect companies' long-term value, pension funds, sovereign wealth funds, foundations and the like—investors with long-term liabilities—should include these metrics as an essential aspect of valuation and investment strategy. Sustainable capitalism requires investors to be good investors, to fully understand the companies they invest in and to believe in their long-term value and potential.

We recommend five key actions for immediate adoption by companies, investors and others to accelerate the current incremental pace of change to one that matches the urgency of the situation:

• Identify and incorporate risk from stranded assets. "Stranded assets" are those whose value would dramatically change, either positively or negatively, when large externalities are taken into account—for example, by attributing a reasonable price to carbon or water. So long as their true value is ignored, stranded assets have the potential to trigger significant reductions in the long-term value of not just particular companies but entire sectors.

That's exactly what occurred when the true value of subprime mortgages was belatedly recognized and mortgage-backed assets were suddenly repriced. Until there are policies requiring the establishment of a fair price on widely understood externalities, academics and financial professionals should strive to quantify the impact of stranded assets and analyze the subsequent implications for investment opportunities.

• Mandate integrated reporting. Despite an increase in the volume and frequency of information made available by companies, access to more data for public equity investors has not necessarily translated into more comprehensive insight into companies. Integrated reporting addresses this problem by encouraging companies to integrate both their financial and ESG performance into one report that includes only the most salient or material metrics.

This enables companies and investors to make better resource-allocation decisions by seeing how ESG performance contributes to sustainable, long-term value creation. While voluntary integrated reporting is gaining momentum, it must be mandated by appropriate agencies such as stock exchanges and securities regulators in order to ensure swift and broad adoption.

• End the default practice of issuing quarterly earnings guidance. The quarterly calendar frequently incentivizes executives to manage for the short-term. It also encourages some investors to overemphasize the significance of these measures at the expense of longer-term, more meaningful measures of sustainable value creation. Ending this practice in favor of companies' issuing guidance only as they deem appropriate (if at all) would encourage a longer-term view of the business.

• Align compensation structures with long-term sustainable performance. Most existing compensation schemes emphasize short-term actions and fail to hold asset managers and corporate executives accountable for the ramifications of their decisions over the long-term. Instead, financial rewards should be paid out over the period during which these results are realized and compensation should be linked to fundamental drivers of long-term value, employing rolling multiyear milestones for performance evaluation.

• Incentivize long-term investing with loyalty-driven securities. The dominance of short-termism in the market fosters general market instability and undermines the efforts of executives seeking long-term value creation. The common argument that more liquidity is always better for markets is based on long-discredited elements of the now-obsolete "standard model" of economics, including the illusion of perfect information and the assumption that markets tend toward equilibrium.

To push against this short-termism, companies could issue securities that offer investors financial rewards for holding onto shares for a certain number of years. This would attract long-term investors with patient capital and would facilitate both long-term value creation in companies and stability in financial markets." (http://online.wsj.com/article/SB10001424052970203430404577092682864215896.htm)


More Information

  1. P2P Metrics
  2. Sustainable Capitalism