ESG rating leaders enjoy higher financial returns, says Kroll

20 December 2023 4 min. read
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Organizations with better environmental, social, and corporate governance (ESG) ratings grow faster then their peers, according to a report by Kroll, which explores the intricate links between financial returns and ESG ratings worldwide.

The report by Kroll, a global management consulting firm, observed a positive correlation between higher ESG ratings and superior performance compared to organizations with lower ratings (laggards).

The ESG ratings data comes from an analysis of over 13,000 organizations in a diverse set of different industries worldwide. Laggards are considered companies that fall behind their peers in terms of ESG performance.

ESG rating leaders enjoy higher financial returns, says Kroll

Outperforming their counterparts, global ESG leaders achieved an annual return of 12.9% over the 8-year period studied, in stark contrast to the 8.6% annual return generated by companies with poorer ESG performance.

“This contrast underscores that organizations with higher ESG ratings demonstrate a significant 50% increase in yearly compound returns relative to their comparative performance,” explained Carla Nunes, Managing Director at Kroll.

Regional breakdown

In North America the picture was close to the global view – companies with higher ESG ratings earned a higher annual average return. In the United States, ESG leaders surpassed laggard businesses by a notable premium of 46%. Meanwhile, in Canada, companies designated as leaders achieved an almost threefold increase in average returns (9.2%) compared to the significantly lower returns of laggards at 3.2%.

Significant progress in ESG initiatives is evident among European businesses as well. In fact, they showed higher average ratings compared to counterparts in other global regions. Particularly noteworthy are France and the United Kingdom, boasting impressive percentages of companies rated as leaders at 37% and 41%, respectively.

ESG rating leaders enjoy higher financial returns, says Kroll

In Western Europe in particular, nearly one-third of companies earned the ESG leaders designation in the Kroll report (based on MSCI data), while only 6% were classified as laggards. In comparison, the percentage of laggards in North America and Asia stood at 17% and 38%.

Asian organizations are notably trailing behind their counterparts in other regions on the ESG journey. ESG Leaders from China, Hong Kong, India, Japan, and South Korea demonstrated an average of 11.6%, outpacing ESG laggards by nearly 6%.

Asia’s landscape however shows a disparate picture. While the overall trend points to higher-rated companies outperforming their lower-rated counterparts, some sectors like energy, consumer staples, health care, and utilities did not follow suit. Notably, information technology stood out with leaders realizing returns more than twice as high as laggards’ average yearly returns (22.5% versus 10.5%).

China and South Korea have a relatively high percentage of companies rated as laggards, at 56% and 69%, respectively. However, it is worth noting that even though these laggard companies underperformed, the general trend of higher-rated companies outshining lower-rated ones still held true in both countries.

Green spending

“Our study shows that companies with better ESG ratings generally outperformed those with lower ratings,” said Nunes.

While the study’s main conclusion is likely to incentivize green spending by CxOs, the authors highlight how it also could spur further investments from private equity and institutional investors in top-performing green companies.

“The idea behind ESG investing is that if significant capital flows into companies that are considered ‘good’ ESG citizens, they should be able to raise capital at a lower cost (when compared to ‘bad’ ESG citizens). From an investor perspective, a lower cost of capital means that investors should expect lower returns from good ESG companies. In practice, however, expected returns do not always equal realized returns,” Nunes stated.

Previous research has highlighted the important of sustainability initiatives needing to go beyond just complying with legislation. Organizations further need to be careful to avoid ‘greenwashing’, or in other words, pushing a superficial sustainability program just for appearances.