ESG Meets a Recession

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In this post you will learn:

• What is ESG

• Why a recession is a threat

• Why ESG will benefit from a recession (in the long run)

What is ESG

Imagine a recession: The demand for goods slows down, companies produce less, therefore need less workers, people lose their jobs, therefore people demand less goods. With less demand and production, corporate revenues and profits decline and in turn the value of their stocks decline.

It’s a vicious cycle.

During this cycle, corporate executives tend to focus investments on 1) keeping the core business going or 2) mission critical projects. As a result, ESG investments could be on the outside looking in.

I previously wrote an article on ESG and Elon Musk. However, if you need a refresher on ESG, here is what it is. ESG stands for environmental, social, and governance. ESG has been gaining popularity in the investing community over the last twenty years with the core idea that companies that create higher stakeholder value will ultimately create higher shareholder value.

ESG Meets Recession

In January 2020, Blackrock accelerated ESG adoption by putting ESG investing at the core of its investment process. While ESG has been around longer than two years, the announcement from such a large, impactful, investment firm accelerated ESG’s adoption across the business world.

The economy was different then.

Aside from the brief recession in March 2020 due to Covid lockdowns, the economy has been booming since that announcement. Businesses have done well (mostly) and can invest in stakeholder friendly projects. However, stakeholder friendly projects such as investments in green technology (solar panels) often come with high upfront costs and long term pay offs. Now that money is tightening, these projects will get scrutinized even more. Insiders (Corporate leadership) may want to cut projects to boost firm profitability, outsiders may demand more investment and put social pressure on the company.

It will be a delicate line to walk.

Why ESG will benefit from a recession (in the long run)

All of this leads to today, where ESG meets their real test. How serious will corporations take ESG when resources are much more limited. Will they stay true to their promises or was it all for show?

But with scarce resources, comes creativity. Companies will have to figure out how to do more with less. They will also have to think critically and strategically about the expected returns on investments. This could lead to wonderful things for ESG such as proven metrics and methodologies to quantify the financial benefits of ESG investing. Additionally, it could lead to industry standards and consistent taxonomies amongst companies implementing ESG practices.

Companies must start somewhere. They should focus on either E, S, or G initiatives independent of one another, and have a single goal. Ungrouping the three, will put a lot less pressure on internal teams to meet ESG performance indicators.

Here’s an example,

• Consider a company looking to improve their environmental footprint

• Environmental footprints often go hand in hand with supply chains

• To improve supply chain carbon emissions, they could:

  • Update machines or vehicles with green technology (capital improvement)

  • Build new warehouses closer to suppliers and customers (operations improvement)

  • Switch to greener vendors (Scope 3 emissions improvements)

People far closer to their business will certainly figure out a solution relevant to them. The point is that all the above may come at a cost. However, they could be a net benefit and reduction of financial costs and environmental costs. It will take strategic leadership to put the puzzle together.

A win for the environment as well as the bottom line? That’s what ESG is all about.