There are significant direct costs associated with non-compliance with ESG-related factors, including fines and legal ramifications for violating, among other, environmental standards, data privacy regulations, safety standards, anti-corruption legislation, and workers’ rights. Fines can be severe, even if the violation wasn’t company policy and, rather, resulted from a “bad apple”. At the same time, there are also serious indirect costs, which are often associated with reputational damage but can also manifest in reduced performance as a result of, for example, poor governance practices that lead to mismanagement, or a negative office culture that reduces productivity. While these are harder to measure, they can sometimes be more impactful than the direct costs.

To illustrate these points, a University of Virginia study investigating over 80,000 ESG incidents between 2007 and 2017 found that companies with more negative ESG incidents performed 2.5% poorer per year than the rest of the market. While this may seem like a small figure, it is only an average and incorporates a broad range of ESG-related events. 

In fact, more serious ESG-related issues – even just one scandal – can have a much greater impact. Between 2014 to 2019, for example, data from the Bank of America indicates that 24 “controversies” involving, among others, accounting malpractice, data breaches, and sexual harassment cases reduced the value of large US companies by 500 billion USD during those years. In other words, ESG reputational concerns cannot only damage a company’s reputation for years to come, but can also severely impact their bottom line.

Can you describe the reputational risk linked to poor adherence to ESG standards/policies?

In today’s atmosphere, performance is only one factor in how a company is judged, with the values they represent growing in importance. To this end, the combination of increasing public interest in social causes and expanding distrust of corporations means that companies and their executives are under greater scrutiny and pressure to demonstrate positive contributions to the world or, at the very least, avoid negative ones. Those perceived, for example, as not doing enough to reduce their carbon footprint, acknowledge injustices in the world, reduce wage disparity, and improve diversity, among others, can be villainized, causing significant damage to their public reputation. Indeed, as a direct result of poor adherence to ESG standards and policies, companies have confronted and could be faced with costly “damage control” campaigns and even calls for boycott and divestment. Even a company with excellent ESG policies is not immune from an ESG scandal: The mere existence of strong ESG policies on paper does not necessarily translate into adherence, highlighting the fact that checking ESG reputation is key.

To clearly demonstrate why conducting reputational due diligence, beyond a regular ESG audit, is necessary, take the following case study. In 2020, a US-based fund reached out to Sqope prior to investing in a fintech company that appeared to have no negative media exposure. Despite presenting themselves on their website as implementing strong diversity and inclusion policies, our initial investigation uncovered online accusations from former employees regarding negative workplace culture and #metoo issues. After digging further into this issue, we discovered additional claims of sexual harassment and a lawsuit against a top executive of that company. As a result of these findings, the fund decided against investing in the fintech and was able to shield themselves from significant negative reputational exposure.