Environmental, social, and governance (ESG) policies and boardroom diversity have historically been concerns for mid- and large-cap institutional investors. But small-caps should consider embracing both, because this type of investor focus is coming to the small-cap ecosystem, and it also happens to be good business.
ESG Is About Scale
ESG factors are essentially a continuum of non-financial performance issues that are weighed alongside traditional financial metrics in the decision-making process of an increasing number of institutional and retail investors globally.
- Some examples of environmental considerations may include: climate change, water usage/impact, renewable energy, emissions, management of hazardous materials, and green building practices.
- Some examples of social considerations may include: human rights, community relations, labor standards, customer privacy, data security, and product liability.
- Some examples of governance considerations may include: risk management, corporate culture, business ethics, materials sourcing, corporate compensation, board composition and political donations.
While the ESG nomenclature might be somewhat new, sophisticated investors have long analyzed non-financial risk elements that they view as complementary to more traditional key performance indicators. Supporters of incorporating ESG aspects into their investment considerations have undertaken research that depicts that companies that are more ESG-focused often outperform their peers with respect to return on invested capital, and have less volatile stocks. Put perhaps a bit differently, there are increasing data to support the conclusion that companies with more fulsome risk apertures – represented by ESG factors – are more likely to scale over time with greater aplomb.
More Diverse Companies…Make More Money
Public companies in the United States are predominantly operated and governed by a comparatively homogenous group – older, white men. And that group statistically errs on the side of hiring people with similar attributes. In 2017, a large executive search firm published data depicting that nearly 70 percent of the 421 board seats filled by Fortune 500 companies in 2016 were sitting or retired CEOs and CFOs – a group that is largely older, white men.
To be sure, the buy-side is predominantly fine with sitting and retired CEOs and CFOs serving on corporate boards, and the continuing consideration of them for future board seats. But savvy investors are increasingly not fine with candidate pools for prospective directors that are substantially limited just to CEOs and CFOs.
According to research conducted by a number of large consulting firms, companies with greater thought diversity outperform less diverse peers. As Larry Fink, CEO of BlackRock, admonished in his 2018 letter to shareholders, “[Diverse boards] are better able to identify opportunities that promote long-term growth.”
Two concluding takeaways for small-cap officers and directors: (1) focus on ESG and boardroom thought diversity is not fleeting; and (2) shareholders can likely benefit from both.
A version of this post was originally published by Nasdaq MarketInsite.
Adam J. Epstein, is a former institutional investor, and now an advisor to CEOs and boards of pre-IPO and small-cap companies through his firm, Third Creek Advisors, LLC. He speaks monthly at private corporate events, and corporate governance and investor conferences, and has appeared internationally more than 100 times since 2012. Mr. Epstein is a key contributor to Nasdaq’s Amplify small-cap content initiative, and a mentor at the Nasdaq Entrepreneurial Center in San Francisco. He writes the “Entrepreneurial Governance” column for Directorship magazine, he’s the author of The Perfect Corporate Board: A Handbook for Mastering the Unique Challenges of Small-Cap Companies (New York: McGraw-Hill, 2012), and he’s a contributing author to The Handbook of Board Governance: A Comprehensive Guide for Public, Private and Not for Profit Board Members (New Jersey: Wiley, 2016). In June 2017, The Perfect Corporate Board was the #1 ranked corporate governance book on Amazon.com, and, in June 2016, The Handbook of Board Governance was the “#1 New Release” in corporate governance on Amazon.com. Connect with Adam on LinkedIn or learn more on his website.