Sustainability Issues All Over the Map at Large Cap Companies

Not only do large cap companies' environmental and ethic policies differ considerably from sector to sector, they also vary widely within sectors as well finds a new study from the RiskMetrics Group. The Washington DC-based research group spent a year studying over 1,700 companies, drawing from companies found in the S&P 500, the Toronto Stock Exchange 300, and the Morgan Stanley EAFE index (excluding Japan.)

RiskMetrics looked at over 200 different policy and performance indicators concerning climate change, the environment, ethics, human rights, and labor. Corporate performance was viewed "using a governance risk lens" including board oversight, management policy, and public disclosure.

"Our research model depends heavily on corporate disclosure in sustainability reports, websites, and securities filings, although we also examine additional sources of information," said Heidi Welsh, Sustainability Research Unit for RiskMetrics. "Even if a company is doing wonderful things, we and other investment researchers can't discern this by osmosis; we need to have public disclosure of their policies and performance to make assessments."

Companies that have more specific policies and disclose more detailed performance information on their progress (such as reducing water use or emissions) scored better in the RiskMetrics study. Firms that do not disclose information and cannot document their progress fared poorly.

Institutional investors and investment managers can use the RiskMetrics Sustainability Risk Reports to determine which companies have comparative best practice for their industry in sustainability governance oversight, management, disclosure, accounting and strategy in each of the four pillars of RiskMetrics' research model. The four pillars examined are climate change, other environmental issues, labor/human rights and ethics.

Sustainability governance was measured on a 100-point scale in the study. The overall average scores were fairly low, less than 50%of the ideals RiskMetrics defined in each of the four pillars. However, Welsh pointed out that this doesn't necessarily mean that all companies are doing poorly, since so much of the measurements depend on disclosure and companies often do things they don't talk about.

"Our aim is to take a hard look at the level of substance in corporate policies and reported performance, looking beyond what can be overheated rhetoric and nicely produced reports," Welsh said. "There are always examples of extra-financial factors that can emerge to ambush a company, hurting its bottom line and its stockholders. This project is about trying to quantify those risks so they can be taken into account in investment decisions."

Companies found in different areas of the globe had different sustainability strengths and weakness. The companies found in the EAFE index outperformed the S&P companies on the environment and climate change according to the RiskMetrics report. The EAFE index measures companies found in developed countries outside the US while the S&P 500 Index follows the top large cap US companies.

European companies are operating with more regulations that insist on a relatively high standard of environmental performance so these results shouldn't come as any surprise Welsh said.

However, US companies had more ethics policies in place than their non-US peers. "The increased emphasis on better U.S. financial and ethical accounting practices post-Enron may have something to do with the results for S&P500 firms in our ethics pillar," Welsh added.

Companies traded in the Toronto Stock Exchange 300 lead over US and European companies when it comes to labor and human rights.

The study places the utilities sector at the top of other economic sectors for having created policies to deal with climate change. Information Technology firms fared the lowest on climate change policies. The study notes: "Performance on climate-related metrics tracks with non-climate environmental indicators for the most part, with eight out of ten sectors coming out at or better on climate than on other environmental factors. This may be further evidence that climate change is a tipping point issue for corporations that aim to position themselves best for the regulatory and physical risks of a carbon constrained economy."

Interestingly, it is the sectors that have the potential negative impact on the climate and environment that have the highest sustainability governance scores. For example, the automobile industry and the chemical industry receive the highest scores. RiskMetrics chalks this up to the public and governmental concern of these sectors' impact on the environment.

"The variety in scores also probably reflects the degree to which management within each sector believes it is exposed to reputational or regulatory risk within each pillar of our model," Welsh explained. "For example, utilities that face significant regulatory risk regarding climate change have the best sustainability governance performance in our model, which makes intuitive sense given the tangible risks they are facing.

"Companies with big coal-fired power portfolios are not going to fare well in an economy that penalizes big carbon emitters," she said.

Companies in sectors that employ unionized workers, i.e. the materials sector, have more policies regarding labor and human rights. The financial sector, on the other hand, scored very low in human policies.

All the companies across the sectors and countries performed more consistently in the area of ethics.

"What's really interesting is drilling down to a more detailed level to see which industries and companies perform in a manner that is different than the image they project in a public policy context," Welsh concluded. "This can be hard to ferret out, and it's still a work in progress. But those might be the companies with the biggest sustainability risk from an investor's viewpoint."

RiskMetrics gets its ESG staff expertise from the formerly separate companies of ISS and IRRC which have become RiskMetrics. They have a combined team of about 50 people working on environmental and social screening and analysis in its new Financial Research & Analysis Unit. RiskMetrics creates a "risk wheel" that allows investors to look at many different aspects of risk and opportunity in an integrated way.