Don Reed CFA

ECOS Corporation 8.9.1 Introduction

The mainstream investment community has made little explicit reference to sustainability issues. Despite this fact, the topic is not really new. There are plenty of examples of investors thinking about the business implications of environmental and social issues in the chemical industry.

Each year Dow Chemical brings the financial analysts who follow the company to Midland for a conference. In the past, this event has featured sessions on how Dow was better than other companies in the industry in every area including the environment. While it is not necessarily clear that analysts cared that this was the case, at least they heard the message.

To understand the view of institutional investors towards sustainability in the chemicals sector and capture a bit of the flavor, this section looks at how environmental and social issues are becoming increasingly seen as business issues by both companies and investors. Then, I address how chemical companies have value at stake on sustainability as well as some generalizations about how sustain-ability leaders in the industry have addressed the value of their efforts in this area. I then explore how mainstream investors are approaching these issues in the industry, beginning with the context, then going on to what tools they have to integrate an understanding of these issues into their work. Finally, I look at the emerging sustainability issues in the industry, how investors might be approaching these issues in years to come, and what opportunities for growth in the industry are based on sus-tainability as an insight.

8.9.2 Environmental and Social Issues as Business Issues

While the proposition that environmental and social issues are business issues still strikes some as a novel perspective, increasing numbers of business leaders and investors understand that this is the case. Social and environmental issues can be seen as market forces. The following framework, shown in Figure 8.28, helps explain this in the same terms an analyst would use to understand any market force and how it affects the prospects of a business.

Like other market forces, the business impact of social and environmental market forces is either increased or decreased by other trends in society and business. Over the past few decades, a familiar set of trends (e.g., globalization, connectedness, rise of civil society, and so on) have come together in such a way as to significantly magnify the business impact of social and environmental market forces. Essentially,

Environmental S Societal Market Forces

- climate change

- resource degradation

-poverty & hopelessness -inequity -mega cities -war & dislocation

Magnifying Trends

- increasing power of civil society

- changing role of gov't - rise of market forces & corps

- globalization

- connectedness

Changed Operating Environment

- more complexity & risk

- more opportunities

- increasing expectations, scrutiny & pressure

- good products are no longer enough

Corporate Responses

- value creation is the goal _ - plan, measure & report value from sustainability

- sustainability integrated as 1—/- create societal & shareholder value together business issue - appeal to mainstream investors cc®s

Copyright Ecos Corporation © 2004

Figure 8.28. Value at stake on societal forces.

- climate change

- resource degradation

- more complexity & risk

- more opportunities there are more people with greater expectations and much more information about corporate actions affecting society and the environment, with much greater ability to organize globally to act on those issues in their roles as voters, citizens, employees, investors, and consumers.

These magnified market forces have changed and continue to change the operating environment for companies. Most good business leaders understand this, whether or not they can put their finger on the causes. They know that many aspects of their business are subject to tipping points in public attitudes and that there is no option to mask poor performance against societal expectations with good public relations. All this makes business more complex. As these market forces have changed the operating environment for companies, one can fairly say that businesses have value at stake on social and environmental issues.

Good business strategy requires responses to changes in the operating environment. That is clearly the case here. While the corporate strategic responses vary by industry and company, our experience is that the successful ones have some common attributes. Rather than focusing on improving social and environmental performance, they focus on creating shareholder value and societal value together. Value creation remains the driving goal. They serve to integrate sustainability issues into business processes rather than concentrate responsibility for them in separate functional groups.

Because these strategic responses focus on delivering shareholder value, they have the potential to appeal to mainstream investors. From the investors' standpoint, the impact of this framework is potentially profound. Most mainstream investors have historically thought of social and environmental issues as being nonfinancial, and therefore outside their scope of responsibility. In fact, their fiduciary duty actually required them to ignore these issues. However, if social and environmental issues can have a material impact on financial performance and business strategy, then investors have a fiduciary duty to examine those issues, understand how the company has value at stake and how their strategy will affect value. In one giant change, the consideration of sustainability issues goes from being prohibited to required.

There are clear signs that exactly this process is happening. For example, Hermes is a large asset manager in the United Kingdom that started out managing the pension fund assets of BT (then British Telecom). Today, Hermes has £44 billion under management. Hermes has recently required the leaders of firms held in portfolio to explain how their companies have "value at stake" on SEE (social, environmental and ethical issues) (Monks, 2001).

This concept of having "value at stake" on social and environmental issues is broad and more powerful than the more traditional view that the main financial import of environmental issues is as potential liabilities. There have been significant efforts made to improve corporate disclosure of material environmental liabilities,25 and the increased emphasis on the identification and disclosure of risks under the Sarbanes-Oxley Act should drive this further. Value at stake includes these potential environmental liabilities as well as the opportunities and competitive advantage that can come from the right environmental strategies.

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