Improving ESG can boost investment returns. The reason is simple: better ESG means healthier firms. Healthier firms trade at higher prices. Hence, improving ESG can boost firm valuation – and investment returns. 

Which ESG aspects should investors prioritise in their engagement? There are many ESG variables. Improving them all at once would be unworkable. We suggest investors prioritise ESG improvements which raise shareholder value most. Few management teams and shareholders would object to creating financial value, making engagement success more likely. 

How much an ESG improvement raises shareholder value depends on two factors: (1) how much financial markets value this ESG aspect; and (2) how much room for improvement there is at company level. We estimate a model assessing how ESG variables drive firm valuations. We then use the model to assess how much shareholder value a firm could generate by improving each variable. 

We focus on eight key ESG variables that meet three criteria: (1) high corporate materiality, (2) high market relevance, and (3) with high data coverage. The variables cover the most relevant E, S and G themes: carbon emissions, waste generation and water usage for “E”; board gender diversity and women promotion for “S”; and board size, tenure, and overboarding for “G”. 

Investors can use our model to prioritise their ESG engagement. Improving all eight variables in line with peers’ top decile practice would increase share prices by 35% on average. Yet, over half this gain (21.5%) stems from improving the two most relevant ESG issues. Therefore, investors can create significant shareholder value by focusing on one or two issues for each firm. Our approach helps identify which ones.

Key Takeaways

  1. Improving material E, S or G practices can boost shareholder value. The intuition is simple: stronger ESG means more resilient corporates, which financial markets price accordingly.
  2. Which ESG aspects should investors prioritise in their engagement? There are many ESG variables. Improving them all at once would be unworkable. We suggest investors prioritise ESG improvements which raise shareholder value most. We design a tool that identifies which E, S or G improvement(s) could raise shareholder value most for each firm.
  3. Firms adopting peers’ best practices on the two most relevant ESG issues can unlock 21.5% shareholder value on average. Therefore, investors can create significant shareholder value by focusing on one or two issues for each firm.