Environmental, Social, and Governance (ESG) criteria have taken the investing world by storm in recent years, pervading every aspect of business as corporations have become increasingly beholden to a growing population of socially conscious investors.[1] ESG criteria are as complex as their acronym is simple. With no universally agreed-upon definition, ESG are generally understood to be standards for a company’s operations that measure its environmental impact and sustainability efforts (environmental), labor practices and supply chain ethics (social), and internal integrity regarding leadership, executive pay, audits, and shareholder rights (governance) among a seemingly endless list of other criteria.[2] As these aspects of companies have come more under the microscope in recent years, a new field of targeted ESG investing has expanded rapidly making new financial products available to socially conscious investors and advantageous financing available to companies with outstanding ESG credentials.[3] With so much emphasis on this newly recognized aspect of every business, it was inevitable that ESG concerns would find their way into M&A deal work eventually.
ESG criteria are increasingly being considered alongside the traditional profits and growth statistics in valuing companies.[4] BlackRock, who began 2021 with over $8.7 trillion in assets under management, has mandated that investment teams incorporate an ESG evaluation into their process.[5] Mirroring the investment community’s emphasis on ESG, deal teams are increasingly assigning financial metrics to ESG criteria applying implied prices on “(1) greenhouse gas emissions (2) increased insurance costs from operations in climate-sensitive areas (3) enhanced demand for goods with positive environmental or social characteristics; and (4) the value of enhanced employee retention and productivity.”[6] As climate change and evolving social expectations are affecting companies more and more, multiple studies have concluded that companies with strong ESG credentials are expected to earn more both in the short term and even more so in the long run.[7] With 30% of companies experiencing operational interruptions due to climate change already,[8] and shareholders of major corporations increasingly associating positive ESG ratings with higher returns,[9] ESG credentials are emerging as a key lever of value which target companies can use to their advantage when negotiating deals.[10]
From the perspective of an acquirer, a target company with strong ESG ratings presents an opportunity for the acquirer to strengthen its own ESG credentials.[11] Studies have also shown that deal pursuits with companies with high levels of corporate social responsibility are more likely to take less time (always a critical factor in M&A) and are less likely to fail.[12] Additionally, the explosion in popularity of socially conscious investing has created a wealth of financial products geared toward promoting ESG.[13] This can make favorable financing terms available to companies who seek to acquire targets with high ESG ratings.[14]
However, integrating ESG concerns into the M&A process is not without its difficulties. The SEC has yet to issue any official guidance about ESG metrics and disclosures, which leaves it up to each company to decide what and how they disclose their ESG efforts.[15] This has led to an epidemic of greenwashing allegations in which investors and customers claim that companies have overstated or misrepresented the degree to which the company’s activities are sustainable and environmentally friendly.[16] In the M&A realm, this lack of guidance has left it up to each acquirer’s due diligence teams to decide by what criteria to evaluate a target’s ESG credentials. There is no shortage of standards out there; bodies around the world like the European Task Force on Climate-Related Financial Disclosures (TCFD) have developed a framework to help public companies and other organizations disclose climate-related risks and opportunities,[17] and the European Union is in the process of finalizing its Corporate Sustainability Reporting Directive (CSRD), which will apply to all companies on regulated markets, and require holistic sustainability reporting according to specified standards.[18] Further, companies that have undertaken ESG reporting have often aligned themselves with voluntary frameworks set out by Sustainability Accounting Standards Board (SASB) and the Global Reporting Initiative (GRI) among others.[19] While these standards can be instructive on the kinds of information due diligence teams should look for, without formal guidance from the SEC, M&A will remain the “Wild West” of ESG standards.[20]
[1] See Dr. Jason Caulfield et al., Unlocking transformative M&A value with ESG, Deloitte (2021), https://www2.deloitte.com/global/en/pages/mergers-and-acquisitions/articles/unlocking-transformative-m-and-a-value-with-esg.html.
[2] See The Investopedia Team, Environmental, Social, and Governance (ESG) Criteria, Investopedia (Feb. 23, 2022), https://www.investopedia.com/terms/e/environmental-social-and-governance-esg-criteria.asp.
[3] See James Bee et al., ESG on the Rise in M&A Transactions, JD Supra (Jan. 11, 2022), https://www.jdsupra.com/legalnews/esg-on-the-rise-in-m-a-transactions-7318436/.
[4] See, e.g., Andrea Levine & David Meadows, Get Ready for ESG to Make an Impact on M&A, Bloomberg Law (Oct. 29, 2021, 4:01 AM), https://news.bloomberglaw.com/esg/get-ready-for-esg-to-make-an-impact-on-m-a; Andrea Brownstein et al., The Coming Impact of ESG on M&A, Harv. L. Sch. F. on Corp. Governance (Feb. 20, 2020), https://corpgov.law.harvard.edu/2020/02/20/the-coming-impact-of-esg-on-ma/.
[5] See How Top M&A Professionals Are Embracing ESG in the Deal Process, SS&C Intralinks, at 3 (May 18, 2021), https://www.lw.com/thoughtLeadership/how-top-ma-professionals-embracing-esg-deal-process.
[6] See id. at 6.
[7] See, e.g., Levine, supra note 4; Toby Belsom & Laura Lake, ESG factors and equity returns – a review of recent industry research, Principles for Responsible Invest. (June 17, 2021), https://www.unpri.org/pri-blog/esg-factors-and-equity-returns-a-review-of-recent-industry-research/7867.article (asserting that recent studies support, when variances across industries are taken in to account, that companies with stronger ESG performance also have stronger returns).
[8] See Caulfield et al., supra note 1.
[9] See id.
[10] See, e.g., Caulfield et al., supra note 1; Kati I. Pajak, What to Watch: ESG in Mergers and Acquisitions, 11 Nat’l L. Rev. 1, 2 n.334 (2021), https://www.natlawreview.com/article/what-to-watch-esg-mergers-and-acquisitions.
[11] See Levine, supra note 4.
[12] See How Top M&A Professionals Are Embracing ESG in the Deal Process, supra note 5, at 7.
[13] See Caulfield et al., supra note 1.
[14] See Bee et al., supra note 3 (“In the financing market, access to ESG-linked financial products has grown in recent years, providing an opportunity for acquirers to obtain favourable terms if certain ESG conditions are met. Investor demand for green bonds has resulted in a “greenium” for acquirers with strong ESG credentials, with cheaper pricing and more attractive terms available.”).
[15] See Greenwashing and the SEC: the 2022 ESG Target, 12 Nat’l L. Rev. 1, 2 n.18 (2022), https://www.natlawreview.com/article/greenwashing-and-sec-2022-esg-target (“In March 2021, the SEC formed the Climate and Environmental, Social and Governance Task Force (ESG Task Force) within its Division of Enforcement . . . the SEC’s ESG Task Force was created for the sole purpose of investigating ESG-related violations.”).
[16] See Will Kenton, Greenwashing, Investopedia (Jan. 23, 2021), https://www.investopedia.com/terms/g/greenwashing.asp; Greenwashing and the SEC: the 2022 ESG Target, supra note 15.
[17] See Emphasis on ESG Continues into 2022, Chapman (Feb. 18, 2022), https://www.chapman.com/publication-emphasis-on-esg-continues-into-2022.
[18] See id.
[19] See Bee et al., supra note 3.
[20] See Caulfield et al., supra note 1.
