If you do it, will they know?

The title is borrowed, loosely (humour me ;) on the Field of Dreams movie’s famous line “if you build it, he will come”.

It refers to the widely held but misguided belief companies have, that if they do it – if they manage their business well, address the risks and seize opportunities, pay careful attention to all the issues that matter to their long-term success – investors will just know. Not only will they know, but they will take that information into account in making their investment decisions about the company. Decisions like whether or not to buy / hold / sell the stock, or how much the stock is worth.

This is true of all information that speaks to a company’s prospects and risks, including information about material environmental, social, and governance (ESG) issues.

Another way to ask the question might be what generates alpha, ‘doing’ or ‘saying’?

The short answer is both.

Value creation is a two-step process.

• The first is what companies do, which is managing their material issues well in order to minimize negative (risks) / maximize positive (prospects) operational and financial performance.
• The second is what investors do, which is take this into account in establishing their forecast models and valuation metrics such as discount rates and earnings multiples.

However, the second step doesn’t just happen. For capital market mechanisms to function and for market value to be created, companies must proactively provide investors with information about how they manage their material issues.

Why? Simply because investors have capacity constraints in siphoning through and analyzing the thousands of investment ideas and millions of data pieces presented to them on a daily basis.

They’re looking for reasons to dismiss companies as potential investments. Can’t see a competitive differentiator? Never mind. Unable to ascertain management quality? Forget it. No clearly defined path to growth? No go.

Similarly, if they are doing some fundamental analysis on your company, but they don’t know that you have a higher employee engagement level and retention rate than your industry, or that the electricity to power your energy-intensive manufacturing process is 100% renewable, they are not likely to reflect that in higher profit margin and lower cost of capital assumptions.

So back to the title question - No, if you do it, they will not know. Unless you tell them.

It is said that high-quality information is the lifeblood of capital markets. Lack of information causes market inefficiencies. For companies, that means less availability and more costly capital (read lower market valuation). Companies are far from powerless in making capital markets as efficient as possible. Their power resides in providing the best reporting possible. Today, that includes ESG reporting.