Embracing environment, social, and governance (ESG) has become a priority for corporations in recent years. Yet, not everyone in the business world is convinced. Warren Buffett, for instance, believes profitability should come first and at the latest World Economic Forum gathering in Davos, some frustrated executives commented off the record that the topic is too broad and distracting. Recent evidence from Brazil, however, suggests that ESG practices may be crucial for publicly-traded companies—especially during extreme events such as the COVID-19 pandemic. This may change the hearts and minds of ESG skeptics.
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ESG-compliant firms, particularly those with more robust governance, have historically outperformed the Brazilian market, as shown in the chart above. In 2005, the Brazil Stock Exchange (B3) created a Corporate Sustainability Index (ISE)—the fourth of its kind in the world—and, a year later, a Corporate Governance Index (IGC-NM) for companies that voluntarily adopt additional practices beyond those required by Brazilian legislation. Using ISE as an alternative for ESG and IGC-NM for governance, we find that companies with adherence to ESG standards saw a total return of 315 percent compared to 273 percent for Ibovespa, B3’s benchmark index and the Brazilian equivalent of the Dow Jones, between 2007 and 2020. Over the same period, the total return for the IGC-NM was even higher and gains accelerated after 2015, further emphasizing the importance of good governance. Besides better returns, both the ISE and IGC-NM displayed slightly less volatility than Ibovespa.
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In addition, at the onset of the pandemic, superior performance correlated with adopting ESG practices broadly rather than solely governance practices. That is, firms embracing good governance without improving their environmental and social standards did not experience higher abnormal returns when the pandemic hit. Considering that two-thirds of the most negotiated listed Brazilian companies already pursue better governance practices, addressing environmental and social factors might be the secret to better performance, especially during crises.
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