Mergers & Acquisitions: The Importance of ESG Factors
By Riccardo Samiolo
Abstract
A strategic approach to ESG factors must consider sustainability in its broadest sense: sustainability that arises from the relationship between a company and its stakeholders. Sustainable companies are able to generate long-term value not only for shareholders, but for all stakeholders. This gives them a stronger ability to adapt to changes in their target markets and a greater propensity for innovation, within a concept of adaptive resilience that is particularly relevant to investors.
ESG in M&A Transactions
Even before the pandemic, issues such as MeToo, gender equality, climate change, humanistic enterprise and the limits of short-term profit were already part of corporate debate. They were also present in economic and business theory, as shown by the work of economists such as Mariana Mazzucato and Muhammad Yunus, as well as Pietro Onida and Vittorio Coda, whose work brought Italian business theory to an advanced level well ahead of its time.
The pandemic accelerated this shift in Western societies, pushing values and issues that had long been considered secondary to the forefront. It restored time for reflection and discussion, allowing companies and economic actors to reconsider past experiences and corporate failures. In many cases, they have come to understand that previous failures were caused by weak or non-existent ESG frameworks. This is driving a significant and decisive socio-economic cultural shift in many countries.
One example of the lack of attention paid by companies to ESG factors is the phenomenon known as the great resignation, first identified in the United States and now also present in Italy. The term refers to the growing number of people who intend to change jobs because of dissatisfaction, poor well-being and the inability to balance work and private life. Such a high level of dissatisfaction forces companies to reflect on past choices and points towards a new approach: moving from human resources to people.
ESG is a way of introducing the social dimension of business into governance and strategy, as theorised by Vittorio Coda.
Why Are These Factors So Important in M&A Transactions?
When preparing to acquire a company, it is necessary to assess the risks connected to the integration plan of the target company and to evaluate the impact of those risks on future earnings.
Until recently, the risks assessed, in addition to competitive strategic risk, were mainly operational risks, usually covered by standard insurance policies: product liability, third-party and employer liability, or D&O policies covering directors and the company in relation to employees and third parties for failures in compliance or supervision, such as workplace mistreatment, discrimination, improper waste management or safety issues.
ESG risk assessment is the method economic operators have developed to update business valuation tools in response to an increasingly complex social context. It is now necessary to consider factors that were once regarded as marginal, such as online reputation, both in relation to customers and suppliers and within the community in which the company operates. A company is no longer just a workplace: it is a community within a broader community.
This requires a more holistic view of the company.
Today, a company can lose 20% of its employees because of a social media backlash, or 30% of sales in six months because of a poorly managed restructuring process. This increased exposure has made ESG a central issue, also because mainstream financial analysts have become aware of the limitations of traditional risk analysis and of the real impact of social dynamics.
Remedies When the Target Company Is Weak from an ESG Perspective
A company’s ESG orientation originates in the cultural and value system of the social group to which the company belongs. Changing that orientation takes time and often requires changes within the C-level team.
No Mahatma Gandhi can simply step in to inspire those who are focused exclusively on short-term profit. Companies need people who understand that financial metrics are tools for ensuring business survival, not value systems in themselves. Senior leaders must embody the founding values of the corporate community.
Becoming ESG-compliant therefore requires emotional engagement and a renewal of the founding narrative of the company’s reference group. A company is made up of people, knowledge and mutual expectations. If those people do not form a cohesive social group with a value system that covers every aspect of work within the company, for the company and towards the market, the company itself cannot grow and may not survive.
Jack Welch famously said: “On the face of it, shareholder value is the dumbest idea in the world. Shareholder value is a result, not a strategy. Your main constituencies are your employees, your customers and your products.” This was his way of addressing what we would now call ESG issues.
Being ESG-compliant is not a political or social ideology. Jack Welch was not a progressive, yet he turned General Electric around through a simple, engaging and reassuring value system: loyalty to the team, loyalty to the company, and doing one’s job properly.
Welch shifted the focus away from share value and concentrated on employee well-being, removing barriers between managers and employees, and ensuring the marketability of the product. This approach now underpins the path taken by many companies and is an integral part of any M&A transaction.
ESG is not a matter of “democracy”, but of the values that guide economic and competitive behaviour and of how those values are experienced by the social group that gives life to the company.
How Does ESG Affect the Value of a Company?
Strategic, operational and management risks affect projected EBITDA by altering prospective costs and expected revenues across the different scenarios used in sensitivity analyses to test business plan models. One example is the need for higher marketing expenditure when ESG reputation is weak. Another effect occurs when greater strategic, operational and management risks penalise company valuation by reducing the EBITDA multiple used in the valuation, or by increasing the discount rate in valuations based on expected cash flows.
A business model that is not consistent with ESG principles, or that fails to take these factors into account, leads to strategic errors.
Not being ESG-compliant may prevent a company from attracting the talent needed to support long-term development and, above all, the post-transaction plan following an M&A deal. Weak ESG means weak consensus.
Social cohesion is built on social fairness. Cohesive organisations reduce employee turnover, encourage people to fight for their community, overperform, respond strongly to external threats and attract talent.
A strong ESG profile generates value propositions, business models and corporate structures that identify opportunities, do not overlook risks and work on weaknesses. The great resignation is one example; another is the need to understand shifts in market sentiment and to move from thinking about human resources to thinking about people.
The command-and-control management style is no longer compatible with the speed of change and response now required. Organisational adaptation is increasingly entrusted to teams operating at the boundaries of the business. Even military organisations have understood the need to grant field commanders degrees of freedom in order to ensure responsiveness, address weaknesses and seize opportunities.
Failure to manage environmental, territorial, social and governance risks can be extremely costly. For example, a male-dominated workplace that pays little attention to maternity, offers limited career opportunities to women and is inhospitable to female employees reduces diversity and may create continuous conflict between departments and groups. This leads to rigid management and a limited understanding of the environment in which the company operates.
Operational risks arising from non-ESG-compliant approaches are easier to explain. One clear example is a supply chain that is not aligned with shared ESG values and introduces structural weaknesses into the company without management noticing. If a supplier’s assets are seized because it exploits labour, pollutes, or simply loses staff and cannot replace them because the work environment is poor, the company downstream suffers the consequences and may become complicit in the supplier’s ESG failure.
In conclusion, talent, diversity and social cohesion generate early detection of problems and opportunities, and create more resilient and innovative environments. A company can benefit from these factors only if it includes them in its strategic design and cultivates them at every level, every day.
This is what it means to create a sustainable ESG environment.
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