WORKING DRAFTLast Modified 4/14/2009 10:39:00 PM Pacific Standard TimePrinted 3/25/2009 4:10:23 AM India Standard Time

Valuing Corporate Social Responsibility and Sustainability

March 2009

CONFIDENTIAL AND PROPRIETARYAny use of this material without specific permission of McKinsey & Company is strictly prohibited

BCCCC Presentation

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Objectives of the research

▪ Focus on financial link between ESG activities and financial value creation

▪ Develop understanding of what it takes to:– Create value through ESG

activities– Develop more sophisticated

metrics to capture the financial value

– Build better tools and methods to communicate that value to internal and external stakeholders

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Key findings

▪ ESG activities create value along the four areas traditionally valued by the market:

– Growth

– Return on Capital

– Risk Management

– Management Quality

▪ Investors and CFOs believe ESG activities create value, but are not fully taking it into account

▪ Many companies create real value from ESG activities, but most do not measure that value, and even fewer communicate the value

▪ There is a real opportunity for ESG professionals to fill this gap

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Research methodology

▪ Examination of ESG programs today, the challenge of measuring value, and methods for assessing and communicating value

▪ Examined existing metric systems

▪ 238 CFOs and investment professionals

▪ 127 ESG professionals and socially responsible institutional investors through BC CCC

▪ Range of industries and regions

▪ 135 interviews across 20 companies

▪ 11 industries▪ U.S. and Europe▪ Range of functions: ESG

professionals, human resources, environment, strategy, finance, and investor relations

▪ Tie ESG to value along 4 dimensions typically used by market: growth, return on capital, risk management, management quality

▪ Develop 10 best practices for designing strategic ESG programs

Initiative white paper, with analysis of ESG measurement issues and recommendations

CFO, Investor, ESG Professional McKinsey Quarterly survey

Company interviews and case studiesFramework for linking ESG activities to Value Creation

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License to operate ▪ Facilitate uninterrupted operations and entry in new markets using local ESG efforts and community dialogue to engage citizens and reduce local resistance

Supply chain/security of supply

▪ Secure consistent, long term, and sustainable access to safe, high quality raw materials and products by engaging in community welfare and development

▪ Mitigate risks by complying with regulatory requirements, industry standards, and NGO demandsRegulatory risk

Reputational risk ▪ Avoid negative publicity and boycotts by addressing ESG issues

Workforce efficiency ▪ Reduce costs generated by employee attraction and turnover by using ESG to build morale ▪ Develop employees’ skills and increase productivity through participation in ESG activities

▪ Enable bottom line cost savings through environmental operations and practices (e.g., energy and water efficiency, less raw materials needed, etc.)

Operational efficiency

Reputation/Price premium ▪ Develop reputation on ESG that garners customers’ willingness to pay price increase or premium

▪ Gain access to new markets and market share through exposure from ESG programsNew markets

Reputation/differentiation ▪ Foster brand loyalty, reputation and goodwill with stakeholders by engaging with them on ESG programs

Innovation ▪ Develop cutting edge technology and innovative products and services for unmet social or environmental needs that could translate to business uses, patents, proprietary knowledge, etc.

New customers/market share ▪ Use ESG to engage consumers and build knowledge of expectations and behaviors

New products ▪ Create products to meet unmet social needs and increase differentiation

ILLUSTRATIVE

SOURCE: Team analysis

Leadership development ▪ Develop leadership skills and improve employee quality through ESG participation

Adaptability ▪ Build ability to adapt to changing political and social situations by engaging local communities

Long term strategic view ▪ Develop long term strategy encompassing ESG issues

Manage-ment quality

Risk manage-ment

Return on capital

Growth

CSR creates value along 4 business dimensions

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What are your “pain points” as an ESG practitioner?

Meeting the demands of existing metric systems

Getting adequate resources, traction and integration internally

Establishing and monitoring metrics to assess impact of program

Getting recognition from the market for effective ESG

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We examined a sample of ESG metrics, measurement, and rating systems1

Categories of ESG metrics, measurement and ratings systems Examples

Our sample

Indices developed by financial index companies

ESG Initiatives and learning networks

Reputation indices produced by media/ polling/PR firms

Rankings and data produced by SRI information providers

ESG-related standards

1 Analysis of ESG metrics systems based only on information publicly available on relevant websites

SOURCE: McKinsey Analysis

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1.7

0.7

1.9

1.1

0.7

1.5Captures opportunities

Distinguishes financially material issues

Avoids the problem of ‘noise’

Covers the full range of ESG issues

Financially quantifiable data

Sensitive to different types of companies

SOURCE: Team analysis

A major “pain point” is the existing metrics and indices that evaluate a company’s ESG programs, but do not take financial value into account

Average score of the range of metrics systems assessed against 6 criteriaPoints (score 0-3 points on each issue)

1

2

3

4

5

6

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How much do you think that ESG activities add to shareholder value?

Add between 2 and 5%

Add more than 5%

Don’t know

Add less than 2%

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1 Environmental, social, and governance2 Excluding any changes stemming from the current economic crisis

SOURCE: S. Bonini, N. Brun, and M. Rosenthal, “Valuing corporate social responsibility,” The McKinsey Quarterly, February 2009

Percentage of respondents

Effect of ESG programs on organization’s shareholder value in typical times2

Value add

Investors and CFOs also believe ESG¹ drives value

22

6

21

18

19

10

4

27

7

10

13

27

5

11

53

0

9

10

15

7

6>11

6-10

2-5

<2

No effect

Don’t know

Reduced value

▪ A large majority of ESG professionals think that ESG programs create value in the short and the long term

▪ CFOs and investors professionals are more likely than ESG professionals to see the long term benefit of these activities

Complementary findings from the survey

CFOs, n = 84

Investment professionals, n = 154

ESG professionals, n = 87

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Although many companies create value from ESG, very few assess the financial value creation and even fewer communicate that to the markets

Creating value Assessing valueCommunicating

value

Percent of companies interviewed = 100%

-40%-40%

-5%-5%

-40%-40%

-10%-10%

ESG program

Maximizing value from ESG

Established metrics to monitor program

Converting ESG metrics to financial value

Communicate ESG value to CFOs, investors

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|SOURCE: Team analysis

Pathway to value from ESG along four dimensions

Leadership development ▪ Develop leadership skills and improve employee quality through ESG participation

Adaptability ▪ Build ability to adapt to changing political and social situations by engaging local communities

Long-term strategic view ▪ Develop long-term strategy encompassing ESG issues

License to operate ▪ Facilitate uninterrupted operations and entry in new markets using local ESG efforts and community dialogue to engage citizens and reduce local resistance

Supply chain/security of supply▪ Secure consistent, long-term, and sustainable access to safe, high quality raw materials and

products by engaging in community welfare and development

▪ Mitigate risks by complying with regulatory requirements, industry standards, and NGO demandsRegulatory risk

Reputational risk ▪ Avoid negative publicity and boycotts by addressing ESG issues

Workforce efficiency ▪ Reduce costs generated by employee attraction and turnover by using ESG to build morale ▪ Develop employees’ skills and increase productivity through participation in ESG activities

▪ Enable bottom line cost savings through environmental operations and practices (e.g., energy and water efficiency, less raw materials needed)

Operational efficiency

Reputation/price premium ▪ Develop reputation on ESG that garners customers’ willingness to pay price increase or premium

▪ Gain access to new markets and market share through exposure from ESG programsNew markets

Reputation/differentiation ▪ Foster brand loyalty, reputation and goodwill with stakeholders by engaging with them on ESG programs

Innovation ▪ Develop cutting edge technology and innovative products and services for unmet social or environmental needs that could translate to business uses, patents, proprietary knowledge, etc.

New customers/market share ▪ Use ESG to engage consumers and build knowledge of expectations and behaviors

New products ▪ Create products to meet unmet social needs and increase differentiation

Management quality

Risk management

Return on capital

Growth

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|SOURCE: Team analysis

4 dimensions Sub-dimensions Examples

▪ Invested $1 billion over 10 years to reduce its energy consumption and improve its efficiency and has saved $7 billion in last 5 years

Operational efficiencyReturn

on capital

▪ Engaged with local stakeholders and built trust with local communities by being responsive to community needs. Has allowed Intel to be proactive about managing concerns, avoiding zoning delays and fines, and benefiting from tax incentives

Reputational riskRisk

manage-ment

▪ Developed “Corporate Service Corps” to send emerging leaders to work pro bono in emerging markets to foster economic growth. Has led to improvements in five areas: global leadership skills, cultural intelligence and global awareness, employee retention and commitment to IBM, new knowledge and skill contribution to IBM, and intrapersonal growth

Leadership development Manage-

ment quality

▪ Novo Nordisk: Engaged in emerging economies like India, China, and Bangladesh to help build clinics, national diabetes programs, systematic education for doctors, nurses and patients, and comprehensive patient support initiatives. As a result, in China, Novo Nordisk has earned market leadership (e.g., market share above 70%)

▪ Verizon: Launched a new product for elderly and disabled to meet social needs of population. Has resulted in increased sales and 100,000 new customers

New customers/ market share

Growth

Illustration of how companies can create value from ESG ILLUSTRATIVE

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Indirect impact

Direct financial impact

ESG programs can have direct and indirect financial impacts, depending on the business drivers they target

ILLUSTRATIVE

Trust & reputation

New geographical markets

Innovation

Human efficiency

Operational efficiency

Business driver

ESG program

Strengthen reputation, goodwill and loyalty with stakeholders

Facilitate markets entry

Expand the number of patents

Develop cutting edge technology/products

Enable bottom line costs saving

Improve talent attraction, morale and retention

Improve skills (e.g. leadership,…)

Effect on business driver

Favourability ratings evolution, # meetings with stakeholders

# and value of new markets entered through program

# and market value of new patents developed

# and value of new products developed and sold

Water, energy and raw materials uses reduction

Employee retention, Cost of training new employees

# employees with new skills from experience

Examples of metrics

Increase revenue through increased sales

Increase revenue from patents

Increase revenue through increased sales

Decrease cost of hiring and training new employees

Increase revenue per person

Increase revenue indirectly through goodwill

Decrease cost

Financial impact

SOURCE: McKinsey analysis

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Improved communication about the value of ESG activities is needed

21

31

32

36

33

44

62

32

23

41

24

24

38

55

36

23

42

19

28

56

54

Offering integrated corporate reporting

(corporate financial + ESG programs data)Integrating information on ESG programs’

financial value into corporate reportsReporting data related to new markets or customers reach through ESG programs

Reporting data related to employees

Providing anecdotal evidence of

how these programs create valueUsing regular business terminology

to communicate about such programs

Reporting data related to innovation

Percentage of respondents2, multiple choice answers

SOURCE: S. Bonini, N. Brun, M. Rosenthal, “Valuing corporate social responsibility”, McKinsey Quarterly, February 2009

Ways to improve the effectiveness of communication about the performance of ESG programs3

1 Environmental, social, and governance2 Respondents who answered “other”, “none of the above” or “don’t know” are not shown3 Excluding any changes stemming from current economic crisis

ESG1 professionals, n = 87

CFOs, n = 84

Investment professionals, n = 154

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▪ Growth▪ Return on

capital ▪ Risk

management▪ Management

quality

Pathway to value created by ESG programs

Industry issues

Stakeholder needs

Business drivers

Metrics CommunicationCreation of ESG Program

Meet stakeholder expectations and ensure their support in managing ESG opportunities while creating value for the company

Turn socio-political issues into ESG opportunities by meeting stakeholder needs and creating financial value along the business drivers

Impact business drivers and create financial value while meeting stakeholder and societal needs and turning them into ESG opportunities

Develop few relevant metrics to capture the financial value of the program

Set clear message depending on the targeted audience and provide informa-tion that the audience is looking for

Design ESG program resulting from industry issues, stake-holders needs and business drivers

Pathway to value

SOURCE: McKinsey analysis

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Questions for discussion

▪ What are the biggest obstacles to integrating better metrics into ESG work?

▪ What are the direct benefits to the company of better metrics?

▪ How might using better metrics change what companies do on the ground in terms of project level impact of ESG?

▪ How can ESG professionals begin to apply a more financial mindset/language to the design, measurement, and communication of ESG programs?

▪ How can ESG practitioners facilitate conversations about the value of ESG activities within their own companies?

▪ How can ESG practitioners begin to create quantitative, financial metrics for ESG activities to allow for seamless communication between ESG professionals, CFOs and investors?

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Appendix

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BusinessFormal contract

Semi-formal contract

Frontierexpecta-tions

Society

Business operates within an overall social contract

Global trends

▪ Consumers and employees

▪ Globalization

ESG issues▪ Environ-

mental

▪ Social

▪ Governance

Growth and opportunity

License to operate

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Participants of the research

20 companies from across industries and geographies

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|SOURCE: Team analysis

We see 10 best practices for creating value from ESG

Utilize core competencies

Take a long-term perspective

Create opportunities and manage risks

Strategy

Organization

Implementation

Fundamentals

Ensure strong leadership support

Embed into the strategy, organization, and culture

Select appropriate partners

Set clear goals and manage like a business

Align with core business strategy

Identify and engage stakeholders

Address key issues facing the industry

Best practices

4

5

6

7

8

3

2

1

9

10

Examples