Mergers & Acquisitions: the importance of ESG factors

By Riccardo Samiolo


A strategic approach to ESG factors must consider a well-rounded sustainability: one that is generated from the relationships between company and stakeholders. Sustainable companies generate value for shareholders and stakeholders over the long term, which allows for a greater adaptability to changes in target markets and a greater propensity to innovate, exemplifying the concept of adaptive resilience so important to investors.    


ESG factors in M&A Transactions   

Even before the Pandemic, the social movements Metoo, gender equality, climate change, humanistic enterprise, profit welfare in the short term etc., already existed in societies. They were also present in economic and business theories: just think of the work of economists Marianna Mazzucato and Muhammad Yunus, or Pietro Onida and Vittorio Coda, whose work brought the Italian business theory to a cutting-edge level for a long time.  

The pandemic has only accelerated and highlighted these changes in Western societies, giving more importance to values and issues that were considered secondary up until now. The time for thinking and exchanging ideas has become important once again. As a society we can look back at the progress made as well as at our failures. Economic players have often come to the realization that past failures have been caused by a deficient or nonexistent ESG framework. This is driving many countries towards an important and decisive socio-economic cultural change.  

An example of the disregard given by companies to ESG factors is the phenomenon of great resignation, term coined in the U.S., and now also present in Italy. Great resignation is defined as the phenomenon whereby a very high number of people (estimated to be around 40 percent of workers in the territory of the Italian state) are intent to change jobs due to dissatisfaction, lack of well-being, and inability to balance work and private life. Such a high rate of dissatisfaction should be a reason to reflect on past choices and focus on new issues: there must be a shift from “human resources” to “people”.  

ESG is the way to introduce the social side of business into governance and strategy, as theorized by Vittorio Coda.  

But why are these factors so important in M&A? 

Before the acquisition a business, it is necessary to estimate the risks associated with the integration plan of the acquired company and assess the effects of these risks on both parties of the M&A operation. 

Up until now, some of the risks assessed, other than strategic competitive risks, were only operational, usually covered by the major insurance policies: product liability (product or service liability), RCTO (third-party and employee liability) or D&O (directors' and company liability to employees and outsiders for non-compliance or even oversight: mistreatment in the company, discrimination, mishandling of waste, safety, and so on).  

Given the increasing social complexity present in business activities, business practitioners have realized that performing an ESG risk assessment is the right way to update their business assessment tools. For example, it is necessary to take into consideration aspects that up until now have been almost irrelevant, such as online reputation. This is an important tool to understand both the company's competitive advantage-i.e., among customers and suppliers-and its reputation in the market in which it operates. The company is no longer just a workplace but it’s a community inside a community in which people carry out their lives. It’s necessary to move towards a more holistic view of the company.  

As a matter of fact, today a company can lose 20 percent of employees for a flame on social media or 30 percent of sales in six months for mishandling a restructuring: this is the case of Birra Pedavena over Heineken.  

This increased exposure has led ESG to become a real "trend" because even the most mainstream financial analysts have come to the realization of the errors in risk analysis and the real effects of social dynamics.  

What to do in case the target company of an M&A transaction is weak from an ESG perspective  

The ESG orientation of a company is based on the cultural and value system of the social group of which the company belongs to and of which it is a subset. Changing it takes time and it often requires changing the C level team.  

There is no Mahatma Ghandi coming to the rescue to inspire those who are oriented to pure profit in the short term. It takes people who understand that financial metrics are a tool to ensure the company's survival, but they are not a value system. It takes people from the top levels who possess the founding values of the corporate community to make a real change.  

Therefore, becoming ESG compliant requires an emotional engagement, a revamping of the founding myth of the company's core group. A company is a collective of people, of knowledge, of mutual expectations, and if the group of people is not a cohesive social group with a value system that touches every aspect of working in the company, for the company and for the market, the company itself has no chance of growing or even surviving.  

It is Jack Welch's famous phrase "At first glance, shareholder value is the stupidest idea in the world. Shareholder value is an outcome, not a strategy...your main concerns are your employees, your customers and your products." That was his way of talking about ESG issues. Being ESG compliant is not a social political orientation and in fact Jack Welch was not a progressive, but he did restore General Electric with a simple but engaging and reassuring value system:  

  • Loyalty to the team   
  • Loyalty to the company  
  • Good job performance  

Jack Welch put stock value aside and focused on employee well-being, on eliminating barriers between managers and employees, and on product saleability. This approach underlies the current path taken by most companies and plays an integral part of every M&A transaction.  

ESG is not about "democracy". It’s about the values that guide economic-competitive actions and how they are experienced by the social group driving the Company.  

How is the value of a business relevant to ESG compliance?  

Strategic, operational and managerial risks affect prospective EBITDA by changing the prospective costs and expected revenues in the different scenarios of sensitivity analysis used to test numerical models of business plans. One example is the need for higher marketing expenditures in response to a low ESG reputation. Another example is when higher strategic, operational, and management risks penalize the Companies' value assessment by reducing the multiplier used in the case of EBITDA valuation or increase the discount rate in the case of valuation based on expected cash flows.  

Having an inconsistent ESG approach and a business model that doesn’t take these factors into consideration results in a flawed strategic approach.  

For example, not being ESG compliant inhibits the involvement of talented people that can support a sustained development and especially the projection of the post-M&A plan. Poor ESG means poor consensus.  

Social cohesion derives from social correctness. Being cohesive reduces people turnover, attracts talent, and makes people fight for their community with overperformance and strong responsiveness to external threats.  

To exemplify the strategic risk and its bearing, the fact of having a strong ESG connotation generates Value proposition, business model, company structuring that considers all opportunities, doesn’t overlook at risks and works from its own weaknesses: take the great resignation or the evolution of the market sentiment as examples to to shift from “human resources” to “people”.  

The "command and control" style of leadership, where the adaptation capacity relies on the endpoints, is no longer effective. Today’s environment demands a high adaptability and quick reaction to changes. Even armies have realized the need for certain degrees of freedom to field commanders to ensure responsiveness, fill weaknesses, and seize opportunities.  

Failure to manage risks in terms of environment, territory and social governance is a management risk that pays a very high price.  For example, a male-dominated work environment pays little attention to motherhood, provides low career opportunities for women, makes the company environment hostile for the female component - often relegated to certain departments-, reduces the cultural and noncultural diversity of the company, and could potentially cause continuous conflicts between departments of different genders. The result is an apodictic management with a narrow vision of the company environment.  

Explaining the operational risks of a non-ESG compliant approach is much easier. One of them is relying on a supply chain that is not ESG-complaint because that creates structural weaknesses in the company: if a supplier must cease operations because of labor exploitation, environment pollution or massive resignation caused by a negative work environment, the companies in the midstream and downstream will have difficulties for being labeled a partner of a non-ESG compliant supplier.  

In conclusion, talent, diversity, and social cohesion are the factors that allow for an early detection of problems and opportunities, which results in more resilient and innovative environments. Any company can have them if they include them in their strategic design and cultivate them at every level and every day.  

This is called creating a sustainable ESG environment.  

Contact Information

Riccardo Samiolo

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