Role of ESG in Mergers and Acquisitions: Opportunities and Risks

Kiran Malik

23 Mar, 2023

Mergers and Acquisitions (M&A) are an integral part of the corporate landscape, providing companies with opportunities for growth, expansion, and increased market share. In recent years, Environmental, Social, and Governance (ESG) factors have become increasingly important in the M&A landscape, as companies seek to demonstrate their commitment to sustainability, social responsibility, and good governance. In India, the importance of ESG in Mergers and Acquisitions cannot be overstated, as the country is one of the fastest-growing economies in the world, attracting significant foreign investment and witnessing a surge in M&A activity. In this blog, we will explore the role of Mergers and Acquisitions in India, highlighting the opportunities and risks associated with ESG, as well as the importance of ESG due diligence in the M&A process.

1. Enhanced Reputation and Brand Value: Companies that prioritize ESG considerations are likely to have an enhanced reputation and brand value. By demonstrating a commitment to sustainability, social responsibility, and good governance, companies can attract customers, investors, and employees who value these factors. This can lead to increased customer loyalty, investor interest, and improved employee retention and engagement.
2. Increased Investor Interest: Investors are increasingly looking for companies that prioritize ESG considerations. By prioritizing ESG, companies can attract more investment and potentially improve their access to capital markets. Investors are also more likely to view ESG-conscious companies as more resilient in the face of economic, social, and environmental challenges.
3. Access to Capital Markets: Companies that prioritize ESG considerations may have better access to capital markets. For example, many green bonds and sustainability-linked loans are available only to companies that meet certain ESG criteria. By meeting these criteria, companies can improve their access to capital markets and potentially lower their cost of capital.
4. Improved Employee Retention and Engagement: Companies that prioritize ESG considerations are likely to have more engaged and committed employees. By prioritizing factors such as employee well-being, diversity, and inclusion, companies can create a positive work culture that fosters innovation, creativity, and productivity. This can lead to improved employee retention, reduced turnover costs, and a more skilled and motivated workforce.
5. Long-term Value Creation: Companies that prioritize ESG considerations are likely to create long-term value by building a more sustainable business model. By investing in renewable energy, reducing carbon emissions, and prioritizing social responsibility, companies can capitalize on the growing demand for sustainable products and services. Moreover, by managing risks associated with climate change, social unrest, and governance issues, companies can protect the long-term value of the company and improve its resilience in the face of challenges.

Risks of Ignoring ESG in Mergers and Acquisitions in India

Following are the risks of ignoring ESG in Mergers and Acquisitions in India:

1. Legal and Regulatory Risks: Ignoring the factors of ESG in Mergers and Acquisitions can expose companies to legal and regulatory risks. Companies that do not comply with environmental regulations, for example, may face fines or legal action. Similarly, companies that ignore labor and human rights^[1] issues may face legal challenges or reputational damage. By ignoring ESG factors, companies may also miss out on potential opportunities for government contracts, licenses, and permits that are available only to companies that meet certain ESG standards.
2. Reputational Risks: Ignoring ESG factors can also expose companies to reputational risks. In an increasingly interconnected world, negative news travels fast and can have a significant impact on a company’s reputation. Companies that ignore environmental, social, and governance issues may face public criticism, boycotts, and protests, which can damage their brand and customer loyalty. Moreover, negative publicity can also affect employee morale, recruitment, and retention, as well as investor confidence.
3. Financial Risks: Ignoring ESG factors can also expose companies to financial risks. For example, companies that ignore climate change risks may face stranded assets, declining demand for carbon-intensive products, and increased insurance and litigation costs. Similarly, companies that ignore social and governance risks may face higher employee turnover, lower productivity, and increased regulatory and legal costs. By ignoring ESG factors, companies may also miss out on potential opportunities for cost savings, revenue growth, and access to capital markets.
4. Environmental Risks: Ignoring environmental risks can have a significant impact on a company’s bottom line. For example, companies that ignore climate change risks may face higher costs associated with resource depletion, pollution, and regulatory compliance. Additionally, companies that ignore climate change risks may face negative impacts on their supply chain, as suppliers and customers increasingly prioritize sustainable practices. By ignoring environmental risks, companies may also miss out on potential opportunities for innovation, cost savings, and new revenue streams.
5. Social Risks: Ignoring social risks can also have a significant impact on a company’s bottom line. For example, companies that ignore human rights issues in their supply chain may face negative publicity and reputational damage, as well as legal and regulatory risks. Similarly, companies that ignore diversity and inclusion issues may face higher employee turnover, lower productivity, and decreased innovation. By ignoring social risks, companies may also miss out on potential opportunities for talent retention and recruitment, as well as access to new markets and customers.

Conclusion

Environmental, Social, and Governance (ESG) factors are increasingly important in the Mergers and Acquisitions (M&A) landscape in India. Ignoring risks of ESG in Mergers and Acquisitions can lead to significant legal and regulatory, reputational, financial, environmental, and social risks. On the other hand, embracing ESG opportunities can lead to enhanced reputation and brand value, increased investor interest, access to capital markets, improved employee retention and engagement, and long-term value creation.

Given the importance of ESG in Mergers and Acquisitions in India, there is a need for a comprehensive ESG due diligence framework that can help companies identify, assess and mitigate ESG risks and opportunities. Such a framework should include an assessment of the company’s ESG policies and practices, compliance with relevant laws and regulations, and identification of potential ESG risks and opportunities.

Stakeholders, including investors, regulators, civil society, and companies themselves, have a crucial role to play in promoting ESG in Mergers and Acquisitions in India. Investors can integrate ESG factors into their investment decisions and engage with companies to improve their ESG performance. Regulators can introduce policies and regulations that incentivize companies to adopt ESG practices. Civil society can raise awareness about the importance of ESG and hold companies accountable for their ESG performance. Companies can take a proactive approach to ESG and integrate ESG considerations into their M&A strategies.

Also Read:
ESG and Due Diligence – An Overview
ESG and Sustainable Development: How are they Related?
Future of Environmental, Social, and Governance (ESG): Emerging Trends and Opportunities for Investors