1. The State of ESG Literature Prof. Robert G. Eccles Professor, Harvard Business School Chairman, Arabesque Partners Corporate Governance Calendar New York State Common Retirement Fund June 23, 2016 New York City

2. Executive Summary 2 In general, sustainability does not hurt financial performance. Done right, sustainability can improve financial performance Performance Research is constrained by the lack of good data and a consensus on definitions. Constraints Nearly all studies show correlation, not causation. The evidence is clearer for companies than for investors. Correlation Future studies will benefit from ESG measurement standards, reporting requirements, and big data. Standards Multiple in-depth and longitudinal field research is needed to prove causation. Causation Context is changing so sustainability may become more important to financial performance Context

3. Structure 3 Professional EvidenceAcademic Evidence Literature on ESG performance Management Studies Finance Studies

4. How Sustainability Can Drive Financial Outperformance 4 (1): G Clark, A Feiner & M Viehs, From the stockholder to the stakeholder, 2015, http://goo.gl/G1dnGyhttp://goo.gl/G1dnGy Overview of current research on ESG Collaboration between Oxford and Arabesque Meta-study of over 200 papers 85% of the world’s 250 largest companies report on sustainability ESG ~ lower cost of capital 90% of studies ESG ~ better operational performance 88% of studies ESG ~ better stock price performance 80% of studies Professiona l Evidence Management Studies Finance Studies

5. ESG and Corporate Performance 5 (1): G Friede, T Busch & A Bassen, ESG and financial performance: Aggregated evidence from more than 2000 empirical studies, Journal of Sustainable Finance & Investment, 5(4), pp. 210 – 233, 2015, http://goo.gl/aa40dLhttp://goo.gl/aa40dL Meta-study of approximately 60 meta-studies Summary of over 2000 empirical studies since 1970s ESG ~ Corporate Financial Performance (CFP) Roughly 90% of studies find non-negative ESG-CFP correlation Professiona l Evidence Management Studies Finance Studies

6. The Sustainable Corporation 6 Recognizes that a license to operate is given by society Balance stakeholders’ interests and genuinely engages with stakeholders Recognizes that trade-offs exist Has a long-term orientation Practices active governance Uses integrated reporting Focuses strategically on ESG issues that are the most “material” (have the greatest impact on the firm’s ability to create shareholder value) Produces major innovations in products, processes and business models addressing those material issues

7. Sustainable (Corporate) Strategy 7 Cutting carbon emissions Reducing waste Enhancing operational efficiency at large Paying workers above-market wages Sustainability Strategies are programs that could include … Addresses the interests of all stakeholders (investors, employees, customers, governments, NGOs, society) Increases shareholder value while improving firm ESG performance Takes into account what is truly material to the company’s strategy Is realistic about tradeoffs between financial and ESG factors But are not a Sustainable Corporate Strategy that …

8. Firms with an explicit emphasis on employees, customers, products, the community, and the environment as part of their business model Adopted policies prior to CSR becoming widespread, less likely to have measurement error by including firms that are either “green-washing” or adopting these policies only for public relations purposes Introduce a long lag between our independent and dependent variables - mitigate the likelihood of biases that could arise from reverse causality Outcome: 90 companies (High Sustainability or Sustainable firms) Match each firm with another firm that has adopted almost no environmental and social policies (Low Sustainability Firms) Reference: The Impact of Corporate Sustainability on Organizational Processes and Performance (Eccles R., Ioannou I., Serafeim G., 2011) Sustainability Pays: Matching 90 High and Low Sustainability Firms Professiona l Evidence Management Studies Finance Studies

9. High Sustainability Firms Stakeholder engagement Long-term horizon Transparency Importance of non-financials Governance mechanisms Characteristics Buy-and-hold stock returns Buy-and-hold financial returns Professiona l Evidence Management Studies Finance Studies

10. 10 Integrated Reporting – Value Creation Framework

11. Standards for Reporting on the Material ESG Issues 11 SASB’s Provisional Standards On April 7, 2016 the Sustainability Accounting Standards Board issued a press release announcing the completion of its provisional standards for all sectors of the economy.Sustainability Accounting Standards Board press release SASB invites stakeholder involvement in its next phase. To get involved: Submit a comment on SASB’s proposed codification process, as outlined in the Rules of Procedure and Conceptual Framework. Proposed updates to SICS, SASB’s industry classification system, are also open for public comment. To submit a comment, visit SASB’s public comment portal.a commentRules of Procedure Conceptual Frameworkupdates to SICSpublic comment portal Provide feedback on the provisional standards. To schedule a consultation with a SASB sector analyst, contact comments@sasb.org. comments@sasb.org Professiona l Evidence Management Studies Finance Studies

12. Insights from SASB’s Provisional Standards 12 Professiona l Evidence Management Studies Finance Studies Climate change Closed-loop economies Resource intensity & scarcity Labor practices & skill development Supply chain management & materials sourcing Product alignment & safety Operational safety SASB has identified themes that are relevant to companies, investors and regulators in the US: 93% USD 28 trillion 84% USD 25 trillion 70% USD 21 trillion 57% USD 17 trillion 43% USD 13 trillion 41% USD 12 trillion 30% USD 9 trillion **** *** * Percentage of companies affected in terms of market cap

13. Source HBS research: http://hbswk.hbs.edu/item/7755.html 13 Citation Khan, Mozaffar and Serafeim, George and Yoon, Aaron, Corporate Sustainability: First Evidence on Materiality (March 9, 2015). The Accounting Review, Forthcoming. Available at SSRN: http://ssrn.com/abstract=2575912 or http://dx.doi.org/10.2139/ssrn.2575912http://ssrn.com/abstract=2575912http://dx.doi.org/10.2139/ssrn.2575912 Corporate Sustainability: First Evidence on Materiality Professiona l Evidence Management Studies Finance Studies Historical KLD data on sustainability performance of ~ 650 companies Classification of the materiality of different sustainability criteria in different sectors Top quintile Bottom quintile Difference in one- year-ahead abnormal stock return performance? Calculate and rank each firm’s change in the sustainability rating of material issues

14. Firms that perform well on material issues enjoy enhanced accounting and market returns over firms that perform poorly on these factors Source HBS research: http://hbswk.hbs.edu/item/7755.html 14 Citation Khan, Mozaffar and Serafeim, George and Yoon, Aaron, Corporate Sustainability: First Evidence on Materiality (March 9, 2015). The Accounting Review, Forthcoming. Available at SSRN: http://ssrn.com/abstract=2575912 or http://dx.doi.org/10.2139/ssrn.2575912http://ssrn.com/abstract=2575912http://dx.doi.org/10.2139/ssrn.2575912 1992199319941995199619971998199920002001200220032004200520062007200820092010201120122013 Importance of Materiality Professiona l Evidence Management Studies Finance Studies

15. 15 1992199319941995199619971998199920002001200220032004200520062007200820092010201120122013 Unimportance of Immateriality Firms that perform well on immaterial issues do not achieve better returns than firms that perform poorly on these factors Source HBS research: http://hbswk.hbs.edu/item/7755.html Citation Khan, Mozaffar and Serafeim, George and Yoon, Aaron, Corporate Sustainability: First Evidence on Materiality (March 9, 2015). The Accounting Review, Forthcoming. Available at SSRN: http://ssrn.com/abstract=2575912 or http://dx.doi.org/10.2139/ssrn.2575912http://ssrn.com/abstract=2575912http://dx.doi.org/10.2139/ssrn.2575912 Professiona l Evidence Management Studies Finance Studies

16. 16 ESG vs. Conventional Funds: Return Comparison R Bauer, K Koedijk and R Otten (2005). International evidence on ethical mutual fund performance and investment style, Journal of Banking and Finance, 29(7), pp. 1751-1767. L Renneboog, J Ter Horst and C Zhang (2008). Socially responsible investments: Institutional aspects, performance, and investor behavior, Journal of Banking and Finance, 32(9), pp. 1723 – 1742. J Derwall, N Guenster, R Bauer and K Koedijk (2004). The eco-efficiency premium puzzle, Financial Analysts Journal, 61(2), pp. 51-63. C Revelli and J-L Viviani (2015). Financial performance socially responsible investing (SRI): What have we learned? A meta-analysis, Business Ethics: A European Review, 24(2), pp. 158-185. No difference in performance Methodological limitations: Heterogeneous approach vs. two-sample comparison Self-labeling Fund manager quality Fee structure Professiona l Evidence Management Studies Finance Studies

17. 17 ESG for All? T Verheyden, R Eccles and A Feiner. (2016). ESG for All? The impact of ESG screening on return, risk and diversification, Journal of Applied Corporate Finance, forthcoming. Professiona l Evidence Management Studies Finance Studies Sustainable investing has traditionally been seen as a niche But can it add value for all investors, irrespective of ESG preferences? Background Results Compare unscreened investment universes with screened alternatives These are the starting points for further analysis by fund managers Methodology Higher returns, lower risk and no loss of diversification in 3 out of 4 cases 10% best-in-class screening works for everyone 25% best-in-class screening may trigger larger swings around the benchmark ESG integration makes sense for all investors

18. Professional Evidence: Some Numbers 18 5,478 companies have published a sustainability report in 2015, up from 436 in 2005. 5 5 80% of studies show that stock price performance is positively correlated with sustainability. 1 1 $21.4 trillion is invested in sustainable products. 4 4 73% of the 50 largest pension funds globally have made a public commitment to sustainable investing. 3 3 79% of CEOs see sustainability as a route to competitive advantage. 2 2 (1): G Clark, A Feiner & M Viehs, From the stockholder to the stakeholder, 2015, http://goo.gl/G1dnGyhttp://goo.gl/G1dnGy (2): UNGC & Accenture, The investor study: Insights from PRI signatories, 2015, https://goo.gl/CLk3IHhttps://goo.gl/CLk3IH (3): Own calculations based on Towers Watson, The world’s 300 largest pension funds – year end 2013, 2014, http://goo.gl/DCsWkx http://goo.gl/DCsWkx (4): Global Sustainable Investment Alliance (GSIA), Global sustainable investment review, 2015, http://goo.gl/mnaSmLhttp://goo.gl/mnaSmL (5): GRI, Sustainability disclosure database, 2016, http://goo.gl/MAhrnkhttp://goo.gl/MAhrnk Professiona l Evidence Management Studies Finance Studies

19. Investing For a Sustainable Future 19 75% of investment firm senior executives agree that sustainability performance is materially important 75% cite improved revenue performance and operational efficiency from sustainability as strong reasons to invest Half of investors won’t invest in a company with a poor sustainability track record 60% are prepared to divest if sustainability performance is poor There is a lack of communication within corporations and investment firms and between them (sustainability issues in 54% of earnings calls and shareholder meetings) Only 44% of companies and 36% of investors consider inclusion on a sustainability index as an important investment decision factor Although a sustainability strategy is considered important, only 60% of companies have developed one and only 25% say a business case has been developed Reference: G. Unruh, D. Kiron, N. Kruschwitz, M. Reeves, H. Rubel, and A.M. zum Felde, “Investing For a Sustainable Future,” MIT Sloan Management Review, May 2016 Professiona l Evidence Management Studies Finance Studies

20. Increasing Investor Demand 20 Sources: Morningstar Magazine, ‘Sustainable Investing Takes Off’, 2016 Morgan Stanley Institute for Sustainable Investing, Sustainable reality: Understanding the performance of sustainable investment strategies, 2015, http://goo.gl/LVITMHhttp://goo.gl/LVITMH CFA Institute, ESG Survey, June 2015, https://www.cfainstitute.org/Survey/esg_survey_report.pdf Professiona l Evidence Management Studies Finance Studies Increasing investor demand, as witnessed by numerous surveys Very strong interest from millennials: upcoming wealth transfer Evidence is mounting to debunk the performance myth

21. Institutional Pressure 21 Growing pressure from asset owners Launch of ESG Fund Ratings by Morningstar and MSCI Strategic Investor Initiative

22. Searching for Alpha in Narrative Data 22 Extracting useful (sustainability) information out of enormous sets of unstructured and rapidly changing data Big Data

23. Conclusion 23 Professional EvidenceAcademic Evidence Positive correlation found in management literature No performance differential between samples of ESG and conventional funds Be mindful of methodological shortcomings Possible to create robust risk- adjusted outperformance Growing demand Pressure from asset owners

24. Prof. Robert G. Eccles Professor, Harvard Business School Chairman, Arabesque Partners Website: http://www.roberteccles.comhttp://www.roberteccles.com Email: robert.eccles@arabesque.comrobert.eccles@arabesque.com Thank You!