By Anthony DeCandido, RSM partner and financial services senior analyst
The number of middle market executives prioritizing environmental, social and governance (ESG) is high. However, there are still skeptics struggling to quantify the immediate return on investment for developing their ESG strategy.
Yes, it has been proven by empirical research that ESG offers above-normal financial and nonfinancial performance. Still, many executives who remain unconvinced might choose to put off what we at RSM believe is a top three business imperative behind technology/digital strategy and regulatory affairs.
Those executives who trust that ESG improves business and societal outcomes are proactive in integrating these principles into corporate activities. But others, who may just see ESG as additional compliance, might only adopt it out of obligation to address stakeholder concerns, such as inquiries on fair labor, supply chain management or carbon emissions practices.
Unlike most prior business initiatives, the movement behind ESG has been almost entirely led by consumers. It is everyday influencers—investors, suppliers, customers, employees and community members—who have demanded ESG prioritization from the bottom up versus a top-down policy driven by regulators or governing bodies.
The evolution of ESG’s driving forces
Whether a middle market executive buys into the ideology of ESG soon may not even matter. Millennials, who are far more mission-focused than their Generation X and baby boomer predecessors and make up the largest segment of the U.S. workforce, are increasingly holding management and executive decision-making responsibilities. This could explain the business community’s growing familiarity with ESG.
According to RSM’s Middle Market Business Index ESG special report,1 the number of firms that are “very familiar” or “somewhat familiar” with ESG has risen substantially from the fourth quarter of 2019 to the third quarter of 2021—from 39% to 69%. As we note in the report, this 30-percentage-point increase is a dramatic change and a sign of how much interest there is today for ESG within the middle market. We are starting to see more organizations take action to incorporate ESG issues into their operations.
Moreover, the tide is already turning from a bottoms-up to a top-down approach, as several regulatory forces converge to bring greater market education, adoption and standardization among the middle market. The American Institute of CPAs, Center for Audit Quality, Auditing Standards Board, Chamber of Commerce, and even the SEC all have task forces concentrated on setting methods for ESG integration, with the goal to push better business and societal outcomes. And, each of them has the power to positively influence executives to adopt ESG practices even faster than what we’ve observed over the past 16 months.
But no one regulator stands to have as great of influence over ESG corporate behavior as the Internal Revenue Service. The IRS can rally ESG priorities among corporate leaders with direct credits and incentives upon ESG adoption. Federal, state and local tax programs and incentives can help executives finance new projects, expand operations, train employees and enhance after-tax earnings.
Such opportunities could be viewed as the short-term, quick wins needed to validate launching an ESG program and convince middle market executives of said program’s value.
Being socially responsible has its benefits
ESG’s financial benefits have become too enticing for organizations to ignore any longer. Consider the substantial credits and incentives available to organizations through the following programs:
- Work opportunity tax credit (WOTC) – Does the company have frequent new hires or anticipate growth in new hires? The WOTC is a federal credit administered by each state and aims to encourage the employment of target groups such as veterans, summer youths and long-term unemployed, to name just a few.
- Renewable energy credits and incentives – Is the business currently involved in or considering developing, constructing, owning, leasing, operating or investing in a renewable energy facility? Companies that invest in qualifying technologies or produce renewable energy may be eligible to claim investment or production tax credits. Qualifying technology includes solar energy, wind energy, geothermal, combined heat and power, waste energy recovery property, municipal waste, hydropower, and open- and closed-loop biomass. Also, businesses that invest in qualifying electric vehicles or charging stations may be eligible to claim tax credits.
- Rehabilitation tax credit – Is the business considering a significant building rehabilitation project? If the building was originally placed in service before 1936 or is a certified historic structure, the company may be entitled to a 10-20% tax credit.
- Low-income housing tax credit (LIHTC) – Is the business considering developing housing units? One of the most successful federal credit programs is the LIHTC. Over a 10-year period, the LIHTC can provide an affordable housing credit of 30% of an existing building’s qualified basis or 70% of a new building’s qualified basis.
- Carbon oxide sequestration – Does the company plan to acquire any equipment that will reduce carbon emissions? Any business that captures carbon dioxide or carbon monoxide and either disposes of or utilizes the gases themselves or hires a third party to do so may be entitled to a credit. This credit may apply to industrial facilities, electricity generating facilities, oil refineries, crude and natural gas drilling operations, ethanol plants, cement manufacturing plants or natural gas processing facilities. Additionally, businesses with taxable income may have the opportunity to invest in a carbon capture sequestration project as a tax-equity investor.
For middle market executives who haven’t yet bridged the gap between ESG adoption and its many advantages to society, our planet and their bottom line, these new tax credits and incentives could provide enough encouragement to win over naysayers and justify taking the leap.
1RSM US LLP, RSM US 2021 Environmental, Social and Governance Special Report, https://rsmus.com/economics/rsm-middle-market-business-index-mmbi/environmental-social-and-governance-esg.html (accessed Oct. 28, 2021).
About the Author
Anthony DeCandido is a partner and financial services senior analyst at RSM US LLP, whose focus is to forecast economic, business and technology trends shaping the industries RSM serves, particularly private equity. Anthony has prepared research around a critical business theme affecting all industries: environmental, social and governance (ESG). As a lead advisor with RSM’s ESG advisory practice, he guides clients through strategy development, data collection, and reporting and communications.