Environmental, Social, & Corporate Governance: Complete Guide to ESG
Responsible business practices and investments have become mainstream, and they rely on three primary criteria pillars: environmental, social, and governance (ESG).
This is a noteworthy shift from what investing used to entail. Over the last decade, and especially the last few years as climate and social issues dominate the headlines, investors have shown interest in prioritizing values over short-term returns with questionable or outright illegal methods.
But what exactly does ESG mean for companies, customers, and investors, and why is it important? We’ll take a closer look at the criteria for ESG and why it’s a beneficial investment.
Key Takeaways:
- Environment, social, and governance (ESG) criteria promote sustainable and responsible investments.
- ESG companies have become more attractive to clients, customers, and shareholders looking to put their money behind a business that shares their values.
- Companies that embrace ESG standards have effectively reduced risks, promoted innovation and efficiency, and projected a positive brand image.
What is ESG?
ESG stands for environmental, social, and governance. To put it simply, think of ESG as social consciousness standards to measure a business’s level of sustainability and responsibility.
The first notable mention of ESG was in the 2006 United Nation’s Principles for Responsible Investment (PRI) report. This was the first time ESG criteria was required to be incorporated into company financial analyses.
Synonymous terms for ESG include socially responsible investing (SRI), sustainable investing, or impact investing.
Since 2006, the demand for businesses to implement ESG policies and commit to being socially responsible has seen a drastic increase, especially by millennials.
Investors are actively seeking out companies that are going green and reducing their carbon footprint.
Likewise, customers have shunned companies that didn’t act responsibly during the COVID-19 crisis, and they’re taking their business to the companies that prioritized the safety of their employees and customers during the pandemic.
As consumers and investors alike continue to demand social consciousness from businesses, ESG will remain a prevalent driving factor in the market.
Why are ESG Ratings Important? Environmental, Social, and Governance Criteria
A high ESG rating can create a ripple effect through a company’s revenue, brand perception, client base, market risks, innovation investments, efficiency, and more.
2020 resulted in record inflows (140%) into ESG products, and 67% of survey respondents say they’ll likely be putting their future investments into ESG-driven companies over the next five years.
As the market continues to shift toward the millennial generation and younger investors, ESG trends will continue to take precedence in the foreseeable future.
Third-party organizations are responsible for researching, measuring, and assessing a company’s ESG rating based on publicly available data. An ESG rating is based on the three main pillars of social consciousness:
1. Environment
Environmental ESG criteria measures a company’s performance as a steward of nature. The current climate crisis is putting more and more pressure on businesses to “go green” and reduce their environmental impact.
Some companies, like Microsoft, have vowed to go a step beyond being carbon neutral and achieve a carbon negative state, essentially erasing their carbon footprint over time.
However, environmental ESG goes much deeper than simply measuring carbon emissions. Other essential data points include:
- Climate change action
- Carbon and/or sustainability reports
- Renewable energy sources
- Lower greenhouse gas emissions
- Restrictions on harmful pollutants
- Ecological footprint
- Resource management and conservation
- Treatment of animals
- Responsible water usage and waste disposal
2. Social
Social ESG criteria analyzes the company’s relationships with clients, employees, customers, suppliers, vendors, stockholders, and other contacts within its network.
The Edelman 2021 Trust Barometer provided a unique insight into consumer mindsets after a chaotic and stressful year of navigating a tumultuous market.
The vast majority of consumers – 86% – expected CEOs to publicly speak out and take the lead on major issues, while 68% strongly felt that it was a CEO’s responsibility to step in if the government failed to respond to societal problems.
While consumer trust in media and government leaders fell to an all-time low, trust in businesses increased.
Social ESG is having a bigger impact on the market than it ever has before. Factors that drive this social consciousness include:
- Ethical supply chains
- Fair wages
- Addressing racial and gender pay gaps
- Employee health and safety
- Customer experience
- Community impact
- Support of diversity and LGBTQ+ rights
- Protection against sexual misconduct
- Labor standards
3. Governance
Governance ESG looks at a company’s leadership, transparency, internal controls, shareholder rights, audits, executive board, et cetera.
Before putting their money into a company, investors need to know about any potential conflicts of interest and questionable practices happening at the highest levels.
Governance ESG factors include:
- Corporate transparency
- Risk management
- Anti-corruption measures
- Tax transparency
- Shareholder rights
- Diversity among company leaders
- Political contributions
- Fair decision-making process across the executive board
All of these factors contribute to a business’s overall ESG rating and other scores that investors rely on to make educated decisions.
Reap the Benefits of an ESG-Driven Business Approach
Boosting your ESG comes with a long list of benefits that make it well worth the investment, including:
- Reduced market and regulation risks: As lawmakers respond to increased pressure against corruption, social injustices, and climate change, businesses will be faced with new rules and regulations. Companies that are using an ESG-driven approach are already acting responsibly and won’t need to worry about drastic changes or fines.
- Better performance: Studies have shown that portfolios with high ESG scores outperformed other investments during the pandemic.
- Attractiveness for investors: Social responsibility and transparency are enticing attributes that appeal to new investors.
- Innovation and efficiency: Staying on top of new cutting-edge technologies and practices improves overall efficiency.
- Positive brand image: Social consciousness can have a powerful effect on a brand’s image. Companies that demonstrate true compassion tend to resonate with customers and investors.
ESG is a critical driving factor in today’s market, which is why we’re dedicated to helping business owners uncover the necessary data to make educated decisions and positively impact their community.
