Many people are hearing about the Environmental, Social and Governance (ESG) movement for the first time recently—especially if they’re interested in investing. What exactly is ESG, and why is it important?
What is ESG?
ESG is a set of guidelines that help businesses make socially and environmentally responsible choices. Many investors now look at a company’s ESG ratings before buying stocks, equities or bonds, and some customers want to know an organization’s ESG score before doing business with it. Companies like Bloomberg, Sustainalytics, S&P, and other analytics and economic agencies award ESG scores.
Complying with ESG standards is often mandatory. For example, the European Union created the Corporate Sustainability Reporting Directive (CSRD) in 2023 to require large companies to disclose ESG information. Starting in 2024, these corporations will have to report their sustainability measures.
The U.S. doesn’t mandate ESG reporting on the federal level, but that could soon change. The U.S. Securities and Exchange Commission (SEC) proposed changes to the rules for reporting ESG in 2022. If the proposal goes into effect, companies that market themselves as sustainable must start providing proof for the ESG measures they implement.
An ESG score offers a snapshot of how a business governs itself, treats the environment and interacts with people. Having a good ESG score is becoming increasingly important in the corporate world. In fact, 41% of chief financial officers plan to pursue these strategies over the coming year—a 5% increase from 2022.
Here’s a breakdown of the core aspects of ESG:
The E in ESG refers to how a company treats the natural world. For example, how much greenhouse gas does a business emit when manufacturing and shipping its products? Does the organization have companywide policies addressing pollution and climate change?
Other environmental aspects of ESG include how many resources a company consumes, where it discharges waste, how it treats animals and whether it uses harmful chemicals during manufacturing. Does the business use any renewable energy sources?
Companies implementing ESG frameworks often must publish sustainability reports that detail the steps they’re taking to help the environment. These publications convey to investors — and the general public — that a business is taking action rather than just talking about sustainability.
ESG reports prevent greenwashing, which is when companies claim they’re helping the environment but not actually making any changes. They also help businesses evaluate their energy use and waste management, guiding them toward better policies.
The social aspect of ESG examines how a business is involved in the communities where it operates. For example, does the company have fair workplace inclusion and diversity policies? How does it treat its customers, suppliers and workers? Does it pay employees a living wage?
The social aspect also examines whether a company avoids child labor, runs ethical supply chains and establishes strong workplace safety practices. Does the business protect its workers against sexual misconduct? How does it treat minority employees and customers?
Investors and clients often care deeply about these aspects of a business because they want to support the fair treatment of workers. Many job seekers also look at the social aspects of ESG when applying for a position.
The third category of ESG covers practices and policies that deal with audits, shareholder rights, executive pay, leadership and internal controls. For example, it examines whether a company accepts bribes. This aspect of ESG also looks at whether a business staggers its board elections, reports how it spends its money, has a diverse board of directors and stays accountable to its shareholders.
Is someone other than the CEO chair of the board? Does the company value diversity and integrity in its management? Following good governance guidelines helps companies reduce costs, attract new talent and create a sense of trust among customers. It also helps businesses grow over time.
Why Do Investors Care About ESG?
Investment decisions used to be purely driven by financial outcomes. Today, however, many investors look at ESG factors when deciding where to spend their money. ESG matters because it:
- Offers insight about risks: Companies with lax ESG policies might face legal issues, which can be expensive or bad for their reputation. A high ESG score often indicates a business is more likely to comply with the law. That’s good for investors who don’t want to invest in risky companies.
- Can affect performance: Investors want to spend their money on businesses that will continue doing well. A high ESG score is a good indication the company will perform well financially.
- Helps investors choose wisely: Investors don’t just look at which organizations will make money. Many also want to invest in companies that align with their ESG values.
Overall, ESG scores give investors a better idea of what a business looks like as a whole.
How Else Does ESG Affect Businesses?
People’s relationships with corporations are changing. Consumers and potential employees have more choices about which businesses to interact with. They also have more information about how companies affect the world around them.
Consequently, people are holding corporations accountable for their actions. They’re asking whether companies keep employees safe, are carbon neutral, donate any of their profits or perform volunteer work. They want to know businesses aren’t taking advantage of people.
Businesses with good ESG practices can advertise it in their job postings. Doing so can attract more applicants, especially those whose values align with company goals. Younger workers increasingly want to work for businesses with strong ESG reputations.
Sustainable business models are good for the environment and surrounding community but also benefit a company’s bottom line. They can help businesses evaluate their performance year by year, showing them where they have room for improvement and how they can save resources. Good ESG practices can even help companies win government contracts.
What Does ESG Mean to You?
For the average individual, the finer details of ESG may seem unimportant. While this is a form of reporting and regulation that matters the most to businesses and investors, being aware of ESG reporting allows people to stay informed and educated about how large companies are impacting the environment.
ESG reporting can help you decide whether or not you want to give your money to a company based on their business practices and ethics, or if you want to apply to work for them. It can show you who is contributing the most (or the least) to major environmental and social issues. ESG is also a subject of great debate in legislation these days, and understanding what it means can help you to better evaluate the stances of the politicians that you vote for.
Environmental, social and governance frameworks guide business decisions, helping companies make better choices and comply with the law. ESG scores are also useful for investors wanting to invest in reputable organizations, and customers and job seekers can look at a company’s ESG ratings to decide whether to shop or work there.
The world is in a transitional period marked by changing consumer values, a shift toward renewable practices, better treatment of workers and a circular economy. In the future, ESG might just be called good business. However, its core principles are surely here to stay.