Environmental, social, and governance (ESG) are three related pillars of criteria used to assess a company through the lenses of ethics and sustainability. The term was first coined in a 2005 study examining these three criteria as value drivers for a business. ESG factors are increasingly considered in investment and governance decisions and span a full spectrum of issues not traditionally part of financial analysis but that may very well have financial relevance. While so-called ESG investments total tens of billions of dollars, this understates ESG’s impact, as institutional investors such as BlackRock are increasingly demanding enhanced actions and reporting on ESG topics.
The first part of ESG relates to environmental criteria. This pillar often involves mitigating environmental damage and climate change and can be harmful to a company if ignored. Factors may include energy consumption, waste disposal, emissions, and compliance with governmental environmental regulations. Failure to be sensitive about environmental impacts can result in hefty fines, damage to areas of operation, and, perhaps most important, a loss of public trust. The latter can be seen in the 2015 Volkswagen emissions scandal, which proved disastrous for the company’s stock, plunging its share price by over 20 percent. Today, as just one example of an increased focus on environmental efforts, most large, public companies publish annual sustainability reports. In fact, 86 percent of S&P 500 Index companies did so in 2018.
Social criteria include the company’s relationships with other businesses, the public, and its employees. This extends to businesses in the company’s supply chain and examining whether they hold similar values as the company. Factors such as diversity, human rights, and community contributions are all considered here. While a company may do well by its shareholders, social criteria consider constituencies beyond them, such as the communities in which they operate. Inadequate attention to social criteria may hurt employee, shareholder, and business relationships and result in a loss of public trust.
Corporate governance focuses on the relationships a business holds with shareholders, particularly regarding the directors’ actions and their oversight of management and the company. This includes pay for executives, internal audits and controls, and the rights of shareholders. Within each of these areas, a company is expected to abide by governance factors such as accountability, integrity, diversity and equality.
The large amount of capital concerned with ESG issues, from ESG funds to institutional investors, demonstrates the need for companies to be focused on these issues. While ESG investing may once have limited the potential pool of target investments, the increasingly broad range of companies from across the spectrum of industries addressing ESG topics broadens this investment area. Major institutional investors are also more focused on ESG, making these considerations crucial for virtually every public company.
Of course, there have been criticisms of ESG. At the moment, there are no uniform standards for reporting on ESG issues, in particular on environmental matters. Nonetheless, companies need to be increasingly attuned to ESG considerations.
Jonathan F. Foster
Founder & Managing Director – Current Capital Partners LLC