Environmental, Social, and Governance (ESG) criteria are a set of standards for a company’s operations that socially conscious investors use to screen potential investments. Environmental criteria consider how a company performs as a steward of nature. Social criteria examine how it manages relationships with employees, suppliers, customers, and the communities where it operates. Governance deals with a company’s leadership, executive pay, audits, internal controls, and shareholder rights. These criteria help to better determine the future financial performance of companies (risk and return) by identifying potential risks and opportunities beyond traditional financial analysis.
The environmental component of ESG looks at how a company's operations impact the natural environment. This includes issues such as a company’s energy use, waste, pollution, and conservation of natural resources. Companies are increasingly measured on their carbon footprint, their production of Greenhouse gases, and their contribution to climate change. Additionally, activities such as deforestation and water usage are scrutinized under this criterion. Companies that pursue sustainability can attract investors and customers who prioritize environmental responsibility, potentially increasing the company's market share and profitability.
On the social front, ESG criteria focus on the company's business relationships. Does it work with suppliers that hold the same values it claims to uphold? Does the company donate a percentage of its earnings to the local community or encourage employees to perform volunteer work? The treatment of workers and the conditions under which they work are also crucial aspects. This includes employee rights, safety, and equal opportunity employment. Companies that excel in these areas may benefit from improved morale, greater productivity, and reduced turnover rates, which can lead to a more robust bottom line.
Governance involves the internal system of practices, controls, and procedures a company adopts to govern itself, make effective decisions, comply with the law, and meet the needs of external stakeholders. Issues such as the diversity of the board, the structure of its meetings, and the transparency of its operations are significant under the governance pillar. A strong corporate governance framework can lead to improved company performance and investment returns as it reduces potential business risks, prevents scandals, and promotes accountability. Transparency in governance also helps in building public trust and ensuring that the actions of the company align with its ethical statements.
By considering ESG factors, investors and other stakeholders can assess how a company is poised to face environmental and social challenges and governance issues that may impact its performance and reputation. Thus, ESG criteria are becoming progressively important in the assessment of potential investments and the broader decision-making processes within companies.