Environmental, Social, and Governance (ESG) is a form of investing in companies based on their commitment to one or more ESG components. It is sometimes called sustainable investing, socially responsible investing, mission-related investing, and impact investing, which ultimately impacts the
real estate market.
Each of the three elements of ESG comprises a number of criteria that may be considered, either by socially responsible investors or by companies looking to adopt a more ESG-conscious operational attitude. While many ESG criteria are subjective, there is movement on several fronts to provide more objective, credible ratings of a company’s performance in terms of ESG policies and actions.
The criteria of Environmental Social Governance
Environmental criteria
Environmental criteria can include a company’s use of renewable energy sources and waste management programs, its responses to deforestation issues and potential air and water pollution resulting from its operations, and its attitude and actions regarding climate change. Additional environmental issues include raw material sourcing and whether a company follows biodiversity practices on land it controls or owns.
Social criteria
Social criteria cover a broad range of potential issues, with most of them centered around social relationships. From the perspective of many socially responsible investors, one of the most important relationships a company holds is its relationship with its employees. Here are some of the issues that may be considered when examining a company’s social relationships:
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Are employees paid fairly or even generously compared to similar jobs or positions in the industry? What type of retirement plans are offered? Does the company contribute to employee retirement plans?
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What are additional benefits provided outside of basic wages or salary? For instance, does the company provide a free buffet lunch for employees once a week, a fitness center, or other lavish perks and amenities?
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Workplace policies regarding inclusion, diversity, and prevention of sexual harassment are considered.
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Does the company provide employee training and education programs? For example, does the company provide financial support for continued or higher education and/or flexible working hours for employees pursuing further education?
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What level of employee engagement with management is there? How much input do employees have in setting operational procedures within their respective departments?
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What is the rate of employee turnover?
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What is the company’s mission statement, and is it socially relevant and beneficial to society as a whole?
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How are customer relationships managed? Does the company engage with customers via social media? How efficient is the customer service sector? Does the company have a negative history of consumer protection issues, such as product recalls?
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Does the company take a political or public stance on human rights issues? Does it donate money to charitable causes?
Governance criteria
In the context of ESG, governance refers to how those in top-floor executive positions manage a company. How well do executive management and the board of directors tend to the interests of the company’s various stakeholders, including employees, suppliers, shareholders, and customers? Does the company give back to the community where it is located?
Sincere financial and accounting transparency and reporting are considered key elements of good
corporate governance. Another critical factor is whether board members act in a genuine fiduciary relationship with stockholders and are careful to avoid conflicts of interest with that duty. Are the company’s executives and board members a diverse and inclusive group?
The issue of executive compensation is a primary focus of many ESG investors, who, for instance, are not in favor of multi-million dollar bonuses for executives while the company imposes a salary freeze for all other employees. Is extra compensation for executives in alignment with increasing long-term value, viability, and profitability of the business? In addition, executive bonuses rely on more than revenue or income — factors such as employee, shareholder, and customer satisfaction are considered.
The software company,
Intuit, is a shining example of a company practicing responsible corporate governance. One of the company’s core policies is aimed to ensure company executives adopt a strong vested interest in the company’s ongoing success, rather than just in earning quarterly bonuses. This rule requires the top-level executive officer to maintain stock ownership equivalent in value to ten times their annual salary.
Common investor objectives
While ESG can mean different things to different people, there are three common investor goals:
1. Integration: People often incorporate ESG in hopes that it will improve investment results. Growing research suggests that ESG factors contribute to long-term financial performance. ESG elements can be used to identify better-managed companies or to flag companies with business models that are likely to face headwinds or tailwinds driven by rapidly evolving regulatory, environmental, demographic, or technological trends. Institutional investors are increasingly looking to ESG factors to better manage these risks and secure long-term sustainable financial performance.
2. Personal values: Investors consider ESG factors to reflect their values, aligning investments with religious, ethical, or political views. ESG research is typically used to screen for dubious activities such as tobacco, weapons, alcohol, gambling, or fossil fuels. This way, investors can better exclude such activities from their investment world. This is an alternative to those considering ESG factors based on potential economic impact.
3. Positive impact: Certain investors turn to ESG factors with the intent of making a positive difference in the world. These investors may seek to direct their capital towards companies that provide solutions to environmental or social challenges. They monitor the extent to which their investments are generating positive change through formal guidelines such as the UN Sustainable Development Goals (SDGs).
Progress of ESG investing
ESG is growing significantly amongst retail and institutional investors. A practice dating back to the 1960s, investors excluded stocks or entire industries from their portfolios based on business activities, including tobacco production or involvement in the South African apartheid regime. Today, ethical considerations and value alignment remain common objectives of many ESG investors. However, the field is quickly growing and changing to include financially relevant ESG factors into the investment process alongside traditional financial analysis.
Global challenges such as climate change, increasing regulatory pressures, and social and demographic shifts are major causes of ESG growth acceleration. Additionally, millennial investors around the globe are helping drive the rapid growth in ESG investment. With more and more investors interested in a more ethical and sustainable future, ESG considerations will continue to skyrocket.
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*Header image courtesy of Pharmaceutical Technology
