Environmental, social, and governance (ESG) is a rating used by asset managers to help socially conscious investors decide which companies to invest in. As the name suggests, it’s an overall score given to companies based on how well they behave in three important areas of business.
The ethical investment movement has exploded in recent years, as an increasing number of investors have begun to care a little less about maximizing returns and a bit more about ensuring positive outcomes for people and the planet. A 2021 PWC survey found that sustainable investing is worth more than $30 trillion globally, growing by $5 trillion in the United States alone between 2018 and 2020.
The challenges for firms that plan to place ESG at the center of their business strategy can be great. But those that achieve it have the chance to shape the future of a marketplace that’s transforming for the better.
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In this article, we’ll take a closer look at what ESG means, and how an ESG strategy can create value for a company rather than restrict it.
The importance of environmental, social, and governance (ESG)
Unpacking precisely what goes into an ESG score can be tricky. Put simply, it’s a broad scoring tool—primarily used by investors—to rank a company’s performance in three key categories: environmental, social, and governance.
The first category holds the most weight. The environmental impact of a company includes things like its carbon footprint, its sustainable practices, and its effects on climate change. It’s a measure of the adverse impact a company has on the health and well-being of the natural world, and everything and everyone who lives in it.
The second category, social, focuses on a company’s fair treatment of its workers and the communities it operates in around the world. The third category, governance, scrutinizes a company’s behavior when it comes to murky legal matters, such as bribery, corruption, and money laundering.
ESG hasn’t always been aligned with the goals of institutional investors. Traditionally an investor’s job has been to maximize shareholder value at any cost, regardless of factors such as environmental damage or weakened labor rights. For that reason, investors have long pushed back against ESG as a measure of a company’s performance or worth.
With the advent of ethical investment, the integration of ESG values into the global investor community has taken off. People are paying more attention to where their money is kept. They want to ensure that their savings and investments reflect their values, while still ensuring a return that can secure their future and the future of their children.
The challenges of creating value with ESG
Of course, in an ideal world, companies should pursue these simple ESG strategies not just as an appeal to trendy and responsible investors, but out of a sense of decency and good corporate practice.
Research shows that a company can in fact create value while still being a force for good. A 2015 paper by the University of Oxford found that companies with a greater focus on environmental and social issues tended to outperform industry rivals with a weaker or nonexistent sustainability agenda.
The benefits go beyond a company’s stock market performance. ESG compliance is closely interlinked with corporate image and brand reputation, and companies that can demonstrate efforts to produce healthier, cleaner products and services are starting to attract more eco-conscious customers and more profit.
In addition to creating value for a company, a strong ESG framework can protect a company’s very existence—as more clients, investors, and policymakers shun polluting firms in favor of smarter, greener, and more moral ones.
Five ways that ESG creates value
1. Reduction of energy and water consumption
The notion that behaving in an environmentally conscious fashion is an inherently more expensive way to do business is outdated. Companies with a focus on ESG typically spend less on energy and resources by reducing their usage and boosting efficiency. This might mean moving to an all-electric fleet or improving infrastructure to reduce water use.
2. Higher employee engagement and more productivity
Clean investors aren’t the only ones who care about an ESG rating—employees do too. Companies that take a responsible approach to socially important matters such as racial justice, environmental protections, and fair governance are better positioned to attract the best employees and retain the talent they have.
3. Increased sales with more loyal clients
The values that make a company an appealing investment are the same that attract and keep hold of new and existing customers. Today, clients and customers are actively choosing to work with and buy from companies that are reducing their environmental impact, protecting workers’ rights, and championing good causes.
4. Deregulations and government support
In many countries, what began as generous subsidies for companies willing to invest in expensive decarbonization efforts has evolved into penalties and red tape for the companies that don’t. A focus on ESG means moving away from the potential costs and restrictions of future government interventions and toward vital support from the state.
5. Long-term investment returns
The phasing out of fossil fuels has left the energy industry holding on to hundreds of billions of dollars worth of potentially stranded assets—oil and gas reserves that are unlikely to provide an economic return and which now must be left in the ground. By shifting capital away from short-term returns and toward more sustainable long-term business goals, a company can protect itself from enormous, climate-related write-downs and ensure cleaner investments long into the future.
How can you start with ESG?
There’s no one-size-fits-all approach to building an ESG framework. Depending on the size of your organization and the industry you work in, sustainability and social consciousness may look a little different. But there are some simple questions to consider before you set your goals.
- What does success look like? In your industry, success could mean reducing the environmental footprint of your production process. Or it could mean ensuring the welfare and happiness of the workers who manufacture and transport your products. Decide what success looks like and build toward it.
- What’s your appetite for risk? You can follow the blueprint of industry leaders who have a proven track record, or you can push ahead and be the first to implement new ESG approaches.
- How can ESG create value for your company? Identify the areas of your business in which ESG can be used to create value, and then use those opportunities to fuel change across the wider business.
ESG examples
Microsoft has one of the highest ESG scores, according to most asset managers who measure it. This is in large part due to the tech giant’s achievements in becoming carbon neutral in 2012 and its commitment to becoming carbon negative by 2030.
These sustainability goals seemingly aren’t at odds with Microsoft’s ambitions to expand its cloud services operations. The company currently has more than 200 data centers around the world, with plans to launch 100 more every year. These goals haven’t tarnished its popularity with shareholders, either. Since becoming carbon neutral in 2012, Microsoft’s stock price has increased almost 1,000 percent.
Steve Hogarty is a writer and journalist based in London. He is the travel editor of City AM newspaper and the deputy editor of City AM Magazine, where his work focuses on technology, travel, and entertainment.
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