Many companies are increasing their focus on environmental, social and governance (ESG) elements of their business. The logic: ESG considerations affected over $40 trillion of investment decisions globally in 2020, according to publication Pensions & Investments, and a growing number of consumers say ESG practices play into their investment decisions, too. Granted, while over three-quarters of consumers say ESG is important in their investment decisions, less than half actually invest based on that preference. Even so, it’s a significant group. An ESG approach may help get the attention of investors — both institutional and closer to home.
What's more, several sources link ESG to better business performance. In an aggregation of over 2,000 empirical studies, The Journal of Sustainable Finance and Investment found a positive correlation between ESG efforts and corporate performance in 63% of analyses. And the S&P ESG Index has outperformed the S&P 500 over the past year.
For those that want in on the action, this article explains ESG’s components (environmental, social and governance) and dives deeper into the potential opportunities that arise from approaching business through an ESG lens.
ESG is the environmental, social and governance "criteria that altogether establish the framework for assessing the impact of the sustainability and ethical practices of a company on its financial performance and operations,” per The Corporate Finance Institute.
Each component in detail:
The environmental component of ESG concerns a company’s impact on the planet. Issues that companies consider in this category include energy and natural resource usage, production and treatment of waste, pollution output and any impact on the environment, plants or animals. Companies that prioritize ESG measure their energy and resource consumption and develop plans to reduce their impact on the environment.
Industry leaders on carbon emissions
Reducing carbon emissions is a big goal for many companies across industries. For instance, BP plans to reach net-zero carbon emissions from oil and gas production by 2050. Companies such as Amazon, Best Buy, Mercedes-Benz and Verizon have pledged to reach net-zero carbon emissions by 2040. And Blackstone, the world’s largest alternative investment firm, started a program to reduce carbon emissions by 15% across all investments in which it controls energy usage.
Smaller companies are creating and achieving environmental-related goals, too. Sometimes, it’s through a direct effort, like using energy from renewable resources. Other times, it’s a byproduct of changes in how business is done: For instance, your stay-at-home workforce is using less gas for commutes while putting in more work hours. And a simple rethink of consumer goods packaging can reduce waste. Sustainable packaging company BioPak, for example, designs and produces eco-friendly, disposable tableware which industrial customers can not only adopt but also compost — via a BioPak initiative — to reduce carbon emissions and waste.
The second component of ESG, social, examines how companies interact with employees, customers, partners and the communities in which they conduct business. Employee-related considerations include wages, workplace safety and diversity and inclusion (D&I). Socially-minded companies work to understand the social impact they have on the regions in which they manufacture, derive resources or conduct operations.
Diversity in enterprise and emerging categories
Companies large and small are incorporating ESG’s social component into their operations.
On the enterprise front, Intel addresses diversity and inclusion in its four-pronged ESG strategy (opens in new tab). The company’s goals include increasing women’s share of technical roles to 40% and doubling the number of women and minorities in leadership. The company is also developing a Global Inclusion Index meant to speed adoption of D&I across the industry, creating a system to track inclusion practices and equipping young people with technology skills.
As an emerging company, your efforts may be more practical and less far-reaching — and that’s okay. A timely way to start is working to fill skills gaps that were a nagging issue for many companies even before the pandemic. Consider using these months to grow the talent your firm might be missing. Smaller companies often work to solve a skills gap by creating a mentorship program that serves underrepresented groups in their area.
Likewise, the supply chains that COVID-19 broke are a chance to evaluate suppliers in a new light. Assessing them on ESG merits may help you find the ones that will be more responsive and better business partners. Reshoring your suppliers will mean differences in how relationships function and create efficiencies. If you’re moving your supply lines back to North America, you may find that some of your potential suppliers are also dedicated to clean energy, diversity and fair living wages.
Governance looks at an organization’s leadership team, executive pay rates, investor relations, financial data availability and more. Governance-related ESG practices aim to develop ethical and transparent governing systems. Some governance controls include anti-money laundering (AML) policies, segregation of duties (SOD) and transparency policies.
Edwards Lifesciences on governance
Edwards Lifesciences Corporation’s Global Integrity Program is based on recommendations from the U.S. Department of Health and Human Services and Office of Inspector General. It covers standards for leadership, ethics and compliance, as well as internal communication, and it explains how to regularly assess these standards. Edwards also has a corporate governance page displaying its internal guidelines and other structural details.
For smaller companies, a governance focus can be as simple as actively working to stay on the right side of regulation, being honest and open about how you’ll use customer data and being clear with employees on how you evaluate their performance and work to create opportunities. Ethics in taking on new business and clarity in your financial reporting among company principals and employees goes a long way toward smoothing operations and achieving consistent, predictable growth.
Companies that desire to get in on the ESG game may choose to focus their efforts in different ways. Here are some of the major areas businesses tackle today:
Prioritization of efficient supply chains continues to grow. The pandemic exposed weaknesses, like lack of transparency and poor compliance structures, in supply chains worldwide. Strategies to fortify supply chains as part of a broader ESG plan (opens in new tab) include:
Supply Chain Sustainability: Why It’s Important & Best Practices: Many ESG-focused companies aim to minimize environmental harm from factors like energy usage, water consumption and waste production in their supply chains. Doing so can decrease energy costs.
Company disclosure on ESG factors will be a top ESG trend for the next decade (opens in new tab), says FTI Consulting. Intensified pressure from investors and more corporate governance reform will push ESG disclosures into the mainstream, the report adds. Companies looking to meet modern ESG standards will need to prepare disclosures that speak to a variety of stakeholders, including employees, customers, partners and regulatory agencies. These disclosures broaden the scope of material information for investors to digest and use in making their decisions.
Driven by research on climate change and governmental sanctions around carbon emissions, companies are increasingly building plans to measure, establish targets for and reduce greenhouse gas emissions and setting goals to reach net-zero carbon emissions. Even sectors that contribute heavily to carbon emissions, such as the fossil fuels, transportation and agriculture, are shifting toward more energy-efficient operations, renewable energy sources and more.
The U.K. pushes mandatory financial disclosure
The U.K. is instituting a plan to make climate change risk reports mandatory for large companies in some industries. Banks, insurance companies, some commercial companies, pension plans and building societies would be required to submit these risk reports by 2025.
ESG has been shown to boost employee retention and job satisfaction, which research links to higher productivity (opens in new tab) in individual employees. And top-rated employers, as measured by employee satisfaction and attractiveness to talent, have significantly higher ESG scores than their competitors, per analyses of data from finance company MSCI by Marsh McLennan, a professional services firm.
Many now consider ESG a standard tool for financial analysis, alongside traditional financial metrics.
“We believe that sustainability should be our new standard for investing,” said BlackRock, the largest institutional investor in the world, in a 2020 letter to clients.
In addition, ESG index funds (opens in new tab) are outperforming their classic, non-ESG-aligned counterparts. This fast-growing investment segment saw record inflows of cash this year. It accounts for $250 billion worldwide, and 20% of that money is in the U.S.
For those interested in taking an ESG approach, there are several expert-vetted frameworks and reporting tools with which to assess and share your ESG performance:
The Environment and Social Framework is a methodology the World Bank and its borrowers use to identify risks and offer business recommendations on environmental and social issues. The ESF is composed of resources such as the World Bank’s Vision for Sustainable Development, Environment and Social Policy for Investment Project Financing (opens in new tab) and Environmental and Social Standards (ESS) (opens in new tab). The ESS cover topics including environmental and social risk mitigation, appropriate land use, community health and safety and natural resource management.
These two resources offer a high-level overview of major ESG focus areas. At the heart of the United Nations’ 2030 Agenda are 17 sustainable development goals (SDGs) (opens in new tab) that cover many of the world's most pressing developmental issues, including climate change, poverty, clean energy and responsible production. Meanwhile, the U.N.’s Guiding Principles on Business and Human Rights (opens in new tab) lay a framework for the role businesses and corporations may choose to take in protecting human rights.
B Lab is the creator of the B Corp status, a designation granted to companies with high ESG performance and standards. The free B Impact Assessment (opens in new tab) tool allows companies to assess their performance on ESG metrics, compare results to similar companies and get a customized improvement plan. Becoming a certified B Corp is a signal to investors that your company is serious about its ESG efforts, which can by itself open new investment opportunities: Before ESG considerations, corporations existed to bring advancement to their shareholders, usually in the form of a monetary return on their investment. In a B Corp, consideration is given to the betterment of stakeholders — which can include customers, employees and communities in which the company operates.
The Global Reporting Initiative (GRI) helps organizations assess their environmental, social and societal impact worldwide through access to resources and standardized reporting methods. Organizations can use the GRI Standards (opens in new tab) to develop, organize and share material issues, highlight progress and display corrective actions.
The Sustainability Accounting Standards Board (SASB) provides resources and tools to businesses and investors regarding ESG standards, reporting methods and major focus areas on an international scale. SASB standards (opens in new tab) comprise a list of 77 financially material sustainability standards and common reporting metrics, while the SASB Materiality Map (opens in new tab) offers a graphical representation of these standards broken down by sector. The Map guides organizations toward understanding the primary issues facing their industry and which ESG metrics are top-of-mind for investors.
The Financial Stability Board created its Task Force on Climate-Related Financial Disclosures to increase reporting on and resources related to the relationship between the climate and global financial markets. The Task Force provides a list of recommendations for climate-related disclosures (opens in new tab) and implementation recommendations (opens in new tab) for general and industry-specific guidance.
ESG is no longer a buzzword that only applies to a small percentage of the world's largest companies. Today, it’s a common business approach fueled by growing popularity among consumers and investors. For those intrigued by the potential, ESG resources can help them explore further.