ESG: Principles for Responsible Investment
Environmental, social, and governance (ESG) is quickly becoming essential for publicly-traded companies to undertake.
ESG is measurements that companies’ collect related to environmental sustainability (Environmental); their labor force, suppliers, and other stakeholders (Social); and their board of directors and transparency (Governance). Socially-motivated investors then evaluate their desire to invest in a company or advocate for company changes based on these indicators.
The ESG Process
Companies will use one or more standardized framework—like the Global Reporting Initiative, Sustainability Accounting Standards Board, or Carbon Disclosure Project—to disclose their ESG indicators. Frameworks may be subdivided into industries since some ESG issues are unique to an industry’s particular circumstances.
To gather ESG data, the company surveys internal and external stakeholders, and calculations may be performed to aggregate information and present it in accordance with framework requirements. The results are typically showcased in the company’s annual corporate responsibility/sustainability report.
Aiding investors in their efforts to contrast ESG across companies, ESG ratings agencies assess companies’ ESG disclosures and provide a scoring mechanism to indicate how companies rank against their peers. Ratings agencies include firms such as MSCI, Bloomberg, and Sustainalytics. Each agency uses its own criteria to evaluate companies, with some providing a separate assessment for E, S, and G, but all offer a cumulative score for cross-company comparison.
Why Report on ESG?
Beyond federal regulation requiring your company to report on ESG, as is mandated in the European Union, other main considerations for undertaking ESG reporting include building your corporate reputation with customers, responding to investor requests for disclosure, and simply staying on par with your competitors. As of 2019, 90% of S&P 500 companies, 65% of Russell 1000 companies, and roughly half of small and mid-size US public reporting companies disclosed their ESG practices. Companies are also reporting on more ESG indicators than they were previously, as companies are frequently rewarded by the ESG ratings agencies for greater transparency in their reporting.
ESG ratings are also being used internally by companies. One study found that almost two-thirds of its 5,000 corporate respondents use ESG ratings to inform internal decision-making. And 78% of company boards of directors plan to add ESG incentives to their executive compensation plans.
All things considered, ESG reporting is a worthwhile endeavor for any company wishing to display its work in environmental, social, and governance.
