Why is ESG Important for Investors?November 18, 2021 3:43 pm
These days, your company’s performance in environmental, social, and corporate governance—i.e., your ESG score—is as advantageous for your firm as it is attractive to your investors. ESG is rapidly becoming one of the most important yardsticks by which to gauge corporate value for companies, stakeholders, and the general public—so what is ESG, and why is it important?
ESG is a system of evaluation that determines the integrity of socially responsible investments. It encompasses three main domains of ethical conduct: environmental impact, social conscience, and corporate behavior.
As more and more consumers demand transparency, accountability, and ethical conduct from corporations, social and environmental stewardship continues to accrue real material value on the market. A poll by Morgan Stanley Bank showed that almost 90% of investors in the millennial age bracket were inclined to billet their portfolios with investments that rest in alignment with their personal ethics.
In this article, we’ll walk through the basics of ESG investment and why it’s in both companies’ and investors’ mutual interests to build up their ranking.
What Is ESG?
To understand ESG, it can help to break it down to its core components, going letter by letter.
As the effects of climate change begin to make landfall, companies are expected to demonstrate a consciousness about their ecological footprint as much as the average consumer. There are five areas where a company’s environmental performance typically affect their ESG score or ESG rating:
- Energy expenditure
- Energy sources
- Carbon emissions
- Biohazard and environmental risk
- Waste management and toxicity
Whether or not your company deals directly with the environment, ESG holds that all corporate entities can do their part to prioritize sustainable business practices.
From a practical standpoint, investors also know that climate disruption will lead to a host of externalities that will inevitably impact a given company’s ability to function, grow, and thrive in a changing environment.
The “social” component of ESG seeks to determine how much a company either promotes or impedes human interest within and beyond their organization. Three key areas are in focus:
- Human rights – Depending on the type of company in question, their effect on human rights may be global or highly localized. Human rights may pertain to how a given firm affects its neighboring communities, how employees are treated, or how resources are extracted further down the supply chain.
- Parity, diversity, and inclusion – 2020 was a watershed year that epitomized the public’s growing expectation for companies to back up their commitments to social equity with substantive action. From an investment perspective, it’s also conceded that removing all barriers to inclusion is advantageous, giving a corporation a large pool of candidates for hire and thus a higher probability of recruiting a first-rate workforce.
- Consumer rights – Consumers are more conscious than ever before of their status as a special interest group. The 2008 financial crisis shifted social responsibility from consumers to companies, mobilizing both the private and public sectors to standardize a system of protections safeguarding consumers from predatory business practices. Today, corporations are expected to exhibit sincerity in a concern for their publics’ interests.
Every organization is composed of the people who keep the gears turning, which means all organizations bear corporate social responsibility. In modern stakeholder capitalism, where social capital equates to capital, investors know that a company’s “social” ranking is essential to both their perceived and real market value.
The corporate governance metric of EGS refers to all aspects related to the leadership culture of a given company. This may include:
- Accountability and transparency with stakeholders
- Conflicts of interest
- Earnings (including bonuses) of executive functionaries
- Equitable compensation of employees
- Extension of benefits and security to employees
- Management structure, checks and balances, and division of power
In evaluating corporate governance, ESG ranking agencies put the most focus on accounting transparency and fair (or unfair) financial practices.
Investors, too, are less inclined to entrust in companies that lavish top-billed executives with bonuses while stiffing their employees: not only is it imprudent, but it’s an unsustainable business model unlikely to grow and achieve returns in the long term.
How Is ESG rated?
It isn’t advisable for companies to audit their own activity and determine their own ESG scores (though some do), and the majority of trustworthy ESG reports are conducted by third-party agencies. These providers are on the rise, but there are a few reputable players considered some of the best in the business:
- Bloomberg ESG Data Service
- Corporate Knights Global 100
- DowJones Sustainability Index
- Institutional Shareholder Services
- MSCI ESG Research
- Sustainalytics Company ESG Report
- Thomson Reuters ESG Research Data
There is a high degree of variation between the methodologies used by various ESG ranking agencies, which makes it a challenge for investors and asset managers to certify they’re getting involved with best-practicing businesses. As recently as 2020, the private sector has registered the meteoric value of ESG and moved towards standardizing rankings, with the World conomic Forum’s International Business Council proposing a fivefold system of measurement for ESG.
Why Is ESG Investing Important?
Before the early aughts, it was customary to believe emphasizing environmental, social, or corporate fairness concerns would not only not help but actually hinder corporate performance.
In just a few decades, the stats revealed the contrary: between 2019 and 2020, ESG funding in the U.S. skyrocketed from $21.4 billion to $51.1 billion in new assets. ESG and sustainable investing is no longer an accessory to corporate growth or a charming way for investors to spruce up their portfolios—it’s where the entire market is headed, and investors are shaping their portfolios around high-ranking companies.
Why ESG Matters to Investors
ESG is important to investors for ethical reasons, as well as practical ones:
- Higher returns – Companies leading in ESG consistently outperform their competitors. A Bloomberg Intelligence report predicts ESG assets will balloon to $140.5 trillion by 2025, while 62% of Fortune 500 companies are applying ESG metrics to their corporate governance strategy. With mounting profits and the rapid standardization of ESG practices, investors can rest assured their investments will yield competitively.
- Lower risk – Transparency is a major feature of ESG, and it’s vital for shareholders to stay apprised of a company’s integrity—financially and morally. For investors looking to make long-term investments, in particular, ESG plays a major role in predicting how well a company will do down the line and determining the degree of risk in their investment.
Yes, ESG plays a big role in reshaping the economy for an uncertain future. But for investors, there’s no uncertainty around the material value of backing best-practicing businesses.
Why ESG Matters to Companies
For a long time, the ethos common to most businesses across and between industries was to maximize profits now and worry about future losses later.
ESG, on the other hand, is geared towards the future—environmental stewardship, human welfare, and sustainable corporate practices—and there are several ways that emphasizing ESG can concretely benefit companies themselves:
- Long-term shareholders – Businesses who make sustainability a centerpiece of their company’s strategy, goals, and definition of success will appeal to shareholders who want to make a long-term business commitment with promising future yields. They’re also more likely to attract investors who are willing to play a guiding role in helping a firm fortify its values and grow into the future.
- Employee fidelity – For the rising workforce of millennials, Gen Z, and Zoomers, it’s customary to view their employers’ values as an extension of their own. A commitment to ethics is simply non-negotiable for modern businesses—not only does it affect the talent you’ll have to draw from, but it can be a major factor in motivating employees and improving their overall productivity.
Lastly, modern communications from Twitter to Facebook have made it easier than ever to arbitrate a company’s standing in plain view. Focalizing ESG can help drive value in the eyes of the public, leading to greater interest from quality investors.
Incorporating Better Practices, Improving ESG
No matter what your business does, it’s virtually impossible to get a perfect ESG score or ESG rating.
That said, the purpose of ESG is to incentivize businesses to respond to the changing environmental, cultural, and economic climate by improving upon their business practices—a dynamic, ever-changing process. Three beginning strategies that can help get it off the ground:
- Depending on the size of your firm, you may want to identify a single area of focus to improve upon—ideally one that is already materially relevant to your company’s operations.
- Tie ESG into your company mission, and identify which of your objectives can be reshaped to coincide with measurable goals in environmental impact, social equity, or corporate fairness.
- Publicize your commitment to ESG concerns across company channels to get the word out to your stakeholders.
Wherever you are in your ESG performance now, there will always be room for improvement. The important thing is that by centering ESG in your business mission, you’ll prove to current and potential investors that your brand’s core values will also translate to the market.
Reshape Your Mission with Issuer Direct
Every business needs an online presence to demonstrate transparency and communicate to their investors—and their publics—where their values lie.
Issuer Direct is a premier communications and compliance platform with analytic capabilities to gauge where you stand with your stakeholders, and how to improve your repute.
Whether you’re just beginning to reshape your ESG strategy, or are well on your way to meeting your next milestone, Issuer Direct can equip you with the tools you need to build momentum—internally and among your stakeholders—around your values.
Corporate Finance Institute. ESG (Environmental, Social and Governance). https://corporatefinanceinstitute.com/resources/knowledge/other/esg-environmental-social-governance/
Harvard Law School Forum on Corporate Governance. ESG Reports and Ratings: What They Are, Why They Matter. https://corpgov.law.harvard.edu/2017/07/27/esg-reports-and-ratings-what-they-are-why-they-matter/
World Economic Forum. Measuring Stakeholder Capitalism: Towards Common Metrics and Consistent Reporting of Sustainable Value Creation.