ESG and sustainability initiatives are very common in various companies and firms nowadays and have started emerging within the last few years. I wasn’t even aware of this initiative before my summer internship and I was really interested in how companies whose primary focus is on money and profits can bring environmentalism into their business.
ESG stands for environmental, social, and governance. It is a term used that is used to represent an organization’s corporate financial interests that focus mainly on sustainable and ethical impacts. ESG investing refers to a set of standards for a company’s behavior used by socially conscious investors to screen potential investments. Environmental criteria consider how a company safeguards the environment, such as corporate policies addressing climate change.
Companies have certain criteria for evaluating and working with ESG initiatives and ESG investing. These standards are the central factors that measure the ethical impact and sustainability of investment in a company. ESG focuses on environmental standards such as climate change, resource depletion, waste and pollution, and deforestation. It also focuses on social standards such as working conditions, local communities, conflict, health and safety, and employee relations and diversity. Finally, ESG focuses on governance standards such as executive pay, corruption, board composition, diversity, and structure. Although it may not seem like it at first glance, these factors have increasing financial relevance for firms. ESG investing identifies and quantifies risks that are overlooked by traditional financial metrics.
The E in ESG, environmental criteria, includes the energy your company takes in and the waste it discharges, the resources it needs, and the consequences for living beings as a result. Not least, E encompasses carbon emissions and climate change. Every company uses energy and resources; every company affects and is affected by, the environment. The S in ESG, social criteria, addresses the relationships your company has and the reputation it fosters with people and institutions in the communities where you do business. S includes labor relations and diversity and inclusion. Every company operates within a broader, diverse society. The G in ESG, governance, is the internal system of practices, controls, and procedures your company adopts in order to govern itself, make effective decisions, comply with the law, and meet the needs of external stakeholders. Every company, which is itself a legal creation, requires governance.
As ESG and sustainability measures and initiatives are a relatively new and emerging tool, the value that it brings to a firm and how effective it is is questionable. ESG’s financial performance has not been giving us promising results. The University of Chicago researchers analyzed the Morningstar sustainability ratings of more than 20,000 mutual funds representing over $8 trillion of investor savings. Although the highest-rated funds in terms of sustainability certainly attracted more capital than the lowest-rated funds, none of the high-sustainability funds outperformed any of the lowest-rated funds. Additionally, researchers at Columbia University and the London School of Economics compared the ESG record of U.S. companies in 147 ESG fund portfolios and that of U.S. companies in 2,428 non-ESG portfolios. They found that the companies in the ESG portfolios had worse compliance records for both labor and environmental rules. They also found that companies added to ESG portfolios did not subsequently improve compliance with labor or environmental regulations.
One of the reasons that ESG funds are performing poorly could be that this is a relatively new development. Therefore, it will take some time for these ESG initiatives to be fully implemented and operational before they are beneficial and advantageous to companies.
Overall, ESG and sustainability initiatives are definitely an exciting tool that is being utilized by so many different companies and firms around the world. At the same time, we need to be cautious about how we can efficiently incorporate these into our businesses and the true value it brings, and the real impact it has on our consumers, our communities, and our world.
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