Environmental, social and governance Corporate standards and principles, often referred to as ESG, are becoming increasingly common and controversial.
But what does ‘ESG’ actually mean?
It is an abbreviation for the way many businesses operate in accordance with the belief that their long-term survival and ability to generate profits require taking into account the impact their decisions and actions have on the environment, society as a whole and their own workforce.
These practices have emerged from longstanding efforts to achieve this make companies more social and environmentally responsible.
ESG investing, also called sustainable investmentalso takes these considerations into account.
Zoom in on the E, S and G
ESG priorities vary widely, but there are some common themes.
These priorities generally emphasize environmental sustainability – the E in ESG – with an emphasis on contributing to efforts to that end slow the pace of climate change.
Efforts are also made to uphold high ethical standards through business operations. This social concerns – the S – could mean, for example, that a company does not buy goods and services from exploitative suppliers, or treats its employees well. Or it could mean ensuring that a diverse workforce is hired and retained, and taking steps to reduce social injustices in the communities where a company operates.
Companies that embrace ESG principles should do so too high-quality governance – the G. Governance includes oversight, carried out by a competent and qualified board of directors, regarding the hiring and firing of top company executives, executive compensation and any dividends paid to shareholders.
Governance also concerns whether a company’s leadership operates honestly and responsibly, with transparency and accountability.
Why ESG is important
By 2026, the total amount invested worldwide according to these principles will be too nearly doubled to $34 trillion of $18.4 trillion in 2021, accounting firm PwC estimates. However, increasing control whose investments actually qualify as ESG could mean it takes longer to reach that volume.
This business concept is becoming a political touchstone in the US as some states like it Florida and Kentucky, arguing that these practices distract from the focus on profit maximization and can harm investors by making other considerations a priority, have discouraged their pension funds from using ESG principles as part of their investment considerations. Some very major asset managers, including BlackRock, are no longer allowed to work with those pension funds.
A lot of the arguments against embracing these principles believe that they reduce profits by taking other factors into account. But how do ESG practices impact financial performance?
A team of scientists from New York University looked at the research results of 1,000 different studies who tried to answer this question. It produced mixed results: some studies found that ESG principles increased returns, others found that they weakened performance, and a third group found that these principles made no difference at all.
It is possible that the differences between the results are largely due to the lack of clarity about what does and does not count as ESG, which is a lengthy discussion and makes it difficult to assess how ESG investments are performing.
The NYU scientists also found two consistent results regarding ESG strategies. First, they help protect investors from risks such as losses from supply chain failure due to environmental or geopolitical issues, and can protect companies from volatility during periods of economic instability and recessions. Second, investors and companies benefit more from ESG strategies in the long term than in the short term.