Environmental and social governance (ESG) criteria are rapidly becoming guideposts for business operations and investor decisions. Investors, consumers and employees all have rising expectations around the environmental and social responsibility of corporations — and businesses increasingly recognize the need to integrate ESG factors into business growth and risk management strategies. But what exactly is ESG, how are ESG criteria evaluated, and how can businesses effectively communicate their ESG commitments to investors, analysts, employees and other key audiences?
What is Environmental and Social Governance (ESG)?
Environmental, social, and governance (ESG) criteria provide a new paradigm for evaluating a company’s operations according to responsible, ethical, and sustainable standards. ESG can also be thought of as an evolution, broadening or integration of Socially Responsible Investing (SRI), Corporate Social Responsibility (CSR), sustainable investing and impact investing.
What are ESG criteria?
As the name suggests, ESG criteria can be broken into three categories:
Environmental criteria look at a company’s impact on the environment. This typically includes ESG factors such as:
- Energy & water usage
- Carbon footprint
- Waste, emissions & pollution
- Use of toxic chemicals in manufacturing processes
- Supply Chain sustainability
- Natural resource conservation
- Compliance with environmental regulations
- Climate change mitigation
Environmental criteria might also look at how a company is assessing, addressing and mitigating future risks that environmental and climate change may present to the business.
Social criteria look at the social impact — both internally and externally — of the company. This includes factors such as:
- Diversity, equity and inclusion (DEI) efforts internally
- Support for DEI causes in the broader community
- Employee mental health & wellness support
- Responsible vendor/partner relationships
- Data hygiene, data privacy & data security
- Charitable donations & volunteer work
- Community relations
Governance criteria look at processes that ensure the company’s leadership — board of directors and executive management — can transparently, consistently and effectively drive positive change. This includes factors such as:
- General accounting & financial reporting practices
- The makeup of the Board of Directors
- Executive compensation guidelines & transparency
- Venture partner compensation & influence
- Political advocacy & contributions
- Shareholder engagement & communications
- Hiring standards
Why do companies need to pay attention to ESG?
The expectations placed upon companies are shifting and rising as consumers, investors and regulators demand that businesses stand for values beyond pure capitalistic profit-maximization. But the business case for ESG criteria is also becoming more compelling — for investors and for companies. Traditionally, Socially Responsible Investing (SRI) and other forms of impact investing implied that the investor was prioritizing ethical value or outcome over financial performance. But increasingly, analysts and investors recognize that ESG criteria provide a strong risk management framework — helping investors avoid companies whose risky practices present undue investment risk. Likewise, evidence suggests that aligning business investments and strategies with ESG criteria position companies for better long-term growth and stability, helping businesses navigate growing environmental and social issues that present risks to bottom-line health and top-line growth, and increasingly threatens the future viability of conventional business models.
To frame the issue in another way, the stunning numbers behind the growth of ESG investing makes this a matter of critical importance for every company. According to a report from early 2020, investors held $17.1 trillion in assets chosen through ESG criteria — a nearly 50% increase over the $12 trillion from 2018. Almost 60% of investors say their interest in ESG investments has increased in the last year, according to a 2020 survey by Investopedia and Treehugger. And the ESG paradigm shift is being powered by younger demographics, with a Morgan Stanley survey finding that 9 in 10 millennial investors are interested in the kind of value-based investing that ESG criteria enable.
How does ESG drive business value?
Making a business case for investing in a strong and compelling ESG strategy or proposition has largely focused around attracting ESG investors. But today, analysts say there’s a much broader business case behind ESG. McKinsey & Company summarized five key ways that ESG factors drive business value:
- Powering top-line growth: This is the traditional business case — that a strong ESG proposition can fuel investor confidence and build consumer preference, helping the business drive top-line growth.
- Cost reduction & cost efficiency: Using ESG criteria to guide and refine operational strategies can deliver a range of cost reductions and operational efficiencies — from significant energy and water savings to smarter big-picture considerations of how to use resources more efficiently in the long term.
- Minimized regulatory & legal burdens: Just as it does with investors and consumers, a strong ESG proposition can earn trust and goodwill among regulatory and governing agencies, helping to minimize regulatory costs and burdens, as well as mitigate the potential for legal issues relating to regulatory compliance.
- Enhanced employee engagement & productivity: Studies demonstrate that a strong ESG proposition can boost employee engagement and satisfaction within a company, as workers increasingly seek to connect their work with value-driven meaning. Higher engagement and satisfaction help boost productivity, as well as helping a company attract and retain quality talent.
- Optimizing investments: Tying back to the second point above, ESG criteria help businesses make smart investments and capital expenditures, and build forward-thinking strategies that more holistically consider long-term sustainability and efficient resource utilization.
- Back to investor/consumer confidence: As the evidence builds connecting ESG factors to stronger business performance, a strong ESG proposition becomes a virtuous cycle. Investors and consumers value the ESG proposition in principle — and are further attracted to the sustainable business performance benefits.
How do you showcase ESG to investors?
With rapidly growing demand from investors, analysts, consumers and employees — and the growing business case beyond that — it’s become critically important that companies not just prioritize ESG factors. Businesses need to effectively showcase their ESG proposition and their ESG-driven programs, investments and strategies.
There are no universal metrics for quantifying ESG factors. However, several reputable analysts — S&P Dow Jones Indices, MSCI and Bloomberg, among others — have attempted to create ESG indices or scoring systems. These ESG ratings consider things like statements made in annual reports and shareholder communications and evaluation of corporate sustainability measures, employee and financial management, board structure and executive compensation, and more. Today’s data-hungry investors are eager for these kinds of objective ESG metrics — though they are far from scientific or comprehensive, and can vary quite a bit for the same company.
Directly communicating your ESG proposition to shareholders, investors & the public
Companies should stay in tune with third-party ESG metrics like those mentioned above. But the value of telling a company’s ESG story has become too important to leave to third-party metrics alone. Companies need to take control and proactively showcase ESG initiatives through their shareholder communications, telling a clear and compelling story around their ESG proposition.
Toppan Merrill is helping hundreds of forward-thinking companies successfully tell their ESG story. The extensive experience we’ve gathered over the last several years has enabled us to create a set of best practices for integrating and showcasing ESG in your proxy statement, annual report and other shareholder communications. These proven best practices go far beyond generic statements and cold metrics. We help companies create highly visual, engaging and compelling storytelling around the what and the why of their ESG proposition — so all key constituents can easily and confidently see how ESG criteria are powering current business strategies and supporting sustainable, value-driven business performance.
Check out our Proxy Statement Style Guide to see how forward-thinking companies are elevating compelling stories around ESG within their shareholder communications.