Environmental, Social, and Government Factors

The ESG Approach: What is it and Why do You Need it?

by Abby Portugal on and last update on January 28, 2020

Whether you’re the company looking for investors, or you have resources you wish to invest, it’s important to get up to date with a popular approach in today’s investing world: ESG.

 

In short, ESG refers to environmental, social and governmental factors. A company that wishes to attract investment will need to score well in all three categories. And if you’re the one looking for a wise investment, an initiative that performs well in all these areas often ends up being the best option.

 

But why the focus on these three aspects? Let’s elaborate.

 

ESG Explained

Environmental Factors

In this category a company is evaluated in terms of its relationship with the environment.

 

For starters, investors need to associate with companies that act according to the same values they hold. If your business promotes sustainable practices it won’t be good for your reputation to be linked to an entity that doesn’t limit its carbon footprint.

 

In this part of the ESG approach, a company can be rated in terms of:

  • Their role in climate change. For example, is the company reliant on fossil fuel and do they have plans to limit greenhouse gas emissions?
  • Does the company use raw materials or renewable energy?
  • Recycling and waste disposal policies
  • Internal initiatives to encourage employees to live in a more environmentally conscious manner, such as offering incentives for those cycling to work or using public transportation.

 

This aspect becomes increasingly important in today’s world where climate change is a looming threat. Companies realize they can no longer simply act without considering their impact on the environment.

 

Social Factors

The next aspect to be evaluated is the company’s relationship with all people involved in its network, including:

  • Employees
  • Clients
  • Suppliers
  • Consumers at large

 

The reasoning here is that it’s wiser to trust investments made in companies that will remain successful in the long run. For example, if a company’s policies don’t ensure fair treatment of employees, staff turnover rates will be high. This leads to more expense for the business and can even lead to its downfall.

 

You also want to invest in companies that prepare their staff for future challenges with proper training. This improves a business’ chances of performing well in a changing environment.

 

In terms of a business’ wider network, make sure that its suppliers follow policies similar to the company’s own. Third parties that don’t care about responsible sourcing could affect the reputation of anyone it’s connected with via business dealings or investments.

 

Some investors may even go so far to consider the business’ impact on the local community. Does it launch projects to uplift individuals’ way of life? Ideally, a company shouldn’t exist only for its own advantage, but for the benefit of its community at large.

 

Business leaders’ sense of social responsibility becomes clear in how they impact others, so it’s easy to gauge this aspect of the ESG approach by researching on your reputation in the neighborhood and industry. For example, if there’s too much negative feedback from previous employees, you may not fare well in this category.

 

Governmental Factors

It also matters how exactly a company is governed. Matters to research here are the board of directors, other stakeholders, and the policies applied by these key people. The system must ensure there’s a balance in how power is allocated to CEOs, directors, and other leaders.

 

Potential investors can ask questions such as:

  • Are top management’s salary packages and bonus payouts fair? Incentives earned by executives must be justified by the success of the business.
  • Is there a proper accounting system in place?
  • How does the voting system work during board meetings? Is the method fair?
  • Does the company act in a transparent manner towards key individuals such as shareholders?
  • Is the board of directors diverse enough to ensure that multiple angles and sectors are considered when making decisions?
  • How are new board members recruited and picked?

 

What Does this Mean for You?

The ESG approach is all about making wise investments. To prove you’re the best long-term investment option for others to trust in, you need to consider how you’ll fare when audited in all these categories. On the other hand, if you’re an investor, the ESG approach may limit your initial investment options, but it’s ultimately meant to guide you to opportunities that will serve you well in the long-term.

If you’re looking for a relevant framework to discover which areas your company should improve in—or if you need to vet a potential new investment before you commit—give some thought to the ESG approach.

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