Today, most companies have committed to improving their environmental, social, and governance (ESG) performance to meet growing demands from investors, regulators, and customers. In an era of climate change, global conflict, and social inequality, ESG has become one of the most important trends in capital allocation, risk assessment, and corporate value creation.
ESG stands for environment, social, and governance, a set of criteria used by investors, boards, managers, and other stakeholders to evaluate the sustainability, responsibility, and risk profile of a business.
While ESG focuses on "non-financial" performance indicators compared to classic investor metrics like profit and earnings-per-share, ESG issues increasingly have material, financial impact on a company's access to capital, operating costs, and long-term competitive standing. ESG criteria give decision-makers a holistic lens to evaluate a business' strategy, operations, opportunities, and risks, by accounting for all its stakeholders, including investors, employees, the environment, and society.
While ESG scores and ratings are often grouped together by investment analysts, each of the three sections have their own distinct considerations:
Environmental ESG activities, attributes, issues, and disclosure areas include:
This ESG category essentially encompasses our basic definition of corporate sustainability — balancing the environment, equity, and economy across products, packaging, facilities, energy usage, people, and waste in a way that doesn’t contribute to global warming, climate change, and biodiversity loss — through an investment and corporate decision-making lens.
Social ESG activities, attributes, issues, and disclosure areas include:
Internally, this ESG category is closely connected to a company's HR (human resources) and CSR (corporate social responsibility) policies, programs, and practices.
Governance ESG activities, attributes, issues, and disclosure areas include:
As well as other aspects that balance the rights, responsibilities, and identity of various shareholders and stakeholders in the company.
A helpful way to view corporate ESG is the social externality side of financial accounting. In modern history, public companies operate, account for their financial performance, and then issue shareholder reports like a 10-K which investors can use to decide if they want to invest in the company or not. The problem with this narrow approach however — as we've recently seen with companies like Exxon Mobil, JPMorgan Chase, Wells Fargo, and Tesla — is that financial accounting alone doesn’t fully account for the consequences and risks of operating a company, particularly long-term:
These are the types of questions ESG attempts to interpret and answer.
Due to a variety of economic, social, scientific, and political factors, support for responsible, stakeholder capitalism and assessing the long-term role of companies in society has grown considerably over the past decade. The impact of the COVID-19 pandemic, climate change, Black Lives Matter, wealth inequality, government gridlock, and regulatory uncertainty have increased the need for companies to proactively integrate ESG issues and risk management into their strategy, policies, business model, company culture, and value chain.
Compared to quarterly earnings cycles and short-term decision-making, ESG is a longer-term lens on risks, opportunities, and value creation. But ESG also carries near-term, immediate consequences, particularly for companies who fail to consider and address material ESG considerations.
In particular, effective ESG integration (or lack thereof) informs important strategic considerations like:
In many ways, ESG performance has become a proxy for responsible management quality, brand reputation, and macroeconomic risk management. A well-run company that cares about its people, customers, and the environment will logically be more resilient over time and outperform its peers who don't.
ESG and sustainability are often used interchangeably within companies to mean similar things. However, there are important differences between ESG and sustainability. We think the best way to understand the difference is to consider an external vs. internal perspective.
In other words:
ESG looks at how the world impacts a company as an investment, whereas sustainability focuses on how a company (or investment) impacts the world
Strong, thoughtful corporate sustainability should correlate with strong ESG performance, but not always. A sustainable products company could still discriminate against certain workers. Or a firm with strong ESG governance and transparent reporting can still cause immense environmental harm in its day-to-day business.
Like sustainability, ESG and CSR are closely related, but fundamentally different. If we refer to our previous definition about the difference between ESG and sustainability, CSR and ESG have a similar relationship.
Inside companies, CSR departments run programs and initiatives centered around non-profit partnerships, philanthropic giving, employee engagement, and community relations designed to create positive social benefit. The same way corporate sustainability targets environmental impact, CSR proactively works to improve a company's social impact.
ESG looks at how society impacts a company as an investment, whereas CSR focuses on how a company (or investment) positively impacts society
Often, within a larger company, the sustainability department will lead the organization's environmental intitiatives, a CSR department will lead external social invitiatives, and HR will manage the company's internal social initiatives like diversity, equity, inclusion, and belonging. All three of these teams will share data with their ESG reporting colleauges, who turn that information into ESG reporting and investor communications.
2022 continues to be an eventful and turbulent year. Much like the news cycle itself, ESG issues also trend in terms of global and stakeholder attention and prioritization. While every company's ESG materiality is unique, here are some of the most important ESG issues leaders, boards, and investors need to keep in mind in 2022:
Within ESG, it's critical for leaders to keep up with - if not anticipate - these trends, while also creating flexible structures, technology, and operating principles to adapt to new and emerging ESG issues.
While ESG may feel like a reporting obligation, dozens of case studies demonstrate that strong, thoughtful, and strategic ESG performance is a competitive business advantage that delivers positive ROI. Many companies start ESG work due to compliance and investor reporting pressures, only to find that as their ESG investments, maturity, and capabilities evolve, their company realizes significant cross-company benefits and efficiencies.