What Does ESG Mean in Business and Sustainability?

Today, thousands of companies are working to improving their environment, 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 frameworks for how businesses and investors think about capital allocation, risk assessment, and corporate sustainability.

What does ESG mean?

ESG means environment, social, and governance, a set of criteria used by investors, boards of directors, managers, and other stakeholders to evaluate the sustainability, responsibility, and risk profile of a business.

ESG focuses on "non-financial" performance indicators compared to financial investor metrics like revenue or earnings-per-share. However, ESG issues are increasingly influencing companies' access to capital, share price, and long-term competitive standing, which have direct financial impacts for businesses. ESG criteria give decision-makers a broad 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 meaning:

Environmental

Environmental ESG means activities, attributes, issues, and disclosure areas like:

In many ways, this ESG category essentially has a similar meaning to how we might define 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

Social ESG means activities, attributes, issues, and disclosure areas like:

Internally, this ESG category is closely connected to a company's HR (human resources) and CSR (corporate social responsibility) policies, programs, and practices.

Governance

Governance ESG means activities, attributes, issues, and disclosure areas like:

As well as other aspects that balance the rights, responsibilities, and identity of various shareholders and stakeholders in the company.

You can think of corporate ESG as 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.

But, as an investor or business decision-maker, if you only rely on a company's financial reporting, you aren't considering the full reality of how that organization operates, or what its impacts might be. As we've recently seen with companies like Exxon Mobil, JPMorgan Chase, Wells Fargo, and Tesla, 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 criteria help investors and other decision-makers interpret and answer.

What ESG Means for Your Business

Due to a variety of economic, social, scientific, and political factors, support for responsible, stakeholder capitalism and assessing the long-term role of business 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 approach to risks, opportunities, and value creation. But ESG also has near-term, immediate consequences, particularly for businesses who fail to consider and address material ESG issues.

In particular, businesses need to consider important and strategic ESG topics like:

In many ways, ESG performance has become a new way to evaluate the responsible management quality, brand reputation, and macroeconomic risk management of a business. 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.

What Does ESG Mean in Regards to Sustainability?

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 ESG as an inward perspective and sustainability as an outward perspective.

In other words:

ESG looks at how the world impacts a business as an investment, whereas sustainability focuses on how a business (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.

Today, the ultimate meaning of ESG is that brands and business leaders need to keep up with - if not anticipate - economic, social, scientific, and regulatory trends, while also designing flexible structures, technology, and operating principles to adapt to new and emerging ESG issues.

How ESG Brings New Meaning to Business and Corporate Purpose

The emerging importance of ESG means businesses need to be able to consistently demonstrate and communicate strong, thoughtful, and strategic ESG performance. The ones who do will have a clear competitive advantage over their peers who ignore ESG, or do the bare minimum. Many companies start ESG work because of compliance and investor reporting pressures, only to find that as their ESG investments, maturity, and capabilities evolve, their company realizes significant cross-company benefits, efficiencies, and positive ROI.

Every company's ESG roadmap is different - and ESG truly is a long-term, strategic journey for businesses and management teams. Nonetheless, the benefits of strong ESG performance on brand reputation, employee talent attraction and retention, culture, operational efficiency, risk management, and access to capital are not only numerous - many are quantifiable.

Ultimately ESG principles give business new meaning - one that extends beyond a narrow view of shareholder value to consider stakeholder and social value. If corporate purpose or a company's mission statement sets its north star, ESG is how an organization realizes that purpose throughout its business, which can be a powerful strategic tool for company culture and innovation.