There’s more to an investment than the amount of cash that it generates. In the long term, factors like the impact that a given business has on the surrounding world, be it human society or the natural environment, needs to be factored in.
Of course, quantifying these things is a tricky thing to do. That’s why investors are increasingly turning to something called Environmental, Social and Governance.
In the long-term, adopting a well-planned ESG strategy will benefit the business financially. It will put it ahead of the curve where legislative change is concerned, and leave it less vulnerable to reputation-damaging scandals. A company which puts in place proactive measures to reduce harm, and to identify potential sources of harm, is less likely to suddenly discover that it’s doing so inadvertently.
But what does ESG actually mean in practice? Let’s examine each part of the acronym in turn.
What does Environmental mean in ESG?
As you might expect, environmental factors relate to the company’s relationship with the environment. Those which spew out pollution and carve out swathes of forest are going to score poorly. Those which limit their emissions and implement a recycling policy will fare better. We should note that an investment’s overall environmental impact is determined by its wider impact on the supply chain: just because a business isn’t generating emissions on-site doesn’t mean that it can’t be a net emitter, thanks to the materials that it’s bringing in.
What does Social mean in ESG?
A socially-responsible business is one that has a positive impact on the people it comes into contact with. This means not just the employees who constitute the business, but the employees of suppliers, the customers, and the wider community within which the business is sited. Working conditions and health and safety are key determiners of Social performance. But we shouldn’t just think of social factors as the absence of negativity, but as a generator of positivity – an investment which creates job satisfaction is likelier to pay off, all other things being equal, than one that doesn’t.
What does Governance mean in ESG?
If a given company isn’t well governed, then the other two factors aren’t worth much in the long-term. To determine the quality of governance, we might look at the rights afforded to shareholders, the amount that executives are paid, and the availability of opportunities across the organisation.
As time goes on, concern about these factors isn’t going to dissipate – it’s only going to intensify, as consumers and investors look for ways of quantifying all of the factors we’ve mentioned. ESG provides a succinct, though imperfect, way of doing just that.
