What is Environmental, Social, and Corporate Governance (ESG)?

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Boards across every industry face mounting pressure to be proactive on environmental, social, and governance (ESG) issues. Here’s how to do it.

According to Deloitte, boardrooms will take an increasing role in overseeing an organization’s environmental, social, and corporate governance (ESG) activities. It means board members will need to assume an active role to ensure that ESG initiatives align with business strategies. They will be responsible for evaluating the risk associated with ESG proposals and assessing an organization’s maturity as it relates to ESG concerns.

As standards converge and reporting requirements become mandatory, boards have an added responsibility to understand ESG frameworks. They need to ensure ESG and financial disclosures align and also consider third-party auditing of ESG initiatives. As more investors look at ESG criteria when making decisions, boards must assess their organizations’ strategies.

What is ESG?

Environmental, social, and corporate governance are the three pillars of ESG activities that the public evaluates when deciding to do business or invest in an organization. Although ESG concerns existed in the 1960s with boycotts of companies participating in the Vietnam War or negatively impacting the environment, only recently has ESG become mainstream.

When consumers and investors evaluate ESG criteria, they look at the following:

Environmental: What is a company doing to improve and protect the environment? What conservation measures are they taking to reduce energy consumption and pollution?
Social: Companies have an obligation to be responsible for their impact on the social fabric. How do they treat employees? Are they using child labor? What are organizations doing to support local communities?
Governance: Are businesses behaving ethically? How do their actions compare with their policies? Organizations need to show diversity and a structure that supports environmental and social initiatives.

Forbes reported that 64% of consumers support socially responsible companies and 36% indicated they would increase spending with these businesses in 2022. Over 80% said they would base their ongoing support of a brand on how the organization treated its employees during the pandemic. Additionally, 76% are concerned about the impact corporations have on both society and the environment.

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What is ESG Investing?

ESG investors look at more than financial data when deciding to invest in a company. They look at non-financial factors such as material risk, sustainability, and social responsibility. Investors consider additional factors beyond stock prices and dividends. Boards should ensure the ESG factors are part of their agenda.

Currently, the evaluation process is hampered by the lack of a single standard. Institutions such as the Sustainability Accounting Standards Board (SASB) and the Global Reporting Initiative (GRI) are just two of the many organizations offering an ESG rating framework. According to Deloitte, a new International Sustainability Standards Board is being formed under the auspices of the United Nations to provide clarity for investors.

ESG Investment Criteria

Different companies use different standards to report their ESG initiatives. Many use third-party firms that provide an ESG auditing function to produce an ESG score or rating. The criteria vary based on the standards used and the firm doing the rating. However, most standards look at the following:

Environmental Criteria: Investors look at a company’s impact on climate change, deforestation, carbon emissions, waste management, water conservation, and pollution.
Social Criteria: Individuals are interested in how organizations perform in areas such as employee engagement, human rights, community relations, labor standards, diversity, and consumer protection.
Governance Criteria: Consumers and investors evaluate how a business operates by assessing its anti-corruption policies, board composition, executive compensation, auditing, political contributions, and lobbying efforts.

How the criteria are applied depends on the standard and the evaluators, making it difficult for investors to determine exactly what an ESG score really means.

What are ESG Funds?

ESG funds can include mutual funds, index funds, and exchange-traded funds that show a positive impact on the environment and society through well-governed policies and procedures. Boards need to ensure their members keep ESG factors on the agenda.

Investing in ESG funds is a strategy that rewards companies that meet stringent ESG standards. In many cases, younger investors are leading the trend. If boards want to ensure a strong investment future, they need to make ESG scores a priority.

What is an ESG Score?

An ESG score rates a company’s ability to balance its sustainability risk against its financial performance. The third-party firms that perform the assessment use proprietary formulas to assign an ESG score. One company may use rankings such as AAA and BBB while another may produce a numeric value such as 15 or 13.2. Without knowing the ESG criteria used, it’s difficult for investors to know which ESG funds to support.

Industry-specific ESG factors provide an equitable set of criteria for evaluating organizations. Comparing a tech company’s ESG rating to a steel producer does not reward the manufacturer who may be leading their industry in ESG initiatives. Boards should ensure they use the appropriate evaluation criteria for ESG investments.

How Boards Measure ESG

The Sustainability Accounting Standards Board (SASB) uses an industry-specific framework to outline what information organizations should collect to produce the most accurate assessment of their ESG efforts. Boards should prepare for ongoing discussions with investors and regulators to understand what ESG concerns to address. The ESG ecosystem is extensive and companies must prioritize the factors that have the largest impact on their financial and sustainability future.

Boards have a responsibility to understand ESG standards and guide their organizations to adopt an inclusive framework. Strong ESG outcomes depend on a cross-functional group that includes risk management, human resources, communications, and investor relations. Through effective communication, boards can break down any silos that could impede their ESG initiatives.

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About The Author

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At OnBoard, we believe board meetings should be informed, effective, and uncomplicated. That’s why we give boards and leadership teams an elegant solution that simplifies governance. With customers in higher education, nonprofit, health care systems, government, and corporate enterprise business, OnBoard is the leading board management provider.