Environmental, social, and governance (ESG) are criteria used to assess how companies’ operations affect the three key aspects of their operations. The environmental aspect evaluates how a company’s operations affect the natural environment by looking at factors such as carbon footprint, water consumption, waste management, energy consumption etc.

The social aspect evaluates the relationship with the company’s human interface, including employees, the immediate neighboring communities, suppliers etc. Finally, the governance aspect looks at the management structure and its adherence to best management practices.

ESG is increasingly being adopted by investors as a yardstick for measuring the risk levels and suitability of potential investment opportunities. Going forward, it is therefore important that businesses integrate ESG into their operations.

Benefits of ESG

ESG reporting has become an invaluable asset for companies seeking to expand their business footprint and endear themselves to investors and communities. ESG creates another layer of protection for would-be investors and streamlines the relationship among companies, their shareholders, communities and natural environments within which operations are carried out.

Through the implementation of ESGs, the bad apples in the corporate world will be filtered out because of bad publicity or as a result of costly, unsustainable business practices. Environmental and social needs are especially of great concern in today’s world. Disasters such as the BP oil spill and the Volkswagen emissions scandal are examples of how costly it can be for companies to neglect their ESG responsibilities.

Adopting ESG reporting may initially be perceived to be a costly inconvenience. However, it has been proven that the benefits of ESG far outweigh the initial investment required. Below are some of the key benefits of ESG, discussed under different thematic criteria.

Environmental factors

  • Promoting efficient use of resources. Under this aspect, ESG looks at resources used by companies, such as energy, water and raw material.  This aspect seeks to promote the use of energy-efficient technologies, promotion of recycling, enhancing water use efficiency, etc.
  • Reducing pollution.  ESG looks at the ways of minimizing the amount of waste generated by companies. This also extends to carbon emissions reduction strategies such as the use of renewable energy. Companies that adopt pollution reduction strategies benefit by avoiding penalties, getting incentives and winning public goodwill, which is an asset for good public relations and promotion of company image.

Social factors

  • Safeguards the wellbeing of employees. ESG ensures that the safety and health of employees are protected. It also promotes good rapport between employees and management. Some of the programs implemented under this segment include the provision of adequate personal protective equipment (PPEs), proper remuneration of workers, provision of insurance cover for employees, etc.

Companies stand to benefit by avoiding lawsuits related to workplace injuries, reducing staff turnover, winning staff loyalty, and increasing productivity.

  • Promotes socially responsible business practices. Companies do not operate in isolation but within communities. This, therefore, means that business activities may adversely affect those living within their areas of operations. Companies, therefore, have to undertake their operations in a socially responsible manner. This includes avoiding/minimizing pollution of water, air, and soils, recruiting local labor, implementing Corporate Social Responsibility (CSR) projects etc.

This strategy protects company image from negative publicity, enhances community support for businesses and protects companies from lawsuits, among other benefits.

Governance

  • Better internal controls and Risk Management. The creation of proper and functional internal control mechanisms is the key to the success of a company. This ensures that employees are keen on detail and willing to take personal responsibility for their actions. It also helps in the identification of systemic risks and promotes proper financial reporting and good bookkeeping.
  • Optimized decision-making. ESG creates structures to incorporate the views of all key stakeholders in the decision-making processes of companies. These include shareholders, directors, managers and the board. In essence, this aims to eliminate a situation whereby the advice of a segment of decision-makers does not count.

Ultimately, this ensures that boardroom feuds are minimized and that the synergies of different decision-making arms of a company are harnessed to optimize profitability. In addition, adopting proper engagement mechanisms between shareholders and management promotes transparency and accountability.

  • Improves the rating/ranking of companies. In addition to improving the performance of companies as highlighted above, ESG is also used by rating agencies in evaluating the standing of companies. Through this, investors and lenders can know what they are getting into. This, therefore, means that a company with a well-established ESG reporting standard stands a better chance of attracting funding than one without. 

Admittedly, ESG is a fairly new concept, but it has gained traction and its adoption is on the rise. ESG also suffers the challenge of a lack of a standard way of reporting. Companies are therefore free to choose the standard that best suits them, but the lack of a universally agreeable standard also makes it difficult to compare the performances of different companies.

How is the ESG Score calculated?

ESG is a composite of environmental, social and governance aspects of companies. In the absence of a universal standard of ESG reporting as highlighted above, companies have a free hand in choosing what works for them. However, in doing so, companies must ensure that they go with the best international practices as pertains to environmental management, accounting/bookkeeping, employee management, etc. This will ensure that the resultant scores are pegged on proven competitive standards which are not susceptible to subjectivity.

Bottom line

Environmental, social, and governance criteria are important considerations for the success of a company. Heading into the future, many investors will be keen to know the level of risk they are exposing their monies to. Companies, on the other hand, stand to gain from ESG  by enhancing their image and improving the efficiency of their operations and productivity. The initial investment in ESG may require a significant increase in expenditure, but the returns always far outweigh the costs.