What is ESG? Environmental, social, and governance commitment explained

What is ESG and why is it important?

Environmental, social, and corporate governance (ESG) is a strategic framework for identifying, assessing, and addressing organizational objectives and activities ranging from the company’s carbon footprint and commitment to sustainability, to its workplace culture and commitment to diversity and inclusion, to its overall ethos regarding corporate risks and practices. It’s an organizational construct that’s become increasingly important, especially to socially responsible investors who want to invest in companies that have a high ESG rating or score.

The three main pillars of ESG include:

• Environmental commitment: This includes everything around a company’s commitment to sustainability and the impact it has on the environment, including its carbon emissions and footprint, energy usage, waste, and environmental responsibility.
• Social commitment: This covers a company’s internal workplace culture, employee satisfaction, retention, diversity, workplace conditions, and employee health and safety. Companies with happy and healthy employees perform better and are viewed as a stronger investment.
• Corporate governance: A company’s commitment to governance includes compliance, the internal corporate culture, pay ratios, the company ethos, and transparency and accountability in leadership. Investors are interested in companies that can keep up with changing laws and regulations, and that have a commitment to equity and equality in the workplace.

Your company’s environmental efforts will only become more important as the effects of climate change continue to grow. Companies that are more prudent with resources, such as water, coal, oil, and electricity, are predicted to fare better in a future where those resources may be limited in certain areas. Similarly, a company’s social profile is more important than ever in a time where a single Tweet can negatively impact an entire brand or company’s reputation. And as more laws and regulations arise around technology, most notably GDPR, a strong commitment to proper governance and compliance will be crucial for keeping a company operating and in business.

ESG score and rating

ESG scores are determined by third-party firms that have their own methodologies to identify a company’s ESG rating. Currently, this isn’t a process that is streamlined across the board, and different companies have their own way of determining a company’s ESG rating. ESG scores and ratings are important because they give an overall picture of the company’s performance in these three areas.

These scores help inform potential or current investors and can even help inform governments as to whether they want a company operating within its borders. A higher ESG score also aligns with a company being more sustainable, having happier employees, and being more productive and profitable overall due to better working conditions. Typically, ESG scores are rated from 0 to 100 with anything above a 70 classified as a “good” ESG rating, while anything below 50 is considered a “bad” rating. Some systems, however, rely on a letter-based scoring system where a grade of C is the worst and A is the best.

ESG investing and analysis

Because ESG has become a large part of the investment process for businesses, having an ESG analysis performed for your company can go a long way to showing investors that your company is worth their time and money. Investors have started looking at the overall values of the companies they’re investing in, and brokerage firms and mutual fund companies have responded by offering exchange-traded funds (ETFs) that track ESG ratings.

ESG investing is often called impact investing, sustainable investing, responsible investing, or socially responsible investing (SRI). ESG investors want to invest in companies that have a commitment to accountability, sustainability, and that are overall good places for employees to work. Companies negatively contributing to the environment, social responsibility, or governance, aren’t viewed favorably by these investors as a solid long-term investment.

What does a good ESG score mean for business?

For companies looking to improve their ESG rating, one big change is switching to smart building technology to manage waste and improve efficiency. Smart building technology can help automate climate control, lighting, and monitor the building for efficient energy use. Using smart technology to manage your building’s energy consumption can also improve worker’s conditions, by ensuring that they’re in a comfortable environment, and can reduce potential waste by adjusting the lighting or temperature in areas of the building not in use. Automating building maintenance can also reduce waste, with sensors available to alert the staff when something breaks or needs repairing, detecting any issues with the building, and improve sustainability.

Companies with a good ESG rating also have a strong commitment to their workers, ensuring fair workplace practices, a commitment to diversity and equity, and creating an environment where everyone feels welcome and accepted. This also includes having safe workplace conditions, benefits for employees and strong support for employee’s overall well-being. Your company’s reputation relies not only on external interactions with clients and customers, but also on having high employee satisfaction within the company. This can boost retention, recruitment, and even productivity since happier employees have been shown to work harder and more efficiently.

Companies with a high ESG rating are also going above and beyond in areas around governance — typically doing more than is required of them in terms of compliance. They have high transparency with investors and employees and create an environment that allows for open and direct feedback. These companies aren’t just following the current laws and regulations, they’re looking ahead to what rules and laws might be implemented in the future and are making the call to make those changes early on. These companies also have a strong commitment to authentic leadership and holding leaders accountable within the organization.  

What does a bad ESG score mean for business?

Companies that have poor sustainability or high carbon footprints typically fall on the lower end of the ESG rating scale. These companies struggle with their overall environmental impact and have a history of energy-intensive practices and procedures. There is often a lack of automation, poor or bare-minimum compliance, and sometimes even unsafe or dangerous working conditions. These companies will have high turnover, poor retention rates, and employees reporting low levels of satisfaction.

At companies with low ESG ratings, there’s also often a lack of transparency with employees and investors, sometimes even going as far as to hide important or relevant information. These companies often do just enough on the side of governance to remain compliant but aren’t making the effort to do any more than the minimum. Companies with a low ESG score simply aren’t appealing to socially responsible investors, and they will struggle to be viewed as a solid long-term investment by this growing base of investors.

ESG challenges

There are some criticisms of ESG ratings — most notably that the scores and analysis aren’t streamlined and there can be variations between how companies give out ratings. ESG ratings also encompass a lot of broad topics in the workplace, making it difficult to standardize the scores across every company and industry. It can also be difficult for older companies to make the changes necessary for a high ESG score — especially around automation and building changes.