What is ESG (Environmental, Social, and Governance)?
Environmental, Social, and Governance (ESG) are the criteria that altogether establish the framework for assessing the impact of the sustainability and ethical practices of a company on its financial performance and operations.
Initially, the ESG framework was only used by impact investors to determine suitable investments. Nowadays, the framework gains more recognition among all types of investors because of the greater attention of governments and regulators to such factors, and a stronger public awareness of the environmental and social influence of companies. The majority of the big publicly traded companies publish reports about their ESG initiatives.
ESG factors can significantly impact a company’s financial performance. For example, Volkswagen’s emission’s scandal in 2015 cost the company $7 billion to cover the costs and more than $4 billion in penalties. In addition, the company’s stock experienced dramatic declines throughout the scandal.
Nevertheless, environmental, social, and governance criteria are very subjective, and accurate assessment of the factors can be extremely challenging.
The environmental factor is primarily concerned with the company’s influence on the environment and its ability to mitigate various risks that could harm the environment. Generally, a company is assessed by its use of energy, waste generation, level of pollution produced, utilization of resources, and treatment of animals.
The company’s environmental policies and its ability to mitigate environmental risks may directly influence its financial performance. More governments around the world are introducing strict environmental policies, and a company’s inability to comply with the standards may result in significant penalties.
In addition, the company’s irresponsible environmental policy may damage areas of its operations and subsequently limit the company’s operational capacity.
The social factor investigates the company’s relationships with other businesses and communities. Social factor considers the attitudes towards diversity, human rights, and consumer protection.
The social factor may affect the company’s operational success by attracting new customers and retaining their loyalty, and maintaining relationships with business partners and communities affected by the company’s operations.
Corporate governance is concerned with the internal company affairs and its relationships with the main company’s stakeholders, including its employees and the shareholders.
Proper and transparent corporate governance can help avoid conflicts of interest between the company’s stakeholders and potentially huge litigation expenses.
In addition, corporate governance is directly linked to a company’s long-term success, as proper governance policies can help to attract and retain talented employees.
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