Importance of ESG

Pavan Anoop | 1/3/24

As the complex and interconnected investment world develops, investors have started to hold companies accountable for their morality. Instead of only chasing profitability, investors have started considering environmental and social circumstances. Investors believed that, with a healthier and more transparent society, the economy would thrive. ESG (environmental, social, and corporate governance) is a set of considerations that promote sustainability and allow for a variety of benefits.

This article will dissect the various concepts surrounding ESG usage and effect on an investment's value and risk. While I will define and break down ESG, there is still some “fog” surrounding ESG due to its lack of definition. ESG is simply defined as the culmination of 3 aspects but lacks a true meaning allowing for assumptions and “moral deliberation”. This ambiguity has greatly contributed to its discussion, research, and ongoing effort to accurately outline it.

‎ ‎ ‎ ‎ ‎ ‎ ‎ ‎ ‎ ‎ Without further delay, let's break down ESG!

Environmental(E) issues commonly relate to how a company deals with how the environment is regulated. Issues such as climate change and pollution are at the forefront of this category. This caused the emergence of environmentally friendly innovations which produced products and services that help the earth. Social(S) issues relate to issues like human rights and politics. This is a more tricky issue because many companies refuse to change their standing on certain issues. One recent scenario that displays the importance of social issues is the boycotting of various companies due to their support of Hamas. Because these companies have controversial viewpoints on social issues, they are generating negative impressions while also losing sales. Negligence of social responsibilities could even drive away investors. Corporate Governance (G) issues are different because they concern the internal structure of a company. Bad corporate governance could include poor working conditions, lack of accounting, corruption, or board of directors codependency. This structure should, ideally, show complete transparency and disclose all of its business practices. This clarity allows investors to assess other issues, like E and S.

Management of ESG has many benefits for a company. As environmental and social trends are constantly changing, companies will develop an understanding of consumer trends. If a company can anticipate new trends, they can capitalize on them, leading to more growth. Companies can capitalize on trends in two ways. First, trend recognition can forecast possible risks allowing companies to adapt to them faster. Second, it can allow a company to develop its intangibles. These include its brand or public image which greatly affect the success of a company and creates shareholder value.

ESG also has a few drawbacks that cause it to be overlooked or misused. Unlike many other metrics, ESG is qualitative not quantitative, meaning that it is based on qualities and characteristics of a company. This makes it difficult to distinguish ESG ratings between companies. This lack of standardization leads to insufficient and inaccessible data. While there are many characteristics that define good or bad ESG, the ratings can still be subjective to personal opinion. This is where the ‘fog’, mentioned earlier, comes into play. Nonetheless, specific ESG criteria provide a satisfactory conclusion on a company’s sustainability.

ESG reports are evolving rapidly. Earlier methods are­ being replaced by more develope­d ones created through the use of AI. This tech he­lps businesses gather and share­ ESG data in a faster, and more error-fre­e, way. This can also help access data and analyze it because of AI’s ability to scan for relevant ESG information. By using this new technology, ESG reporting is advancing to answe­r the increasing call for thorough, trustworthy, and accessible sustainability information.

In conclusion, ESG considerations open up new sustainable markets while closing unsustainable ones. This grows company’s and society to become more consumer and environmentally friendly. As ESG becomes more popular company’s may start releasing more qualitative data, giving investors the ability to make better investments. The next time you are about to invest in a company, check its ESG and make sure it is sustainable.

Thanks for reading and happy investing!


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    Inst for Law & Econ Research Paper No. 22-23, European Corporate Governance
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