Environmental, social, and governance (ESG) criteria comprise a set of standards socially responsible investors use to evaluate a company based on three main criteria: environmental, social, and corporate governance. Combined they help assess the social responsibility effort of companies in the marketplace.
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Understanding ESG criteria
Platforms such as Robinhood and Wealthfront have made investing more accessible to a new generation of investors who prefer to invest in companies whose values align with their own.
Climate change, social unrest, and the coronavirus pandemic have also increased awareness about the interconnectedness of sustainability and the financial system.
In response to these trends, brokerage firms and mutual fund companies now offer exchange-traded funds (ETFs) and other financial products that respect various environmental, social, and governance criteria.
This figure constituted around 33% of the total assets under professional management in the United States.
While rarely mentioned in mandatory financial reporting, many investors evaluate ESG criteria to better understand the various companies in their investment portfolio.
Indeed, investors consider companies that share their values and concerns about the world, with the profitability and risk of the company a secondary concern at best.
In the following sections, we will discuss some specific criteria for each category.
Before we proceed, however, it should be noted that there is no exhaustive or definitive list of ESG criteria. Furthermore, some criteria are interrelated and it can be difficult to assign one to a single category.
Environmental criteria
Environmental criteria deal with the conservation of the natural world and external factors not affected by market mechanisms that can impact company revenue.
Microsoft recently became the first company among its peers to target a “carbon negative” status by the year 2030.
To that end, the company created a $1 billion fund to reduce emissions and remove all the carbon it has emitted since it was founded in 1975.
Social criteria
Social criteria encompass the various relationships a company has with people, institutions, and communities.
Since every company operates within a broader society, the way in which it carries itself is critical to attracting socially responsible investors.
Examples of social criteria include:
Customer satisfaction.
Community relations and involvement.
Human rights.
Employee engagement, and
Data protection and privacy.
Graphics card manufacturer NVIDIA has a strict policy to never use conflict minerals in its products.
The company’s Conflict Minerals Policy ensures that gold, tantalum, tungsten, and tin purchased from the Democratic Republic of Congo do not directly or indirectly finance armed militia groups.
Corporate governance criteria
Corporate governance criteria are assessed by investors to ensure the company uses accurate and transparent accounting methods, avoids potential conflicts of interest, and allows shareholders to vote on important issues.
Construction and infrastructure company Emcor Group is also known for giving employees unprecedented encouragement to raise potential ethics breaches.
Key takeaways:
Environmental, social, and governance (ESG) criteria comprise a set of standards socially responsible investors use to evaluate a company. Younger investors are considering ESG criteria as the basis for investment decisions, with less credence given to profitability or risk.
Environmental criteria encompass the natural world and external market mechanisms, including water pollution, air pollution, climate change, waste management, and deforestation.
Social criteria describe the relationships a company has with wider society and the reputation it earns as a consequence. Governance criteria, on the other hand, may include executive compensation, shareholder rights, and recruitment best practices.
Key Highlights
ESG Criteria Overview:
ESG criteria stand for Environmental, Social, and Governance, representing a set of standards used by socially responsible investors to evaluate companies.
These criteria help assess a company’s commitment to sustainability, ethical behavior, and responsible management.
Investor Preference for ESG:
Platforms like Robinhood and Wealthfront have made investing accessible to a new generation prioritizing values-aligned investments.
Global challenges like climate change and social unrest emphasize the link between sustainability and the financial system.
ESG in Financial Products:
Brokerage firms and mutual fund companies offer ESG-based products such as ETFs.
In 2020, sustainable investment strategies managed $17.1 trillion in US assets, about 33% of total professionally managed assets.
Importance of ESG Criteria:
ESG criteria are not always mandatory in financial reporting, but investors use them to evaluate companies based on shared values.
Investors consider values alongside profitability and risk when making investment decisions.
Environmental Criteria:
Focus on conserving the natural world and non-market factors affecting revenue.
Includes air and water pollution, waste management, climate change, biodiversity, and deforestation.
Companies like Microsoft target “carbon negative” status, investing in emission reduction and carbon removal.
Social Criteria:
Encompasses relationships a company has with people, institutions, and communities.
Includes customer satisfaction, community involvement, human rights, employee engagement, and data protection.
Companies like NVIDIA avoid conflict minerals to prevent financing armed groups.
Corporate Governance Criteria:
Assesses accurate accounting, conflict avoidance, and shareholder engagement.
Covers areas like bribery, executive compensation, shareholder rights, political contributions, and audit committee structure.
Companies like GSK aim for gender diversity in leadership, while Emcor encourages ethics reporting.
Change is an important and necessary fact of life for all organizations. But change is often unsuccessful because the people within organizations are resistant to change. Change management is a systematic approach to managing the transformation of organizational goals, values, technologies, or processes.
Harvard Business School professor Dr. John Kotter has been a thought-leader on organizational change, and he developed Kotter’s 8-step change model, which helps business managers deal with organizational change. Kotter created the 8-step model to drive organizational transformation.
McKinsey’s Seven Degrees of Freedom for Growth is a strategy tool. Developed by partners at McKinsey and Company, the tool helps businesses understand which opportunities will contribute to expansion, and therefore it helps to prioritize those initiatives.
The McKinsey 7-S Model was developed in the late 1970s by Robert Waterman and Thomas Peters, who were consultants at McKinsey & Company. Waterman and Peters created seven key internal elements that inform a business of how well positioned it is to achieve its goals, based on three hard elements and four soft elements.
Lewin’s change managementmodel helps businesses manage the uncertainty and resistance associated with change. Kurt Lewin, one of the first academics to focus his research on group dynamics, developed a three-stage model. He proposed that the behavior of individuals happened as a function of group behavior.
The ADKAR model is a management tool designed to assist employees and businesses in transitioning through organizational change. To maximize the chances of employees embracing change, the ADKAR model was developed by author and engineer Jeff Hiatt in 2003. The model seeks to guide people through the change process and importantly, ensure that people do not revert to habitual ways of operating after some time has passed.
Social psychologist Kurt Lewin developed the force-field analysis in the 1940s. The force-field analysis is a decision-making tool used to quantify factors that support or oppose a change initiative. Lewin argued that businesses contain dynamic and interactive forces that work together in opposite directions. To institute successful change, the forces driving the change must be stronger than the forces hindering the change.
Business innovation is about creating new opportunities for an organization to reinvent its core offerings, revenue streams, and enhance the value proposition for existing or new customers, thus renewing its whole businessmodel. Business innovation springs by understanding the structure of the market, thus adapting or anticipating those changes.
According to Prosci founder Jeff Hiatt, the secret to successful change “lies beyond the visible and busy activities that surround change. Successful change, at its core, is rooted in something much simpler: how to facilitate change with one person.”
Gennaro is the creator of FourWeekMBA, which reached about four million business people, comprising C-level executives, investors, analysts, product managers, and aspiring digital entrepreneurs in 2022 alone | He is also Director of Sales for a high-tech scaleup in the AI Industry | In 2012, Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy.
