The standard definition for the acronym ESG is environmental, social and governance. ESG used to be more of a niche topic. Today, it’s becoming more the rule than the exception. The term ESG is often equated with sustainable investing. Related names include:
- Socially responsible.
- Sustainable and responsible.
To narrow the definition down a bit further, there are three distinctions of ESG investing:
- First, ESG refers to weeding out companies that clearly aren’t in keeping with ESG principles, such as investments in coal, tobacco and weapons. It also refers to companies that clearly represent and uphold ESG values as a matter of priority.
- Second, ESG refers to impact investing in companies with social or environmental aims.
- Third, incorporating ESG factors into financial analytics.
Studies have shown that companies that have strong ESG performances are likely to produce strong financial returns while experiencing reduced risks. The current challenge with assessing ESG is that there is currently a lack of meaningful measurement for social efforts. Also, there is currently a lack of defined terms and a lack of consistent standards for measurement and disclosures. Investors often try to advance sustainability goals once they’ve made an investment in a company through engagement and shareholder voting.
The Growing Importance of ESG in Business
There are a number of signs of the growing importance of ESG in the business world if you know where to look for them.
ESG issues are popular with women and millennial investors. According to MarketWatch, women are expected to control two-thirds of all private wealth in the United States by 2020. Christopher Ma, the director of the George Investments Institute at Stetson University in DeLand, Florida, states, “More than 75 million millennials born between 1981 and 1997 are ready to take over an estimated $30 trillion in wealth from baby boomers.” Both women and millennials will make up a large group of investors that have their eye on ESG products and strategies in the very near future.
While investors have long talked about how they know they need to favor long-term growth over short-term growth, they haven’t been putting that talk into action. The positive impact of ESG issues requires a long-range look at the analyses. In this way, ESG is helping investors shift their focus back to the importance of looking at long-term results.
The demand for ESG products is expanding, with steady growth in ESG investing since 2016.
An RBC survey reported that of the institutional investors they surveyed, 77% were using ESG principles in their investment approaches, as they indicated by responding “between somewhat to a significant degree.”
Challenges in Measuring the Impact of Social
Investors admit that environmental and governance impacts are easier to measure than the impact of social efforts. This is one of the things that makes them question the degree to which the “S” in ESG actually leads to longer-term profitability.
Measuring the impact of a company’s social efforts is complex and multidimensional. Intangible changes are often subjective, making them extremely difficult to quantify. Governments have long struggled to measure social performance over time and have not been able to find accurate ways of doing so. Investors continue to look for ways to reduce the complexity of the analysis of social impact on investments and turn it into some form of measurement that’s easy to compare. Despite the complexity of the problem, some analysts have been able to measure the level of customer satisfaction or put a value on intangible issues such as innovation, brand recognition, culture, etc.
Types of Social Measurement
In a paper called “Putting the S in ESG: Measuring Human Rights Performance for Investors,” the authors discuss three types of social measurement. Company-focused frameworks aim to highlight sustainability and human rights reporting guidelines as the best way for companies to share data in public disclosures and sustainability practices.
Investor-focused frameworks rely on ESG data providers, third-party researchers, and ratings and indices that are geared toward the investor audience. Human rights-focused frameworks look at publicly available ratings and rankings that were designed by human rights experts to identify which businesses take the lead on labor and other human rights factors.
What Can We Expect From “S” in the Future?
Financial experts have done some studies on the impact of efforts versus effects.
Under the heading of efforts, they include resource investments such as funds that are dedicated to sustainability projects, staff time or donations, and activities that will result in advances in social objectives. These efforts can be measured by the number of training and community programs and the staff assigned to sustainability oversight, policies and audits, as noted in the paper, “Putting the S in ESG.”
The paper notes that effects can be measured by the outcomes and longer-term impacts of efforts and provides a few examples on how to measure it. Some indicators include such things as the number of human rights violations reported during various periods, an increase in the number of new jobs or a noticeable increase in diversity at the senior leadership level.
What Should We Expect in the Future of Social Measurement?
In the future, financial and ESG experts hope to have better methods for measuring companies’ real-world effects, in addition to measuring their efforts. They also hope to develop more diversified data and data that exceeds the requirements for company disclosure. To obtain measurable data, experts will need to establish clear, reliable standards for evaluating social investments. The primary audience for ESG metrics will target investors.
ESG is a modern governance issue that is growing in significance. It’s necessary for corporate boards to be forward-thinking in their strategic planning, which should include analysis of ESG issues. This is precisely why boards need a modern governance solution that leads to real-time insights and predictive analytics like Diligent Boards and Governance Cloud. These tools give boards the same access to the data that investors and proxy advisors are using to anticipate changes and trends in the marketplace. Diligent Corporation is an industry leader for governance in the digital age and your first choice for a full range of highly secure, fully integrated board management software products.