What is ESG and why is it an important part of a company?

By Indeed Editorial Team

Updated 7 December 2022

Published 9 May 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

When investors decide on their portfolio, they do so with a thorough assessment of various factors. Due diligence means that companies make informed decisions regarding investments. Using ESG, they can benefit from better long-term investment strategies since they trust the companies they invested in. In this article, we discuss ESG, why it's an important part of a company and why using ESG has many benefits for investors.

What is ESG?

If you're wondering, 'What is ESG?' it's an acronym for Environmental, Social and Governance. It refers to a range of different aspects of a company. These aspects outline a broad idea of the ethos and ethical stances of the company, informing investors of what they expect when investing in the company. Besides acting as an ethical analysis, ESG builds a better understanding of risks in a company. A company paying attention to its ethical side is more likely to be attentive to various other business continuity factors.

What are the elements of ESG?

The three elements of ESG are those in the Environmental, Social and Governance acronym. Reviewing each of these aspects is key to fully understanding the company a business invests in. Learn more about the individual elements of ESG and why each aspect is important below:

Related: What is corporate governance? (Definition, importance and roles)

Environmental

A company's environmental behaviour is more important in recent years as the threat of climate change has become more prominent. Environmental aspects refer to a company's sustainability and how it impacts the surrounding environment. Working more sustainably and reliably is an indicator of a company's self-awareness and the extent to which it understands the consequences of its actions. Learn some examples of environmental factors below:

  • renewable or sustainable energy sources

  • Methods of waste disposal and recycling the organisation uses

  • wastewater management systems in place

  • Carbon emissions over a set period

  • contribution to issues such as deforestation

  • compliance with government environmental standards and goals

Related: How To Become an Environmental Consultant (With Salary Info)

Social

The social behaviour of a company or organisation is another key indicator for investors, setting out a perspective on the ethical status of a company. This refers to how a company treats its employees, stakeholders and wider community members. A good social reputation means the company benefits and avoids incidents such as boycotts and protests. Highly regarded companies account for the welfare of the wider community in their decision-making. Here are some key social criteria:

  • relationships with shareholders and business partners

  • ethical use of customer information

  • safety and security of working methods

  • provision of fair wages for the standard of work

  • company commitments to satisfying customers

  • company stances on ongoing social and political issues

Governance

Governance refers to the internal operations, structures and functions of a company. From board-level transparency to how the company implements its rules, this provides insight into how fair and effective the company's operations are. This also refers to external laws and the company's consistently obeying national and international rules and regulations. See some examples of governance criteria below:

  • The number of legal cases the company is a part of

  • company donations to external political campaigns

  • The extent to which company officials follow the company's rules

  • executive treatment compared with standard employees

  • alignment with government regulations and financial reporting rules

  • internal and external auditing results

Related: How to become a compliance officer: a step-by-step guide

The benefits of using ESG in investment identification

There are several key benefits of using ESG in identifying ideal investments for a company. These are moral and financial benefits for the investor, changing how an investment fund operates. Learn some of the key benefits of using ESG factors in identifying investment targets below:

Reveals reliable investments

Besides the financial aspects of a company, trusting the behind-the-scenes management of an organisation is essential for an investor. Knowing that the company behaves rationally and reliably means that investors know what they get. Using ESG establishes a good idea of how company management behaves, and investors eliminate unreliable companies from the process. The remaining shortlist contains reliable companies. Investors then choose because of financial results, with no worries about the moral and ethical positions of the companies on the shortlist.

Establishes expectations

Investors use ESG criteria before investment because it establishes a reliable expectation of how investment partners behave in the long term. Having a comprehensive understanding of a company's social, environmental and governmental behaviour means an investor knows what to expect. This means that if investors take on more risky investments because of ESG criteria, they still understand the company's behaviour patterns and respond appropriately.

Related: What is quantitative analysis? (With definitions and examples)

Opens new opportunities

Looking into companies' environmental and social aspects reveals opportunities that some organisations miss. For example, if a company focuses on improving its green policies, pays staff well, and recently received a government grant, it is innovating in green technology. Use ESG assessments to understand a company's short-term potential to make the most of your investment package.

Find patterns

Suppose investors track the ESG of a company over an extended period. In that case, there's potential for a better understanding of suppose a company doesn't publish financial reports for a couple of quarters after doing so for several years. In that case, patterns of behaviour in the business. For example, suppose a company doesn't publish financial reports for a couple of quarters after doing so for several years. This implies that divesting is an ideal strategy, as the company's finances are less than ideal. Long-term ESG assessments are ultimately beneficial for reacting to events before they occur.

Generates positive brand recognition

Using ESG as a determining factor for investment and infrastructure decisions can help build trust in the community. It's usually a favourable sign to partners, consumers and government agencies that ESG factors matter to a company. Both investors and start-ups can have mutual benefits from prioritising Environmental, Social and Governance models in their business plans and negotiations. Even when a partner is silent, those who review the business may still consider the ESG elements.

How to complete ESG assessments

Completing ESG assessments is a difficult process. This is for various reasons, such as the accessibility of information, the selection of companies available and multiple sources offering differing information for investors. Here is how you can complete ESG assessments, with tips on completing each step effectively:

1. Select the companies

The first step in completing an ESG assessment is selecting the companies you assess. There are thousands of companies in every industry, each with investment potential. Choosing the right companies is an important part of an ESG assessment process. By focusing on companies with a clear interest in receiving investment, investors spend their time wisely and narrow down a field of exclusively eligible potential investment candidates.

2. Complete research

At the next process stage, complete your initial research into each company. This includes completing searches into the Company's House entries of each of the organisations, researching each of the companies online and developing a better understanding of some of the company's recent actions. Use official documentation and more recognisable sources wherever possible. This is especially true with conflicting information, as using the right source means you benefit from the most accurate information and have an informative ESG assessment.

Related: Research skills: definition and examples

3. Talk to knowledgeable people

In a range of different companies, there's a selection of knowledgeable individuals. These include ex-employees, journalists and industry experts with further information about the business. This is ideal for aspects such as the 'Social' side of ESG, as you better understand how people feel about the organisation. Talking to people with knowledge about the company is essential as you gain further insight than is available to those simply reading through documentation as a research method.

4. Write a report

Upon completing your research, write a final report on the company. This entails a significant amount of information, with details surrounding the company's environmental, social and governmental aspects. An ESG report ends with an assessment of the ethical position of the company and a final recommendation of whether investing in the organisation is an ideal step forwards. The report is one of the most important parts of the process, as this is the main document companies use in decision-making.

The model shown is for illustration purposes only and may require additional formatting to meet accepted standards.

Related:

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  • What is behaviour modelling? (With examples and definition)

  • What does an investment analyst do? (With skills and salary)

  • What is investment? Definition, types and how it works

  • An annual report of a company: definition and importance


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