ESG Investing and Criteria: Definition and Importance

By Indeed Editorial Team

Published September 15, 2021

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.

ESG stands for environmental, social and governance, and it's a type of investing criteria. These standards help investors choose which organizations to fund based on ethical values and financial risk. If you're an employee in the business or economic field, you might benefit from learning the importance of ESG scores. In this article, we discuss the definition and significance of ESG investing and criteria, explore the way to determine these scores and offer the benefits of these popular standards.

What is ESG investing?

ESG investing is the decision to provide capital to an organization based on environmental, social and governance criteria. These standards involve more than just a business's financial performance, but also its impact on the environment, its support of and interaction with employees and various communities and its management style and internal controls. Investors use these benchmarks to evaluate potential investment opportunities because they know that these factors actually affect a company's revenue streams. They also want to find and back companies that match their value systems and beliefs.

Related: A Complete Guide to Investment Banking

What are ESG criteria?

ESG criteria are the principles that the investing community has decided are important for companies to fulfill. Companies may practice these methods already, but some may seek to improve their operations to gain more financial support. ESG criteria involve various elements, but the primary components are these:

  • Environmental standards: This segment of the criteria is about how well a business can care for nature and environmental elements. This means maintaining the health and quality of land, water, air, ecosystems and animal habitats to support public health and biodiversity.

  • Social standards: These standards pertain to social relationships and systems involving employees, vendors, customers and communities where the company operates. Companies that pass ESG criteria are dedicated to ensuring the health, well-being, safety and security of anyone involved with or impacted by their operations.

  • Governance standards: This part of ESG criteria refers to the way a company leads and manages people but also to the structure of its activities. These standards may involve executive pay, audits and shareholder rights.

Related: Stakeholder Model: A Definitive Guide

Why is ESG important to investing?

ESG is important to investing because it allows financiers to make well-informed investment decisions. They can weigh ESG factors to evaluate how well a company matches their moral values and beliefs about ethical practices. This is important, especially when investors want to support future generations by assisting in environmentally friendly and sustainable procedures. It's also significant if you care about the well-being of the people involved in an organization.

Investors can also use ESG to account for risk and make smarter choices. Because many customers care about environmental, social and governance business standards, especially in the current era, a company's ability to meet these can define their customer base. It can be the deciding factor on how much revenue they receive, how much financial success they achieve and even whether they can remain in business. With decreasing support for coal and fossil fuel companies, for example, the financial stability of these may be in question. As investors want a high return on investments, they take these factors into consideration.

How are ESG scores determined?

ESG scores are determined based on the following company activities:

Environmental

Investors assess a company's environmental impact, compliance with governmental and other environmental laws and regulations and nature-related methods. These can involve energy use, recycling and waste disposal strategies, pollution levels, natural resource preservation efforts and treatment of animals. For example, companies may experience issues with contamination of land, elimination of hazardous waste and management of toxic chemicals and emissions.

Related: What Is Environmental Health? Definitions and Careers in Environmental Health

Social

Investors looking at social criteria are interested in how a business treats people, and whether they value and care about the health and wellness of others. Businesses that receive a high score on this part make it their mission to support the nourishment and safety of communities and do all they can to address and solve public issues. For example, many companies want to donate profits to homeless shelters, increase access to nutritional foods in their areas, increase access to education or provide jobs for those in need. Another powerful social activity is volunteer work within the community.

In addition to determining a business's customer and community relationships, investors also examine the standards of any other organizations with which a company works, such as suppliers and vendors. They find it necessary to appraise a company's treatment of and care for its own team members. It's important for companies to behave toward employees ethically, including paying them fair wages and benefits, supporting their mental and physical health and respecting their rights. Employee satisfaction also affects actual revenue and financial success, so it's a key factor in investment decisions.

Related: How To Improve Employee Morale and Job Satisfaction

Governmental

Financiers score governmental or governance factors based on a company's leadership and operation methods. Investors usually want to fund companies that perform democratic operations where everyone involved has equal and valued representation in decision-making. They also look for checks and balances in power, so colleagues can work together to create excellent products and meet customer needs. These kinds of assurances can prevent fraud and conflicts of interest and increase ethical business practices. Another primary part of governance standards is ensuring proper and transparent accounting and documentation strategies and adhering to all applicable legal regulations.

Benefits of ESG investing

ESG investing provides accountability for the conduct of organizations. Here are some benefits of this process:

  • Protection for the environment: As the negative effects of pollution increase and create challenges for the health of communities, ESG investing inspires businesses to increase their sustainability strategies. This can aid in the protection of both the environment and people.

  • Strong communities: ESG investing encourages businesses to improve the social impact of their operational practices. This might involve implementing social programs and can have positive benefits for community members, fostering collaboration and financial stability.

  • High-quality products and services: Businesses seeking ESG investing can feel motivated to meet the criteria, leading to higher quality products and services. This could be partly due to more satisfied and productive employees and better workflow systems.

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