There are three different components to ESG investing: environmental, social and governance. For a company to truly be considered an ESG investment, it must meet at least some of the criteria in each of these three categories:
The environmental component of ESG investing looks at how a company impacts the environment. Do they take steps to reduce or offset their carbon footprint? Companies can meet environmental ESG criteria either by limiting their negative impact on the environment or by having a positive impact on the environment.
As more people begin to understand the importance of environmentalism, it becomes increasingly easy to find companies focused on their environmental impact. Many companies publicly donate a percentage of their profits to environmental issues. Others have pledged to reduce their carbon emissions, use of plastic and more.
But just as a company can meet ESG criteria by supporting environmental initiatives, a company can make itself ineligible to meet the criteria with a poor environmental impact. You’ve probably seen companies making headlines due to their environmental impact, whether through their high carbon emissions or their high level of plastic pollution.
Some additional examples of environmental criteria for ESG investing include:
- Carbon emissions
- Air and water pollution
- Energy efficiency
- Water scarcity
- Animal rights
The social component of ESG criteria looks at how a company impacts people and society. To meet social criteria, a company should aim to have a positive impact on all people, whether it be its customers, its employees or its community.
While it’s not always easy to tell what sort of impact a company has on the community, many companies have stood out for their positive — or negative — impact on people.
The pandemic has served as a unique opportunity for companies to show just how much they care about their employees. And while many companies have put their employees’ health above profit, others have made headlines for doing just the opposite. Similarly, many companies over the past two years have spoken out and taken action on issues such as racial justice and worker rights.
Meanwhile, other companies were created with social impact in mind. It’s not hard to find socially impactful companies that donate their product, or a percentage of profits, to social and community issues.
Other social criteria include:
- Diversity and inclusion
- Employee health and safety
- Customer satisfaction
- Community engagement
- Community service
- Fair labor practices
- Human rights
The final component of ESG criteria is governance, which looks at how a company is run. Companies that meet governance criteria have a transparent business model and a history of being honest with their customers, stakeholders and shareholders.
A major way that companies can succeed or fail in this category is how they treat their shareholders. Companies with good governance policies prioritize shareholder rights, ensuring they every owner has a say in the company. On the other hand, companies with poor governance policies may hide things from shareholders or make decisions the shareholders largely disagree with.
Another major area where a company’s governance policies are important is ethical and legal activity. Companies that have a history of corruption or spend much of their money lobbying for harmful policies aren’t likely to meet the ESG governance criteria.
Other examples of governance criteria include:
- Board diversity
- Executive compensation
- Political contributions
- Lobbying efforts
- Corruption and illegal activity
- Large-scale lawsuits
- Shareholder rights