The Governance Component of ESG
Last Updated: May 12, 2021| 2 mins
The Governance component of ESG addresses the internal system of practices, controls, and procedures organizations adopt in order to govern themselves, make effective decisions, comply with the law, and meet the needs of external stakeholders.
The governance criteria within ESG considers the way on which organizations manage topics such as:
- tax avoidance
- executive pay
- director nomination
- company leadership
- executive pay
- internal controls
- shareholder rights
ESG criteria are a popular way for investors to evaluate companies in which they might want to invest as ESG criteria can guide customers and investors to those companies that are lower risk due to their ESG practices. But new imperatives are driving ESG today. These four main imperatives include:
- New Stakeholders — though ESG started as a way for investors to better target their investments to environmentally sound areas, it is now expanding. Employees want to be aligned with the company they work for and are interested in seeing the ESG metrics. Many are focused on gender, pay, and racially equality at work and have started diversity, inclusion, and equality (DEI) councils. Customers are also interested in ESG reports and are starting to base their purchase decisions on a company’s information.
- Transparency — In this new era of transparency, companies that choose not to report in these areas may seem to be hiding something. Even though ESG reporting is nascent, the window is closing for companies, and even private companies will need to report some findings. The good news is that no one is expected to be perfect—but companies need to prove investment in resources and responsibility for making changes. Baselining your ESG metrics is the first step in addressing internal issues.
- Ratings — Many companies, especially public ones, have ratings by external providers which are publicly exposed. Each ratings company has their own methodology, but in the end, your rating may be on the Internet, whether you are involved in the process or not. A low rating may not indicate improper practices, just a lack of data. By being more transparent and sharing data, your ratings score should improve.
- Regulation — Though there isn’t regulation around ESG metrics, most investment authorities like the SEC or the European Securities and Market Authority (ESMA) are considering which ESG metrics will become required to report on, on a regular basis. Most agree regulation in this area, like what’s been done with privacy, is only a matter of time.