The way a performance of a company is measured has experienced a shift over the last few decades. Rather than just looking at profits on the bottom line, partners and investors look to some relevant metrics when deciding on potential work with a business. While the company’s R&D, expenditures, and EBITDA remain crucial in those considerations, staffing, along with ethical and environmental issues has become increasingly just as important.
With that in mind, the ESG (environmental, social, and governance) score was created and has become a regular part of how a company is presented to investors, as well as to the public.
ESG Score: what is it?
As implied by its name, the ESG score is a grade of accomplishment in how well a company performs in the realms of governance, environmental, and social issues. The better the business practices approach those three aspects, the higher their ESG score is rated. So what do these factors entail, exactly?
● Environmental: This part of the score is based on the company’s effect on and interaction with the environment that takes sustainability and environmental aspects such as energy efficiency, recycling, waste generation, and disposal, as well as their overall carbon footprint, into account.
● Social: This part of the ESG score focuses on the company’s work with its community, and society at large. It considers where they donate money, which causes they support, and can even entail interactions with their customer base, especially in terms of privacy concerns.
● Governance: This part considers how a company interacts with its staff, its corporate structure, and its approach to diversity. Another sizable consideration here includes the transparency of their business practices, and how the business compiles the ESG score.
The ESG score also includes a number of key factors such as:
● The carbon footprint of the business
● Waste products generated
● Diversity of the workforce and the board
● Transparency of executive payroll
● Energy efficiency
● Well being and safety of the staff
● Nature and magnitude of political and charitable donations
The categories of the ESG score don’t change, but they do vary based on the industry in question. Collectively, this also points to how the industry deals with larger environmental and societal aspects on a broader level. The scale ranges from 0 to 100, with scores over 70 considered to be good, while those under 50 are deemed poor. These scores generally break down into three specific categories:
● Laggards: When a company scores low across the board, deemed as needing improvement in multiple categories as determined by the ESG examination process.
● Average: The middle-scoring companies who score well in certain areas, but need to improve in others.
● Leaders: Those companies that are the standard bearers in an industry in terms of sustainability.
A great example of a company that consistently scores over 70 on its ESG scores, and is therefore regarded as a leader in environmental and social efforts with sights on a sustainable future, while ranking high in profitability is Microsoft. The companies that cannot seem to escape the other extreme in the laggard category are companies like EchoStar and Xerox, due largely to staffing and social hardships. Echostar has been criticized for concealing its environmental and personnel statistics from the public, with the lack of transparency leading them to low ESG scores. Xerox believed that its relatively low public presence means that it had no way to implement changes to its social practices.
Who determines the ESG Score?
Scoring anything should be done by an impartial party, so companies bring in third-party groups with no affiliation to the business to calculate the ESG scores impartially without any undue influence. Some of the groups that conduct ESG scoring include the Sustainability Accounting Standards Board, Principles for Responsible Investment, and Global Reporting Initiative.
Every organization scores ESG in a variety of ways, some by industry guidelines, while others with a more keen focus on public and current metrics. Certain organizations might approach scoring in a way that is specific to the industry or a particular issue. They may investigate business practices differently, such as in the case of the Carbon Disclosure Project which is known for deep levels of investigation and research, rather than being provided information by the company they are grading.
Certain organizations take a specific scoring approach, such as the Institutional Shareholder Services, one of the world’s largest advisories, offering water, carbon, and other risk ratings, allowing for the assessment of practices and focused analysis of particular risk ratings.
The reason for these particularities is that every company does need to be evaluated based on the context of the industry that they are in. The industry standards or environmental guidelines, therefore, are more granularly specific in those terms of the ESG. If this aspect is not part of the scoring, greenwashing accusations can be levied against companies, such as granting particular entities high scores for cutting-edge methods, when they are simply following the regulations and staying inside the legal boundaries of their particular industry already.
The importance of an ESG Score
Many investors want to only consider making investments in companies with a high ESG score, finding such companies attractive based on the fact that their propensity for lower waste generation, a more robust and productive workforce, as well as lower energy costs, raise their potential to be more profitable, resulting in greater ROI (return on investment).
Both quarterly and annual reports of companies are also featuring ESG in a list of expanding requirements. The EU has already been implementing the practice of requiring reports and ESG scores from businesses, a practice that the United States is starting to catch on to as well. When a company is looking to conduct overseas business, the ESG score is also pivotal, as countries will use it as part of the consideration of whether to permit a company to operate within their borders or not.
In China, for instance, where reporting ESG is voluntary, the announcement was recently made to standardize ESG scoring to achieve greater uniformity in the grading system, and to work toward achieving a more “common prosperity.”
Since one of the factors of a higher ESG score is the treatment of employees, a higher ESG score generally correlates to a better, more productive workforce, drawn to the company’s perks, benefits, and a welcoming work environment. All of these factors lead to increased productivity. As an increasingly progressive slew of new hires from a new generation enters the workforce, it becomes increasingly important to offer opportunities for individuals whose minds are set on positive stances and progressive opinions in terms of sustainability and environmentalism. By making a company inviting to such individuals, companies benefit by attracting high-quality applicants.
All of these positives come before even mentioning that a good ESG score underlines a company’s positive reputation. It illustrates to the public where the brand stands on issues, provides transparency about the company’s inner dealings, and elevates the public opinion of that business.
On the other end of the spectrum, ESG scores are used to keep companies that do not score, accountable for their actions (or inactions). After having the standards and practices of their business evaluated, the companies become forced to adjust, right the ship if need be, and be more transparent about how they will respond to environmental sustainability issues that are increasingly more important to the public.
ESG is not universally supported
While the benefits of ESG are undeniable, some detractors see a trend that may be growing in popularity, but for the wrong reasons. Many, like the Social Capital CEO and founder Chamath Palihapitiya, call ESG great marketing, but “a lot of sizzle, no steak.” His concerns extend to companies simply using higher scores to secure loans, which in turn gives them more ways to artificially inflate their scores. He points to the EU specifically, noting that an ESG score is just a way to acquire money for free.
There is also a manipulation factor of ESG that concerns him. Many of the ESG scores are centered on intended plans for the future, which stem from hypothetical plans of future actions, rather than taking steps presently or having a basis in currently tangible results. Many critics dismiss the effect of ESG scores on sustainability and larger profits, citing it as a “faux win-win” scenario. For investors, it should not be about making the expectations of making the most money possible, they say, and while the decision to invest in “good” stocks has absolute merit, ESG scores are not the best argument for maximizing wealth.
There is also the matter of fraud and corruption that ESG scores open doors to. Some companies may publicly boast about their sustainability efforts and ESG scores, but have the opposite mindset in the confines of their boardrooms. In other words, there is a lot more spin than there are actual sustainability efforts.
Should a company concern itself over ESG Scores?
As ESG scores become more popular, and in some cases, mandatory, companies both big and small should pay attention to these scores. After all, if the score is low, it is an opportunity to learn about a company’s weak points and focus on improving those areas.
By distinguishing the areas where a business is successful, as well as where additional effort is needed for improvement, a company can enact positive change that can lead to a higher ESG score and a better reputation. Therefore, an understanding of a company’s ESG gives it a track record and sets it up for success with notably known areas of improvement. This also puts a company ahead in that regard compared to competitors, giving the particular business the edge in any industry.
FAQs
What does an ESG Score show?
The ESG (environmental, social, and governance) score grades a company based on how it conducts business in those vital spheres. It accounts for how the business stacks up in terms of optimal expectations in workforce issues, business operations, environmental factors, and sustainability.
Who will measure the ESG Score?
The scoring is performed by independent third-party firms, all of whom use varying approaches to score. Some will use guidelines and regulations while others compare the company’s performance against contemporary metrics and the latest scientific data. The scoring should not be performed by the company or a subsidiary of such, as the intent of the score is to accurately and truthfully assess the company without any biases.
What is the importance of the ESG Score?
Prospective investors and potential partners can look to the ESG score to see how a company stacks up in terms of social impact and sustainability. A higher ESG score often elicits confidence from would-be investors that the company could be successful and profitable due to a healthy workplace, minimal waste, and a high-quality operation.
Does a company need an ESG Score?
Whether a company actually needs an ESG score depends on the situation, but its exploration is helpful with smaller business endeavors. It allows a growing company to get used to the scoring processes and allows it to work out the areas of struggle before approaching potential investors. It also illustrates to the company itself how successful they are in its environmental and sustainability efforts, and in what areas they can stand to improve.
