Your guide to understanding the ESG criteria
Over the last few years, investors (especially millennials) have become increasingly interested in investing in sustainable companies. But how do we term a company as sustainable, and even if it is, how do we determine exactly how sustainable they are?
That’s where the ESG criteria come in. They measure how a company fares in each of these three criteria – Environmental, Social and Governance. They are then assigned a rank indicating how sustainable they are. Here’s what they take into account when measuring each criterion.
The environmental criterion of a company evaluates how the actions of a company affect the environment. This includes the company’s carbon footprint, how it manages waste, how it handles its waste, and its policies regarding energy efficiency.
This also extends to how they source their raw materials and their treatment of animals used (if any). Companies that source ingredients through fair trade suppliers and try sourcing organic ingredients score higher on this scale than those that don’t.
The fulfilment of the social criterion can be determined by the relationship the company has with three major stakeholders – the local community, other companies and its own employees. It explores the impact and standing it has in the community and if they are perceived positively.
The employees of a company are one of its biggest stakeholders and should therefore be treated fairly. A company that ranks high on the social criterion typically has fair pay (with compensation at the market rate), perks and benefits, health insurance, regular employee training and has an open-door policy with the top management to hear their concerns.
The governance criterion essentially measures how well top executives manage the company govern. Financial transparency and accountable corporate policies are key factors in this. Since this criterion looks closely at the top management, the governance criterion can also be affected by the composition of the board (how diverse it is) and the board salaries. A company that focuses on profits and the financial upliftment of the few over fairly compensating all its workers cannot be termed as a wholly sustainable company.
While it’s not mandatory for companies to include ESG metrics as part of the year-end financial reports, many companies do include them to appear more transparent and proactive. Following the ESG criteria also affects companies now much more than they did in the past. For example, till late last century, companies with bad ESG metrics would perform well financially. However, there has been a shift. Now, when companies slip up and cause a breach in even one of the ESG factors, their stock prices immediately tank and cause financial loss to the company.
In light of these recent changes in the business landscape, it is best for even more companies to measure their performance against standard ESG metrics and mention it in their annual reports. After all – a sustainable company is one that is profitable for all its stakeholders.
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