Environmental, social, and governance (ESG) criteria are a set of standards for a company’s operations that socially conscious investors use to screen potential investments. Environmental criteria consider how a company performs as a steward of nature. Social criteria examine how it manages relationships with employees, suppliers, customers, and the communities where it operates. Governance deals with a company’s leadership, executive pay, audits, internal controls, and shareholder rights.
To assess a company based on environmental, social, and governance (ESG) criteria, investors look at a broad range of behaviors. Environmental criteria may include a company’s energy use, waste, pollution, natural resource conservation, and treatment of animals. The criteria can also be used in evaluating any environmental risks a company might face and how the company is managing those risks.
Social criteria look at the company’s business relationships. Regarding governance, investors may want to know that a company uses accurate and transparent accounting methods and that stockholders are allowed to vote on important issues. They may also want assurances that companies avoid conflicts of interest in their choice of board members, don’t use political contributions to get unduly favorable treatment and, of course, don’t engage in illegal practices.
No single company may pass every test in every category, of course, so investors need to decide what’s most important to them. On a practical level, investment firms that follow ESG criteria must also set priorities.