Why is ESG important?
Environmental, Social and Governance (ESG) is a broad term that refers to a collective of factors used to evaluate companies.
Environmental factors include traditional issues like climate change but have also evolved to include new issues like replacing the traditional commute with work from home arrangements. Social factors draw on a company's workforce and its involvement with society, and includes topics like diversity, equity, and inclusion and humane working conditions. Governance addresses a company's external ESG efforts along with its internal efforts to govern itself and be accountable to its many stakeholders now focusing on ESG.
ESG issues are increasingly important for companies as regulators, investors, employees, and society as a whole are paying closer attention to companies' ESG efforts.
Regulators are increasingly requiring companies to establish ESG policies and practices. For example, several states have either passed or are considering laws that introduce a quota requiring publicly traded companies to include women on their boards of directors. Similarly, the U.S. Department of Labor is in the process of finalizing a rule that would enable ERISA retirement plans to consider ESG factors as part of investment selection and recently put out a "Request for Information on Possible Agency Actions to Protect Life Savings and Pensions from Threats of Climate-Related Financial Risk."
Moreover, employees, motivated by Black Lives Matter, #metoo, COVID-19, and other catalysts, are also driving companies to establish ESG policies and practices. Indeed, in 2020 union organizing increased, driven, in part, by COVID-19 and workers' desire for increased health and safety practices. During the so-called Great Resignation, companies are quick to pay attention to their employees' desires.
Activist investors have also played a key role in companies' developing ESG policies. For example, certain investment firms have issued proxy voting guidelines that state they will press companies to demonstrate their commitment to mitigating climate risk and increasing diverse board membership. Even routine corporate due diligence increasingly probes companies' business culture to assess the strength of a target's ESG practices.
Companies are responding to the multifaceted push for ESG programs. After the U.S. Securities and Exchange Commission signaled it would be paying increased attention to ESG matters, the number of companies' proxy statements and 10-Ks discussing ESG programs has skyrocketed. Companies' increased focus on ESG appears fruitful as recent research indicates that companies with strong ESG programs yield better investment returns.
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