Explaining the concept of environmental , social and governance (ESG), Discuss how it leads to value creation for a business.
(GS-4 Ethics, 250 words, 15 marks)
Approach:
- Introduce your answer by explaining what is ESG and elaborating on its significance.
- In the body, explain its various components and how it lead to value creation for a business.
- Conclude your answer appropriately.
Model Answer:
Environmental, social, and governance (ESG) investing refers to a set of standards for a company’s behaviour used to screen investments based on corporate policies and to encourage companies to act responsibly. Business success today is defined by much more than just profits, with customers, shareholders and even employees expecting companies to adhere to high standards of sustainability, corporate responsibility, ethics and transparency. These expectations are clubbed together under the term ESG that a business should meet.
ESG mainly consist of three components:
- Environment: The environmental aspect of ESG examines how a business or organization operates as a steward of the natural environment, focusing on all aspects of sustainability, including waste and pollution, resource depletion, greenhouse gas emissions, climate change, etc.
- Social: Within ESG, the social criterion examines the impact of an organization’s operations on the labour and human rights of its employees and other community members. It encompasses workplace conditions, diversity and inclusion and factoring in the long-term well-being of other stakeholders, pay parity and equity.
- Governance: The governance dimension brings together the role played by independent directors and board effectiveness in ensuring transparency and stakeholder well-being through systems, processes, and audit controls.
Components of ESG
The significance of environmental, social and governance (ESG) in creating value for a business can be seen as:
- Risk management and adaptation for investors: ESG framework helps identify, organise, analyse, prioritise and accordingly guide decisions on various business risks. These risks, if left unaddressed, can prove costly to the functioning and sustenance of businesses.
- Reduced regulatory and legal interventions: A stronger external value proposition can enable companies to achieve greater strategic freedom and easing of regulatory pressure. Further, strengths in ESG help reduce a company’s risk of adverse government action. It can also engender government support.
- Helps uplift productivity: A strong ESG proposition can help companies attract and retain quality employees, enhance employee motivation by instilling a sense of purpose, and increase productivity overall. Positive social impact also correlates with higher job satisfaction among employees.
- Cost reductions: ESG can also reduce costs substantially. Among other advantages, executing ESG effectively can help combat rising operating expenses for, e.g., raw-material costs and the cost of water or carbon.
- Enhances return on investment: ESG can further help enhance investment returns by allocating capital to more promising and more sustainable opportunities, e.g.: renewables, waste reduction, and scrubbers. It can also help companies avoid stranded investments that may not pay off because of longer-term environmental issues.
Transparency, connectivity and the role of stakeholders and institutional investors are bound to increase in times to come. This requires corporates and business eco-systems to put mechanisms in place for fighting corruption, ensuring higher standards of ethics, compliance, conduct and concern towards stakeholder well-being. In this context, ESG plays a pivotal role in ensuring the long-term sustainability of businesses as it encompasses all the non-financial aspects, which either directly or indirectly impact the stakeholders.
