What is ESG?

Brace for impact. In recent years, as millennials and even Gen Z have asserted their influence over the global economy, there’s been increased scrutiny on the impact companies have in the world. Creating value for shareholders may still be a company’s raison d’être, but other stakeholders, including investors and employees, are increasingly concerned with whether their company is a net positive for the world.

Environmental, social, and governance (ESG) criteria have emerged as a way to measure a company’s impact. As you might expect, environmental criteria measure a company’s environmental footprint. Social criteria consider a company’s relationships, including with employees, with institutions, and in communities where it operates. And governance takes into account the way a company manages itself, including executive pay, decision making, and compliance with the law. (As an example of a company’s self-reporting, here is McKinsey’s 2021 ESG report.)

There’s been a meteoric rise in ESG-oriented investing in recent years. As of 2019, global sustainable investment topped $30 trillion. That’s up 68 percent since 2014 and a whopping tenfold increase since 2004. This has been driven by heightened social, governmental, and consumer attention on the broader impact of corporations, as well as by investors and executives who realize that a strong ESG proposition can nurture a company’s long-term success.

How does ESG create value?

Based on McKinsey’s research and experience working with companies from a variety of industries, ESG can create value in five key ways:

1. Top-line growth. A strong ESG proposition helps companies tap new markets and expand into existing ones. Evidence shows that sustainability-marketed products grow 5.6 times faster than conventional products.
2. Cost reductions. Good ESG execution can combat rising operating expenses, including raw-material costs and the true cost of water or carbon. McKinsey has found a strong correlation for companies in various sectors between resource efficiency and financial performance.
3. Regulatory relief. A stronger external value proposition can mean greater strategic freedom for companies, less regulatory pressure, more government support, and better relationships within communities.
4. Productivity uplift. Strong ESG efforts can boost employee morale and motivation and attract quality talent. In a recent McKinsey survey, 82 percent of participants, representing a sample of employees of US companies, affirmed the importance of purpose. They listed “contributing to society” and “creating meaningful work” as their top two priorities. And yet, only 42 percent believed their company’s stated purpose had much effect.
5. Investment and asset optimization. Well-executed ESG can strengthen investment returns by allocating capital to more promising and sustainable opportunities, like renewables and waste reduction. While the investment required to update operations according to an ESG strategy might be significant, doing nothing may be far more expensive in the long run.

But ESG is not a one-size-fits-all solution. A tailored, analytic approach to ESG will look very different from one company to the next. Consumer goods companies, for example, are increasingly looking to offer sustainable products. Oil and gas companies are strongly focused on reducing carbon emissions.

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