Finding the best ESG companies means probing for the risks and opportunities they present based on their ESG practices. Here are nine questions that can help weed out the good corporate citizens from those that lag behind their peers. These types of questions represent one element in the “best-in-class” approach, terminology that refers to a specific type of strategy incorporating ESG into the investment process.
Some of the best companies take a holistic approach to environmental, social and governance (ESG) issues.
- What steps are taken to limit greenhouse gas production?
The business case for low carbon companies span across cost savings linked to energy efficiency, customer satisfaction and reputation, and alignment with regulation (in certain countries and/or regions). Carbon targets can drive reductions in energy spend, which can make a material difference to profitability and cash flow. When companies exceed their caps on carbon dioxide emissions, they raise their expenses. This makes them less competitive than their peers that stay within their limits. Also, as many countries strive to cut their greenhouse gas production by 50% as part of the Paris Agreement of 2015, they will impose new limits on companies’ greenhouse gas production. If companies don’t work on limiting that production now, in the future they may need to leave reserves in the ground and take those assets off their balance sheets.
- Does the company seek opportunities to invest in green energy and spaces?
Investments in green energy and spaces can present opportunities. If the market moves towards a low carbon economy, green energy may be in high demand. Investing and innov
ating early gives companies a competitive advantage. Later, they could benefit from high barriers to entry.
- Are materials sourced in an environmentally efficient manner?
Making the manufacturing process more efficient not only cuts costs, but also conserves resources. Sourcing efficiently — especially materials with high environmental impact, such as palm oil and water — can create best practices and cut the risk of controversy and lawsuits.
- Is employee safety taken seriously? Does the company consider the social impact of its supply chain?
Employee safety could mean maintaining high standards for safety at a mine to avoid cave-ins or toxic waste spills. Or monitoring its supply chain closely to confirm that child labor isn’t used in the manufacture of its products, such as clothing. Another example: some Chinese technology suppliers reportedly have high rates of employee suicides due to overwork.
- Is there any product liability?
This is especially important in terms of privacy and data. As cybercrime increases, companies that seek to invest in the protection of their clients and end-users are the best ESG companies.
- Does the company have an independent board?
A company’s board is the key to its governance. If the board is dominated by a founding owner or family, the board may rubber-stamp management’s decision. An independent board made up of members without direct ties to the company can make tough decisions and push for change when necessary.
- Is the corporate strategy transparent?
As the market moves towards a more sustainable and long-term mentality, investors are asking companies to be more transparent. Examples like Volkswagen’s emissions scandal show the downside of the lack of transparency. Being transparent keeps companies accountable and investors aware of details.
- Does the company have independent audit and remuneration committees?
A global technology company that inflated its net profits is just one of many famous global companies guilty of accounting fraud. The right governance wasn’t in place, including oversight of financial reporting by an audit committee. A remuneration committee affirms that the pay of directors and certain executives is related to the company’s recent performance.
- Are shareholder rights protected?
The company should be willing to engage with investors regarding their material ESG risks. It should also show responsiveness to shareholders by acting on proxy proposals passed by shareholders.
There are numerous elements to best ESG practices. This is only a sample of questions that investors can ask companies to determine whether they are at the forefront of running their businesses in line with ESG values. Learn more about ESG investing at northerntrust.com.
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