Environmental, social and governance (ESG) has become a mainstream way to invest. ESG criteria relates to a set of socially conscious standards that you can use to filter the types of investments you put in your portfolio. These criteria allow you to align your investments with your core values.
You may already know what each letter of ESG stands for — “environmental,” “social” and “governance” — but let’s focus on answering the question, “What is the “G” in ESG?” While you may know that “G” stands for “governance,” it may be the lesser known of the triplets.
By the time you’ve finished reading this article, you’ll know exactly what it means and how you can incorporate it into your own personal investing strategy.
What does governance mean in ESG?
For large companies to succeed, they must demonstrate good corporate citizenship. But what does governance mean in ESG, exactly?
Corporate governance refers to a wide range of corporate activities, including the rights and responsibilities of the board of directors, managers and stakeholders. (Stakeholders include shareholders, customers, suppliers, government entities and the community.) For example, a company with good governance may have a highly ethical board and management structure, well-structured company policies and ethical investing business practices.
As an investor, you can look into a company’s governance policies and practices to make sure it offers the most ethical practices for your preferences. Start connecting your wallet with your heart!
ESG governance examples
What are some examples of ESG governance practices you should keep in mind when you’re looking into investments that fit your needs? Let’s find out.
Executive pay and behavior
The Economic Policy Institute found that CEO pay has increased 1,322% since 1978. CEOs were paid 351 times as much as a typical worker in 2020. Due to these increases, many investors would like to see policy changes that reduce CEO incentives, make CEO pay linked to meeting ESG goals and have higher income tax rates.
In addition, ESG may also demand certain behaviors from executives (such as a lack of corruption or bribery). These practices may guide promotion and hiring decisions in organizations.
Shareholder rights protection
Shareholder-friendly governance in ESG practices, such as fewer shareholder rights restrictions, may offer transparent reporting and oversight practices. Shareholder rights restrictions may include equal voting rights, restrictions on the right to call a special meeting and majority vote requirements.
Business ethics gets right to the point of ESG — putting values first and foremost, which includes ESG investing transparency and fairness in all areas of a corporation. Businesses that can project honesty and trust can prove their social value and maximize investment value for investors.
Regulatory and legal environment
A business’s regulatory and legal environment also remains an important part of the governance part of ESG. If a company’s registration, licensing and other regulatory factors aren’t up to date, it can result in legal fees, expensive litigation and a potential sudden decrease in stock value. Not following regulatory and legal environment rules can put a puncture in a company’s current and future success.
Board independence, diversity and structure
Independent boards structured with diversity in mind can oversee management and guide company strategy. When a company puts a high priority on board accountability and responsiveness, it can improve the results for all shareholders.
Why governance matters to investors
When a company meets specific benchmarks and objectives and operates ethically and efficiently, investors can benefit in several ways:
- Cash flow benefits: Putting a priority on governance ensures adequate capital flow throughout the organization, which can increase dividend output or other benefits to investors. Good governance practices can mean that once you invest, your investments, whether they are ETF, stocks, mutual funds or other types of investments, can benefit.
- Lessens risk: Governance transparency also helps mitigate risks because it improves the company’s reputation and brand value. The board of directors and executives can then make better decisions within already-established policies and a concrete framework for the company.
- Benefits all stakeholders: From shareholders to employees, companies that abide by good governance practices can benefit from responsible business decisions and practices.
How can you include governance in your investments?
Ready to make sure the companies on your shortlist meet your expectations for governance? How do you check for the most transparent governance policies and practices for your investments?
Check the investor relations site on each company’s website. Companies will list information about corporate leadership, governance documents, their articles of incorporation and more.
Your brokerage account can also simplify your search. You can get ultra-specific about the qualities you want in a company. Many brokers can give you access to tools that screen for specific ESG factors.
How can we improve governance ESG?
Shaping a company’s culture purposefully with an ESG mindset can help drive positive ESG outcomes.
Overall improvements in reporting can also make ESG ratings more effective. Mandatory and comprehensive reporting can help standardize governance criteria among ESG companies.
Learn more: ESG investing FAQs
Putting a priority on ESG means corporations and stakeholders can benefit in the long term, with higher quality businesses that can withstand future challenges. The best governance practices can alleviate risk and volatility and help you choose investments that align with your most deeply held values.
Interested in corporate governance ESG or want to shift to an ESG portfolio? Check out Ally’s Robo Portfolios and Self-Directed opportunities.