American vs. European comparison: What are the standards and practices to rank a firm according to the ESG Environmental criteria ?
Environmental, social and governance (ESG) criteria are a set of standards for a company’s operations that socially conscious investors use to screen potential investments. Environmental criteria consider how a company performs as a steward of nature. Social criteria examine how it manages relationships with employees, suppliers, customers, and the communities where it operates. Governance deals with a company’s leadership, executive pay, audits, internal controls, and shareholder rights.
In the US to assess a company based on environmental, social, and governance (ESG) criteria, investors look at a broad range of behaviors. Environmental criteria may include a company’s energy use, waste, pollution, natural resource conservation, and treatment of animals. Social criteria look at the company’s business relationships. With regard to governance, investors may want to know that a company uses accurate and transparent accounting methods and that stockholders are given an opportunity to vote on important issues. ESG scores and short in those with the lowest scores yields a significantly negative abnormal return. Interestingly, this is caused by the strong positive return of firms with the lowest ESG activity. ESG investing grew out of investment philosophies such as Socially Responsible Investing (SRI), but there are key differences. ESG investing and analysis, on the other hand, looks at finding value in companies—not simply at supporting a set of values.
ESG stands for Environmental, Social, and Governance. Investors are increasingly applying these non-financial factors as part of their analysis process to identify material risks and growth opportunities. ESG metrics are not commonly part of mandatory financial reporting, though companies are increasingly making disclosures in their annual report or in a standalone sustainability report. (Lopez de Salines. 2019). Numerous institutions, such as the Sustainable Accounting Standards Board (SASB), the Global Reporting Initiative (GRI), and CDP are working to form standards and define materiality to facilitate incorporation of these factors into the investment process.
Thus, as we find that increasing ESG scores reduce firm risk (particularly downside risk), this hints at an insurance-like character of corporate social responsibility: Firms with low ESG activity need to offer a corresponding risk premium. The perception of ESG as an insurance can be shown to be stronger in more volatile capital markets for U.S. firms, but not for European firms. Socially responsible investment may therefore be of varying attractiveness in different market phases.
Christina E. Bannier, Yannik Bofinger, Björn Rock. Doing safe by doing good : ESG investing and corporate social responsibility in the U.S. and Europe. Center for Financial Studies (Frankfurt am Main): CFS working paper series ; No. 621. 2019
Lopez de Silanes, Florencio and McCahery, Joseph A. and Pudschedl, Paul C., ESG Performance and Disclosure: A Cross-Country Analysis (December 18, 2019). TILEC Discussion Paper No. DP2019-032;
Green to Gold: How Smart Companies Use Environmental Strategy to Innovate, Create Value, and Build Competitive Advantage. Daniel C. Esty, Andrew S. Winston, reprint, Yale University Press, 2006