Environmental, social, and governance (ESG) is a short way of describing an investing approach that focuses on environmental concerns, social concerns, and how companies are managed. This type of investing is sometimes called responsible investing. In more active cases, it may also be called impact investing. The term ESG is often used in the same way as corporate social responsibility and sustainability, but these terms have different meanings, beginnings, and uses.

The term ESG became well-known in 2004 through a report titled "Who Cares Wins." This report was created by financial institutions at the request of the United Nations (UN). By 2023, the ESG movement had grown from a UN initiative into a worldwide trend with more than US$30 trillion in investments managed under ESG principles.

Criticisms of ESG depend on the perspective and topic being discussed. These topics include poor quality of data, lack of clear standards, changing rules and politics, greenwashing (when companies falsely claim to be environmentally friendly), and differences in how social benefits are defined and measured. Some people argue that ESG acts like an extension of government rules, with large investment companies like BlackRock setting ESG standards that governments do not or cannot directly create. This has led to claims that ESG influences markets and company behavior without proper oversight, causing worries about fairness and excessive control.

History

Investment decisions are mostly based on how much money a person might earn for the level of risk they take. However, people have always used other reasons to decide where to put their money, such as political beliefs or religious goals.

In the 1970s, people around the world strongly disliked the apartheid system in South Africa. This led to one of the most famous examples of stopping investments for ethical reasons. In response to calls for sanctions against the system, Reverend Leon Sullivan, a member of General Motors’ board in the United States, created a Code of Conduct in 1977 for businesses operating in South Africa. This code, called the Sullivan Principles, received a lot of attention. The U.S. government asked for reports to check how many American companies were investing in South African businesses that broke the Sullivan Code. The results of these reports caused the United States to stop investing in many South African companies. This pressure from the business community helped increase the push to end the apartheid system.

In the 1960s and 1970s, economist Milton Friedman argued that focusing on social responsibility could hurt a company’s financial success. He believed that government rules and interference would harm the economy. His idea that companies should mostly care about making money, not social costs, was widely accepted for most of the 20th century. However, by the end of the 20th century, a different idea began to grow. In 1988, James S. Coleman wrote an article titled “Social Capital in the Creation of Human Capital,” which questioned the idea that self-interest was the main focus of economics. He introduced the idea of “social capital” as a way to measure value.

A new kind of pressure began to form, with environmental groups working together. Investors used their combined power to encourage companies and financial markets to consider environmental and social risks and opportunities in their decisions.

Although the idea of choosing where to invest based on values was not new, the investment market had long focused on controlling the effects of investments. At the start of the 21st century, the supply side of the investment market began to respond. This area was called ethical or socially responsible investment. The investment market started offering products for people who wanted to invest in ways that matched their values. In 1981, Freer Spreckley, the creator of Social Enterprise, wrote a book titled Social Audit — A Management Tool for Co-operative Working, where he first introduced the idea of using internal criteria like financial success, social wealth creation, good governance, and environmental responsibility in planning and accounting. These ideas became known as social accounting and auditing. In 1998, John Elkington, co-founder of the business consultancy Sustainability, wrote Cannibals with Forks: the Triple Bottom Line of 21st Century Business, where he introduced the idea of including financial, environmental, and social factors in measuring a company’s value. He called this the “triple bottom line.” At the same time, the strict separation between the environmental and financial sectors started to change. In 2002, Chris Yates-Smith, a member of a group overseeing environmental standards, helped create one of the first environmental finance research groups in the City of London. A group of financial leaders, lawyers, and environmental groups, called The Virtuous Circle, studied how environmental and social standards relate to financial success. Major banks and investment companies began offering services related to ESG (Environmental, Social, and Governance) investments.

In the early years of the new millennium, many in the investment market still believed that ethical investments might reduce financial returns. Philanthropy was not seen as helpful for business, and Milton Friedman’s ideas supported the belief that ethical behavior would cost more than it gained. However, this belief began to change. In 1998, two journalists, Robert Levering and Milton, published a list called “Fortune 100 Best Companies to Work For,” which highlighted U.S. companies that focused on corporate social responsibility and showed how their financial performance was affected. The environmental and social aspects of ESG received more public attention, partly because of concerns about climate change. Moskowitz brought attention to the corporate governance side of responsible investing, showing that better management practices improved productivity and efficiency. His research showed that improving corporate governance did not hurt financial results but instead helped companies perform better. In the early 2000s, the success of Moskowitz’s list influenced how companies recruited workers and built their reputations, challenging old ideas about ESG’s financial impact. In 2011, Alex Edmans, a finance professor at Wharton, published a study showing that the “100 Best Companies to Work For” had higher stock returns and better earnings than other companies.

In 2005, the United Nations Environment Programme Finance Initiative asked the law firm Freshfields Bruckhaus Deringer to study how ESG issues relate to investment laws. The report said it was not only allowed but also a duty for investment companies to consider ESG factors in their decisions. In 2014, the Law Commission in England and Wales confirmed that pension funds and others could legally consider ESG factors when making investments.

Milton Friedman had supported the idea that ESG factors might lower financial performance. However, many reports in the early 2000s showed the opposite. In 2006, Oxford University’s Michael Barnett and New York University’s Robert S.——

Investments with ESG criteria

Responsible investing using ESG standards has been supported worldwide by the Paris Agreement (COP21) and the UN 2030 Sustainable Development Goals.

In 2021, the value of ESG investments reached over $18.4 trillion, with an expected increase of 12.9% by 2026. For the first time in 2023, ESG investments experienced outflows, meaning money was taken out of these funds.

By 2023, the European Union held 84% of the world’s assets in sustainable funds, while the United States had 11%.

Because of concerns about greenwashing and new rules, fewer funds now use ESG-related terms in their names. In the United States, more funds are removing these terms, but this is not happening in Europe.

Even though ESG funds have grown overall, the first quarter of 2025 saw the largest amount of money ever taken out of sustainable funds.

Dimensions

ESG is used in the U.S. financial industry to describe and measure how companies affect the environment and society. MSCI, a global ESG rating agency, explains that ESG investing includes looking at environmental, social, and governance factors along with financial factors when making investment decisions. S&P also notes that these factors can affect how well companies perform.

• Environmental: Companies report data about climate change, greenhouse gas emissions, biodiversity loss, deforestation, pollution control, energy efficiency, and water management.
• Social: Companies report data about employee safety, working conditions, diversity, equity, inclusion, and conflicts. These factors influence customer satisfaction and employee engagement, which affect investment risks and returns.
• Governance: Companies report data about corporate practices, such as preventing corruption, board diversity, executive pay, cybersecurity, and management structure.

Concerns about climate change have grown, so investors now consider sustainability to manage risks and improve returns. These issues often involve external effects, such as how climate change impacts a company’s operations and profits. While many ESG topics exist, key areas include greenhouse gas emissions, biodiversity, and waste management.

Research on climate change has led some investors, like pension funds, to avoid industries heavily dependent on fossil fuels. In the UK, the Stern Review (2006) influenced policies by showing that addressing climate change early benefits the economy more than it costs. A major global framework for climate-related financial reporting is the Taskforce on Climate-Related Financial Disclosures (TCFD).

Companies must now consider whether their products or services will become outdated due to resource depletion or changing industry needs. Investors increasingly focus on long-term value.

The social part of ESG includes how companies treat employees and communities, such as workplace safety, human rights, and supply chain practices. Strong social practices can improve employee satisfaction and financial results.

Diverse teams are linked to innovation and better performance. However, diversity training alone is not enough. Companies that intentionally build inclusive teams, like the U.S. military, benefit more from diversity.

In 2006, U.S. courts said companies have social responsibilities that affect financial decisions. This now includes examining how companies impact local communities, employee health, and supply chains. A major framework for this is the United Nations Guiding Principles on Business and Human Rights.

Historically, consumers were expected to protect themselves, but now, consumer protection is a key concern for investors. The collapse of the U.S. subprime mortgage market led to more focus on fair lending practices.

Animal welfare issues include testing products on animals, factory farming, and using animals for exhibitions.

In 2021, 22 out of 435 ESG shareholder proposals were classified as conservative by As You Sow. Some conservative proposals include reports on charitable donations and board diversity.

The European SFDR excludes certain defense companies involved in weapons like anti-personnel mines and chemical weapons. However, the defense industry argues that it supports peace and development.

Corporate governance involves how companies are managed and controlled. Good governance ensures companies are accountable, transparent, and responsive to investors.

In ESG, governance includes board diversity, executive pay, ethical business practices, tax transparency, and board oversight. In 2024, the Fair Tax Foundation identified five tax-related areas ESG investors should consider.

MSCI highlights governance issues like board behavior, executive pay, and transparency. Other concerns include ethical practices, board independence, shareholder rights, and political donations.

A company’s management structure affects its value. Recent attention has focused on the balance of power between the CEO and the board of directors.

Responsible investment

The three areas of environmental, social, and corporate governance are closely connected to the idea of responsible investment (RI). RI started as a small part of the investment world, helping people who wanted to invest but also wanted to follow ethical rules. In recent years, it has grown to become a larger part of the investment market. By June 2020, money flowing into U.S. sustainable funds reached $20.9 billion, almost the same as the $21.4 billion in 2019. By the end of 2020, money flowing into U.S. sustainable funds exceeded $51 billion. Worldwide, sustainable funds held $1.65 trillion in assets by the end of 2020.

ESG corporate reporting helps people who care about a company’s impact to understand the risks and opportunities related to sustainability. Investors may also use ESG data to evaluate a company’s value by creating models that assume managing sustainability-related risks and opportunities for all people involved in the company can lead to better long-term returns.

RI uses several methods to guide where investments are placed:

• Positive selection: Investors choose companies to invest in based on ESG standards or by selecting top-performing companies that follow ESG rules.
• Activism: Investors vote on company issues or push for changes in how a company is managed.
• Engagement: Investment funds monitor ESG performance of companies in their portfolios and have conversations with companies to encourage progress.
• Consulting role: Large investors often meet with company leaders to share information and act as early warnings for risks or problems.
• Exclusion: Some sectors or companies are removed from investment options based on ESG rules.
• Integration: ESG risks and opportunities are included in traditional financial analysis of a company’s value.

However, these methods can also create new risks:

• Concentration risk: For example, the FTSE4Good Index has more focus on technology companies than the FTSE All-World Index.
• Ineffectiveness in removing certain industries: Companies in areas like alcohol, tobacco, gambling, defense, AI, cryptocurrencies, oil, gas, and coal are still included in major investment indexes.

Research on how ESG practices affect a company’s value has shown mixed results. Some studies find a link between certain ESG factors and better company performance. However, other studies suggest that focusing too much on ESG may not always help a company’s value. In some cases, too much investment in ESG or too much oversight by investors might reduce benefits.

Studies suggest the relationship between ESG performance and company value may not be straightforward. It could follow a pattern where benefits increase to a point and then decrease. This means there might be an ideal level of ESG investment that gives the most benefit, after which returns drop or become harmful.

A major change in the investment world is the growing difference between companies and their investors. Institutional investors, such as insurance companies, mutual funds, and pension funds, now own most of the stock. In the U.S., institutional ownership rose from 35% in 1981 to 58% in 2002. In the U.K., it rose from 42% in 1963 to 84.7% in 2004. These investors often focus on long-term goals, unlike individual investors who may seek short-term gains. Pension funds, for example, must follow rules like ERISA, which limits how much investment decisions can be based on factors other than maximizing returns for participants.

Because responsible investment is believed to protect and improve returns, it has become a common focus for institutional investors. By late 2016, more than a third of institutional investors in Europe and Asia-Pacific said ESG factors were a major reason for refusing to invest in private equity funds. A fifth of North American investors also used ESG considerations for this purpose. In response, trade groups in private equity and other industries created ESG guidelines, including questionnaires for fund managers to use before investing.

In the second half of 2019, institutional investors increased their focus on ESG-informed investments. The idea of "SDG Driven Investment" became more popular among pension funds, sovereign wealth funds, and asset managers. This happened during events like the G7 Pensions Roundtable in Biarritz, France, and the Business Roundtable in Washington, D.C.

Groups of institutional investors have formed to address climate change. These groups commit to meeting climate action goals, such as the Institutional Investors Group on Climate Change, which aims to reach net zero emissions by 2030. These groups also work with investment frameworks, like Climate Action 100+, to evaluate how well companies are working toward reducing greenhouse gas emissions.

The Principles for Responsible Investment Initiative (PRI), started in 2005 by the United Nations, provides a framework to help investors analyze ESG issues and support responsible ownership. By April 2019, over 2,350 organizations had signed onto the PRI.

The Equator Principles are a set of rules used by financial institutions to assess and manage environmental and social risks in projects. They set a minimum standard for checking if projects are safe for the environment and society. As of October 2019, 97 financial institutions in 37 countries had adopted the Equator Principles. These institutions agree not to fund projects where the borrower cannot follow social and environmental policies. The Equator Principles were created in 2003 based on guidelines from the International Finance Corporation and have been updated over time.

Statistics

A survey from Finder UK, which represents people across the UK, found that more than half (57%) of UK investors have ESG investments. Generation Z is the most likely generation to invest through ESG, with 66% of those surveyed expressing interest in ESG investing. Baby boomers are the least likely to consider ethical investments, as only 11% of this generation plan to invest in ethical ways.

ESG rating agencies

ESG rating agencies act as key middlemen in ESG investing. In 2018, Sustainalytics estimated that more than 600 ESG rating companies existed in the market.

The market for ESG rating providers is becoming more focused, with fewer companies controlling a larger share. For example, by 2017, Morningstar owned 40% of Sustainalytics. In 2019, Moody's acquired Vigeo Eiris, a major European ESG rating company. Institutional Shareholder Services (ISS) purchased Oekom in Germany, and S&P Global bought the ESG rating business of RobecoSAM. The market is divided between a few large non-European providers and many smaller European providers.

In this focused market, large index providers like MSCI play a key role in setting standards for what is considered sustainable finance.

ESG rating agencies can be grouped into two main categories. First, ESG risk rating agencies, such as MSCI, Sustainalytics, S&P, and FTSE Russell, measure how likely a company is to face ESG-related problems, rather than focusing on specific actions taken. Second, ESG effectiveness rating agencies, such as Refinitiv, Moody's, ECPI, Sensefolio, and Inrate, evaluate how well companies commit to, integrate, and achieve results in ESG factors, and how these efforts impact society.

This classification helps explain why ESG ratings may not always reflect strong environmental, social, and governance effects. A company with a high score may have low exposure to ESG risks, not necessarily strong positive impacts.

Financial institutions, such as asset managers, increasingly use ESG rating agencies to evaluate and compare companies' ESG performance. Recently, publications like Newsweek have used ESG data from companies like Statista to rank the most responsible organizations in a country.

Companies like ESG Analytics use artificial intelligence to rate companies' ESG commitments. Each rating agency uses its own methods to measure ESG compliance, and there is no single standard used across the industry.

In Latin America, the Latin American Quality Institute (LAQI), based in Panama City and operating in 19 countries, leads ESG certification efforts. LAQI has issued over 10,000 certifications. In 2024, LAQI launched the LAQI Q-ESG CERTIFICATION, a system that checks how well organizations meet ESG standards across four areas: Quality (Q), Environmental (E), Social (S), and Governance (G). This certification applies to small and medium-sized businesses in 22 sectors. Each certificate is recorded on LAQIChain, a secure online record using blockchain technology. The full system is available publicly.

Disclosure and regulation

The first ten years of the 21st century saw growth in the ESG investment market. Many large banks now have teams that focus on responsible investment. Smaller companies that help businesses make decisions about environmental, social, and governance (ESG) issues are also increasing in number. A key reason for this growth is the difficulty of measuring ESG information. ESG data is not financial and cannot be easily turned into numbers. Investors have long considered non-financial factors, like a company’s reputation, when making decisions. However, ESG factors are harder to measure and check because there are no clear rules or standards. This lack of clear guidelines has caused concerns that companies may use ESG claims to improve their image without making real improvements to the environment or society.

A major challenge in ESG reporting is transparency. Business activities can harm the environment, including air, water, and ecosystems. Financial information is usually easy to find and verify because company records are checked by outside experts. However, ESG data often comes from the companies themselves, and it is rarely checked by others. Without universal rules or standards for how to measure ESG factors, the information can be unclear or biased.

One solution to the problem of unclear ESG data is to create widely accepted standards. Organizations like the International Organization for Standardization (ISO) have developed rules for many areas. Some companies, like Probus-Sigma, have created methods to rate ESG performance based on these standards and verified by outside experts. However, not all financial markets use these standards consistently.

Corporate governance has more rules than ESG because it has a longer history of regulation. In 1992, the London Stock Exchange and the Financial Reporting Commission created the Cadbury Commission to address past governance failures. Their findings led to the Combined Code on Corporate Governance in 2003, which is now widely used as a guide for good business practices.

In an interview, Francis Menassa of JAR Capital said the European Union’s 2014 Non-Financial Reporting Directive requires large companies to share information about their social and environmental practices. This helps investors and others assess how well companies are managing these issues. The goal is to encourage businesses to act responsibly.

A key issue in ESG reporting is creating reliable ratings for companies. Many financial groups, such as the Dow Jones Sustainability Index and the MSCI ESG Indices, have developed ESG-related ratings. These tools help investors compare companies based on their ESG performance.

European regulators have introduced rules to stop companies from using ESG claims misleadingly. These rules come from the European Commission’s Action Plan on Sustainable Finance.

In March 2021, the U.S. Securities and Exchange Commission (SEC) said it would focus on checking how companies report ESG information. Around the same time, the U.S. Labor Department said it would not enforce a rule that limited ESG considerations in 401(k) investments. In September 2021, the SEC chair said the agency was working on new rules for ESG investment funds. In October 2021, the Labor Department proposed reversing a rule that limited ESG factors in 401(k) decisions.

In November 2021, the SEC removed a rule that allowed companies to exclude ESG proposals from shareholder meetings. In May 2022, the SEC proposed changes to ESG fund rules to stop misleading marketing and improve transparency. In October 2022, the SEC reopened comments on these rules due to a technical issue. In November 2022, the Labor Department finalized a rule that allows ESG factors to be considered in 401(k) decisions. In March 2023, President Joe Biden rejected a bill that would have overturned this rule.

Under ESG reporting, companies must share data from financial and non-financial sources to show they meet standards set by groups like the Sustainability Accounting Standards Board and the Global Reporting Initiative. This data must also be available to rating agencies and shareholders.

ESG reporting means companies share information about their impact on the environment, society, and how they are governed. This is usually done voluntarily, meaning companies choose to do it to be transparent with stakeholders like investors. However, in some places, like India, ESG reporting is required for certain companies. For example, in India, the top 1000 companies by market value must provide a report called BRSR to show their ESG performance.

Research findings

A 2021 study by the NYU Stern Center for Sustainable Business, which reviewed over 1,000 studies, found that different studies use varying scores for companies based on the data providers they use.

Gallup reported that 28% of U.S. employees strongly agree with the statement, "My organization makes a positive impact on people and the planet."

Research shows that intangible assets, such as brand reputation and customer trust, are becoming a larger part of a company’s future value.

A study by the European Securities and Markets Authority found that ESG factors generally improve investment returns and reduce costs over time. Analysis over five years showed that stock funds focused on ESG scores performed better: European markets saw an average annual return increase of 1.59%, Asia-Pacific markets had an increase of 1.02%, and North American and global markets had increases of 0.13% to 0.17%.

In January 2023, a Rasmussen poll in the U.S. found that 9% of Americans believed promoting causes like diversity and environmentalism was the most important goal for companies. Sixty-nine percent said companies should focus on providing quality goods and services, and 13% said increasing profit was most important. A PricewaterhouseCoopers poll found that 83% of consumers believe companies should actively support ESG best practices. Additionally, 76% of consumers said they would stop doing business with companies that treat employees, communities, or the environment poorly.

ESG guidelines for arms manufacturers in western Europe have been criticized for prioritizing environmentally friendly practices over practical durability in battlefield conditions. During the Russo-Ukrainian War, military equipment sent to Ukraine by western European countries included electronic components with insulation made from corn fiber instead of synthetic materials. This choice led to malfunctions because rodents damaged the corn fiber insulation.