Environmental, social, and governance (ESG) is a short way of describing an investing principle that focuses on environmental issues, social issues, and how companies are managed. Investing with ESG considerations is sometimes called responsible investing or, when goals are more specific, impact investing. The term ESG is often used in the same way as corporate social responsibility and sustainability, even though these ideas have different purposes, beginnings, and uses.

The term ESG became well-known in a 2004 report called "Who Cares Wins," created by financial institutions at the request of the United Nations (UN). By 2023, the ESG movement had grown from a UN initiative about corporate social responsibility into a worldwide trend managing more than $30 trillion in investments.

Criticisms of ESG depend on the perspective and area of focus. These areas include problems with data quality and a lack of clear standards; changes in laws and politics; using misleading claims about environmental benefits (greenwashing); and differences in how social good is defined and measured. Some critics say ESG acts like an extension of government rules, with large investment companies like BlackRock setting ESG standards that governments do not directly create. This has caused concerns that ESG influences markets and company behavior without proper oversight, raising questions about fairness and too much control.

History

Investment decisions are mostly based on the chance of making money for a certain level of risk. However, people have always considered other factors when choosing where to put their money, such as political issues or religious beliefs.

In the 1970s, people around the world strongly opposed the apartheid system in South Africa. This led to one of the most famous examples of choosing not to invest in companies based on ethical reasons. In response to calls for sanctions against the South African government, 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 Principles. The results of these reports caused the United States to stop investing in many South African companies. This pressure from businesses in South Africa 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. Friedman claimed that a company’s value should be based almost entirely on financial results, with the costs of social responsibility seen as unimportant. This idea, called the Friedman doctrine, was widely accepted for much of the 20th century. However, by the late 20th century, a different theory began to gain popularity. In 1988, James S. Coleman wrote an article titled "Social Capital in the Creation of Human Capital," which questioned the focus on self-interest in economics and introduced the idea of social capital as a way to measure value.

A new type of pressure began to grow, with environmental groups and investors working together. They 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 selective investment was not new, the focus on controlling the effects of investments had a long history. 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 to meet the growing demand for products aimed at responsible investors. In 1981, Freer Spreckley, who created Social Enterprise, published a book titled Social Audit — A Management Tool for Co-operative Working, where he introduced four internal criteria for social enterprises and other organizations: financial viability, social wealth creation, organizational governance, and environmental responsibility. These became known as social accounting and auditing. Later, in 1998, John Elkington, co-founder of the business consultancy Sustainability, published Cannibals with Forks: the Triple Bottom Line of 21st Century Business, where he identified the importance of including non-financial factors in company value. He introduced the term "triple bottom line," referring to financial, environmental, and social factors. Around the same time, the strict separation between environmental and financial sectors started to fade. In 2002, Chris Yates-Smith, a member of an international panel overseeing environmental standards, helped create one of the first environmental finance research groups in London. This group, called The Virtuous Circle, studied how environmental and social standards relate to financial performance. Major banks and investment firms, such as Brazil’s Unibanco and London’s Jupiter Fund, began offering services based on ESG (Environmental, Social, and Governance) research in 2001.

At the start of the new millennium, most of the investment market still believed that ethical investments might reduce financial returns. Philanthropy was not seen as helpful for business success, and Friedman’s ideas were widely accepted. However, these beliefs began to change. In 1998, two journalists, Robert Levering and Milton, published the "Fortune 100 Best Companies to Work For," a list of U.S. companies known for their corporate social responsibility and financial performance. The environmental and social aspects of ESG received more public attention, partly due to growing concerns about climate change. Moskowitz focused on corporate governance, showing that better management practices improved productivity and helped companies attract top talent. His work influenced companies to improve their governance, which in turn helped their financial results. In the early 2000s, the success of Moskowitz’s list and its impact on hiring and brand reputation began to challenge old ideas about ESG’s financial effects. In 2011, Alex Edmans, a finance professor at Wharton, published a study showing that the "100 Best Companies to Work For" outperformed other companies in stock returns by 2–3% annually from 1984 to 2009, and their earnings exceeded expectations.

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 concluded that it was not only allowed but also a legal responsibility for investment companies to include ESG factors in their decisions. In 2014, the Law Commission in England and Wales confirmed that pension fund managers and others could consider ESG factors when making investments.

While Friedman supported the idea that ESG factors might hurt financial performance, many studies in the early 2000s showed the opposite. In 2006, researchers from Oxford University and New York University found evidence that ESG factors could improve financial results.

Investments with ESG criteria

Responsible investing through ESG has been influenced by the Paris Agreement (COP21) and the UN 2030 Sustainable Development Goals. In 2021, the value of ESG investments was over $18.4 trillion. It is expected to grow by 12.9% by 2026. For the first time in 2023, investors withdrew money from ESG funds.

In 2023, the EU held 84% of the world’s sustainable fund assets, while the US held 11%. Because of concerns about greenwashing and stricter rules, fewer funds now use ESG-related terms in their names. In the United States, more funds are removing ESG-related terms from their names, but this trend is not seen in Europe.

Even though ESG funds have generally increased, the first quarter of 2025 saw the most money ever taken out of sustainable funds.

Dimensions

ESG is used in the U.S. financial industry to describe how companies impact the environment and society. MSCI, an ESG rating company, explains ESG investing as considering environmental, social, and governance factors along with financial factors when making investment decisions. S&P also notes that these factors can affect a company’s performance by influencing risks and opportunities.

• Environmental: Information is shared about climate change, greenhouse gas emissions, loss of biodiversity, deforestation, pollution control, energy use, and water management.
• Social: Information includes employee safety, working conditions, diversity and inclusion, and how companies handle conflicts or humanitarian issues. These factors affect customer satisfaction and employee engagement, which are important for investment decisions.
• Governance: Information covers corporate practices like preventing corruption, board diversity, executive pay, cybersecurity, and management structure.

Investors are increasingly considering sustainability because climate change and its risks are growing. These issues often involve external effects, such as how climate change impacts a company’s operations or profits. While many ESG concerns exist, key areas include greenhouse gas emissions, biodiversity, waste, and water use.

Research on climate change has led some investors, like pension funds and insurance companies, to evaluate how investments affect climate-related risks. Industries relying heavily on fossil fuels are less appealing. In the UK, the 2006 Stern Review, which analyzed climate change’s economic effects, encouraged including climate considerations in financial decisions. A global tool called the Taskforce on Climate-Related Financial Disclosures (TCFD) is widely used to guide these efforts.

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

The social part of ESG includes how companies treat employees and communities, such as workplace safety, fair treatment, and human rights in supply chains. Strong social practices can improve employee satisfaction and help companies remain stable over time. Studies show that companies with good ESG practices often gain more trust from investors and achieve better financial results.

More diverse workforces are seen as beneficial for innovation and problem-solving. However, simply requiring diversity training is not enough. Companies that intentionally build diverse teams, like the U.S. military, often succeed better.

In 2006, U.S. courts ruled that companies have social responsibilities that affect financial decisions. This has expanded to include how companies impact local communities, employee health, and supply chain practices. A key tool for this is the United Nations Guiding Principles on Business and Human Rights.

Historically, consumers were expected to protect themselves ("buyer beware"). Now, companies are held to higher standards to avoid harm, and consumer protection is a major concern for investors. The collapse of the U.S. subprime mortgage market also led to greater focus on fair lending practices.

Animal welfare concerns include testing products on animals, breeding for testing, or conditions in factory farms.

In 2021, 22 of 435 ESG-related shareholder proposals were labeled "conservative" by As You Sow. Some conservative proposals include reports on charitable work and board diversity.

The European SFDR excludes certain defense companies involved in weapons like anti-personnel mines or chemical weapons. However, defense companies like Elbit Systems or Airbus still receive ESG-labeled investments. The Aerospace and Defence Industries Association of Europe argues that defense is necessary for peace and development.

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

In ESG, governance includes board diversity, executive pay, ethical business practices, tax transparency, and oversight of leadership. 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 in financial reporting. Other concerns include ethical practices, board oversight, and shareholder rights.

The internal systems that manage a company’s operations are important for evaluating its value. Recent focus has been on the balance of power between the CEO and the board of directors.

Responsible investment

Responsible investment (RI) connects closely with three areas: environmental, social, and corporate governance. RI started as a small part of the investment world, helping people who wanted to invest but only in ways that met ethical standards. Over time, it has grown to become a major part of the investment market. In June 2020, $20.9 billion was invested in U.S. sustainable funds, almost the same as the $21.4 billion invested in 2019. By the end of 2020, total investments in U.S. sustainable funds reached $51 billion. Worldwide, sustainable funds held $1.65 trillion in assets by the end of 2020.

ESG reporting helps stakeholders understand the risks and opportunities related to sustainability for a company. Investors use ESG data not only to assess risks but also to evaluate a company’s overall value. They may create models based on the idea that managing sustainability-related risks and opportunities for all groups connected to a company can lead to better long-term returns.

RI uses several methods to guide investments:

• Positive selection: Investors choose companies based on ESG criteria or by selecting top-performing ESG-compliant companies.
• Activism: Shareholders vote to support specific issues or change how a company is governed.
• Engagement: Investment funds monitor ESG performance and work with companies to improve progress.
• Consulting role: Large investors meet with company leaders to share information and identify risks early.
• Exclusion: Certain sectors or companies are removed from investment options based on ESG criteria.
• Integration: ESG risks and opportunities are included in traditional financial analysis of a company’s value.

However, these methods can introduce new risks:

• Concentration risk: For example, the FTSE4Good Index has more focus on technology companies compared to the FTSE All-World Index.
• Ineffectiveness in removing industries: Some industries, like alcohol, tobacco, gambling, defense, AI, cryptocurrencies, oil, gas, and coal, still appear in major investment indices.

Research on ESG practices and corporate value has shown mixed results. Some studies find a positive link between ESG factors and company performance, while others question whether ESG investments always improve corporate value. Some researchers suggest that too much focus on ESG can be unhelpful or even harmful to a company’s value in certain cases. Studies also show that the relationship between ESG performance and corporate value may not be straightforward. It could follow a pattern where benefits increase up to a point and then decrease, meaning there is an ideal level of ESG investment for maximizing value.

A major change in the investment world is the shift in how companies and their investors interact. Institutional investors, such as insurance companies, mutual funds, and pension funds, now own most of the stock in the U.S. and U.K. These investors focus on long-term goals, unlike individual investors who may prioritize short-term gains. Pension funds, for example, must follow rules that limit investments to those that maximize returns for participants.

Because of the belief that addressing ESG issues can protect and improve investment returns, responsible investment is now common in the institutional investment industry. By late 2016, more than a third of institutional investors in Europe and Asia-Pacific said ESG considerations were important in deciding not to invest in private equity funds. Similar trends were seen in North America. In response, private equity and other industry groups created ESG best practices, including tools for checking a company’s ESG performance before investing.

In 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 was highlighted at events like the G7 Pensions Roundtable and the Business Roundtable in 2019.

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 frameworks like Climate Action 100+ to evaluate how well companies are reducing greenhouse gas emissions.

The Principles for Responsible Investment Initiative (PRI), created in 2005 by the United Nations, provides a framework to improve ESG analysis in investing and help companies act responsibly. As of April 2019, over 2,350 organizations had signed onto the PRI.

The Equator Principles are a set of rules used by financial institutions to manage environmental and social risks in project financing. They ensure that projects meet minimum standards for responsible decision-making. As of October 2019, 97 financial institutions in 37 countries had adopted the Equator Principles. These institutions agree not to fund projects that fail to follow required social and environmental policies.

The Equator Principles, introduced in 2003, were based on standards from the International Finance Corporation. These standards have been updated over time and are now known as the International Finance Corporation Performance Standards and the World Bank Group Environmental, Health, and Safety Guidelines.

Statistics

A survey from Finder UK, which included people from across the United Kingdom, found that more than half (57%) of UK investors have ESG investments. Generation Z is the most likely group to invest through ESG, with 66% of those surveyed saying they are interested in ESG investing. Baby Boomers are the least likely to think about investing in an ethical way, with only 11% of this group planning to invest in ethical investments.

ESG rating agencies

ESG rating agencies act as middlemen in ESG investing. In 2018, Sustainalytics estimated there were more than 600 ESG rating companies operating globally.

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

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

ESG rating agencies can be divided into two groups based on their purpose. First, ESG risk rating agencies, such as MSCI, Sustainalytics, S&P, and FTSE Russell, measure how likely a company is to face negative impacts from ESG risks, rather than focusing on the company’s actions to address these risks. Second, ESG effectiveness rating agencies, such as Refinitiv, Moody's, ECPI, Sensefolio, and Inrate, evaluate how well a company integrates ESG factors, its progress, and its positive impact on society.

This classification helps explain why ESG ratings may not always reflect a company’s true impact on environmental, social, and governance issues. A company with a high score may have low exposure to ESG risks, not necessarily strong positive effects on the world.

Financial institutions and 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 such as ESG Analytics use artificial intelligence to rate companies’ ESG commitment. Each rating agency uses its own methods to measure ESG compliance, and there are no universal standards across the industry.

In Latin America, the Latin American Quality Institute (LAQI), based in Panama City and active in 19 countries, leads ESG certification efforts. LAQI has issued more than 10,000 certifications. In 2024, LAQI launched the LAQI Q-ESG CERTIFICATION, a system that evaluates organizations 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 stored on LAQIChain, a blockchain system on the Polygon network. The full certification framework is publicly available.

Disclosure and regulation

The first ten years of the 21st century saw growth in the ESG investment market. Most 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 growing in number. A key reason for this growth is that ESG data is not based on numbers but on descriptions. This type of data is hard to measure and check because it is not financial. Investors have long dealt with intangible factors like goodwill, which are not based on numbers but on descriptions. However, ESG factors are even harder to measure and verify. Without clear rules or standards, some companies may use ESG claims to improve their public image without making real changes to help the environment or society.

A major issue in ESG reporting is the lack of clear information. Business activities can harm the environment, such as polluting air, water, or land. Investors can usually find financial information by looking at company reports, which are often checked by outside experts. However, ESG information is usually provided by the company itself, and it is rarely checked by others. Without universal rules or standards, measuring ESG data is difficult and often based on opinions.

One solution to the challenges of ESG data is to create widely accepted standards for measuring ESG factors. Organizations like the International Organization for Standardization (ISO) have developed such standards. Some companies have created methods to rate ESG performance using ISO standards and verified by outside experts. However, these standards are not yet used universally.

Corporate governance, which includes how companies are managed, has more rules and standards because it has a longer history of regulation. In 1992, the London Stock Exchange and the Financial Reporting Commission formed the Cadbury Commission to study governance failures in the UK. Their findings led to the Combined Code on Corporate Governance in 2003, which is widely accepted as a guide for good company management.

In an interview with Yahoo! Finance, Francis Menassa of JAR Capital said the EU’s 2014 Non-Financial Reporting Directive requires large companies to share information about their social and environmental impacts. This helps investors, consumers, and others evaluate how well companies address these issues.

A key challenge in ESG reporting is creating reliable ratings for companies. Many financial organizations, such as the Dow Jones Sustainability Index, FTSE4Good Index, Bloomberg ESG data, MSCI ESG Indices, and GRESB benchmarks, have created ESG-related ratings.

European regulators have introduced rules to stop companies from misleading the public about their ESG efforts, such as 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 if companies follow ESG disclosure rules. The same month, the U.S. Labor Department said it would not enforce a rule from the Trump administration that limited ESG considerations in 401(k) investments. In September 2021, SEC Chair Gary Gensler said the agency was working on new ESG disclosure rules. In October 2021, the Labor Department proposed reversing the Trump rule.

In November 2021, the SEC removed a rule that allowed companies to ignore ESG proposals from shareholders. In May 2022, the SEC proposed changes to prevent ESG marketing practices that mislead investors and increase ESG disclosure requirements. In October 2022, the SEC reopened the public comment period for its ESG rules due to a technical error. In November 2022, the Labor Department finalized a rule that allows ESG factors to be considered in 401(k) investments. In March 2023, President Joe Biden rejected a bill that would have overturned the Labor Department’s ESG 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, the Global Reporting Initiative, and the Task Force on Climate-related Financial Disclosures. This data must also be shared with rating agencies and shareholders.

ESG reporting means companies share information about their environmental, social, and governance impacts. This is usually done voluntarily, but in some places like India, it is required for certain companies. In India, the top 1000 companies by market value must report on ESG issues under the BRSR rule.

Research findings

A 2021 study by the NYU Stern Center for Sustainable Business found that over 1,000 studies show companies have different scores based on the data providers used.

Gallup reports 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 reputation and brand value, are becoming a larger part of future company value.

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

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 companies should focus on increasing profit. A PricewaterhouseCoopers poll found that 83% of consumers believe companies should actively shape ESG best practices, and 76% said they would stop doing business with companies that treat employees, communities, or the environment poorly.

ESG guidelines for Western European arms manufacturers have been criticized for prioritizing environmentally-friendly manufacturing practices over making weapons durable in real battlefield conditions. During the Russo-Ukrainian War, military equipment sent to Ukraine by Western European countries had electronic components with insulation made from corn fiber instead of synthetic materials. This insulation was damaged by rodents, causing the equipment to malfunction.