The expression that people “vote with their feet” has never been more true than in the case of investing with regard to environmental, social, and governance (ESG) factors. Although in the case of ESG investing, perhaps the expression should be that people vote with their money. By year-end 2022, investor assets in sustainable investments amounted to $8.4 trillion, or about 12.6% of all U.S. assets under management. And between 2019 and 2022, the share of index funds with an ESG mandate nearly doubled, from 3% to 5%. These statistics demonstrate that investor demand for ESG funds means ESG investing is here to stay.
What is ESG?
ESG investing is a form of sustainable investing that considers environmental, social, and governance factors to judge an investment’s financial returns and its overall impact. Each of the three terms in “ESG” encompasses a variety of important aspects of corporate planning and operations that investors want to know about before deciding whether to invest in a company.
Environmental criteria reflect how a company contributes to, or mitigates, degradation of the environment. The most prominent example is a company’s approach to climate change caused by greenhouse gas emissions: How does a company contribute to climate change, and how is the company addressing those risks and the climate change problem more generally? Environmental criteria may also reflect a company’s energy use, its handling of waste and other pollutants, and its position on deforestation and other issues of natural resource conservation.
Social criteria examine a wide range of issues about social relations. A significant aspect is how the company treats its employees and whether it provides them with fair compensation and benefits. These factors also reflect the composition of a company’s workforce: Does it reflect racial and gender diversity, and, importantly, is that diversity reflected up and down the corporate ladder? The “social” aspect of ESG also concerns whether the company’s vendors reflect its own stated values and where the company stands on human rights issues.
Governance criteria deal with how well a company is managed by its leadership and whether the company has sufficient controls in place to ensure management serves the interests of, and is accountable to, various company stakeholders. Important components include executive compensation that produces the right incentives for management, adequate board oversight, and robust auditing and other controls. Governance criteria also evaluate how the company treats shareholders and whether it provides them with the full and fair right to participate in corporate governance by voting through the proxy process.
Because investors are increasingly using the ESG criteria to make investment decisions that align with their core values, they need access to information about the degree to which companies have incorporated the ESG considerations into their structures and operations. This information enables investors to tailor their investment decisions and allocate their capital in ways they think are most effective in advancing their personal values. More disclosure about how companies are actually incorporating the ESG factors into their businesses will also help make those factors a reality. That, in turn, means progress toward increasing the sustainability, fairness, and quality of life our society can maintain. In short, to the extent profit-seeking companies see value in taking steps to prevent the ongoing degradation of the environment, address racism and sexism, reduce income inequality, and prevent fraud and other corporate malfeasance, all at the insistence of profit-seeking investors, the results will be market-based solutions, or at least mitigants, of some of our societies’ most vexing problems.
Since roughly 2006, when the acronym “ESG” was first coined, more and more investors have been basing their investment decisions at least in part according to the way that companies incorporate the ESG factors into their operations, risk assessments, and planning processes. Indeed, investor demand has driven the growth of ESG investing.
 Ryan Ermey, What is ESG Investing: A beginner’s guide to choosing a sustainable fund, CNBC (May 1, 2023), https://www.cnbc.com/2023/05/01/beginners-guide-to-esg-investing.html.
 National Bureau of Economic Research, Investors’ Willingness to Pay for ESF Funds, https://www.nber.org/digest/20231/investors-willingness-pay-esg-funds.
 Alana Benson, ESG for Beginners: Environmental, Social, and Governance Investing, Nerdwallet (Feb. 21, 2023), https://www.nerdwallet.com/article/investing/esg-investing.