By investing in ethical companies with strong governance, ESG investing can help investors better understand and manage their portfolio risks. It may not be obvious but harming the environment, biodiversity and nature loss can impact the economy and poses hidden risks to investments. Some sectors vulnerable to environmental damage include construction, agriculture, and forestry are dependent on the environment.
Investing in ESG-oriented companies may reduce overall investment risk, given those companies’ stronger relative governance practices and better business ethics. Corporate governance practices determine a company’s approach to building stakeholder value, including how it seeks to mitigate risks and pursue opportunities related to the E and S factors. Governance can comprise of corporate governance and corporate behavior.
Good governance involves the makeup of a company’s board, ownership, and management teams and through their oversight roles to ensure good accounting, auditing, and corporate disclosure practices. Under the corporate behavior umbrella, there’s the company’s business ethics, transparency, and regulatory compliance as well as the presence of any anticompetitive practices, corruption, or instability.
There are several reasons why good governance in a company is important. First, it affects the bottom line. Weak governance can have a big impact on a company’s financial health. Poor governance decisions can cost shareholders through reputational damage, legal liabilities, and ultimately financial losses. It’s also possible that investors may feel less inclined to associate themselves with or invest in stock or bonds issued by a company known to have poor governance or unethical practices.
Second, sustainability-oriented governance can lead to better opportunities for companies to put sustainability practices in place, which then can be incorporated into the values and rules of the organization. In this way, with good governance practices in place, a company may protect long-term investor, social, and environmental interests with long-term operational efficiency.
Indeed, an increasing number of public and regulatory bodies are imposing members with the fiduciary duty to factor in ESG in their investment decisions. Meanwhile, more Asia-Pacific stock exchanges are requiring listed companies to file ESG disclosures in their annual ESG reports.
The importance of good governance is growing. Recent headlines about corporate governance among oil and gas majors and the growing attention paid to sustainability and ESG factors. In general, publicly traded companies are increasingly faced with pressure to expand their objectives beyond profits and shareholder interests and embrace a broader set of goals and stakeholders. Not only are firms motivated to make products and services that people want to buy, they are equally incented to approach governance and corporate practices in ways that make customers and clients comfortable doing business with them.1
1 Manulife Investment Management, “Sustainable investing: unpacking the corporate governance factor in ESG”, 14 April 2022.