Environmental criteria may include a company’s energy use, waste, pollution, natural resource conservation, and treatment of animals. The criteria can also be used in evaluating any environmental risks a company might face and how the company is managing those risks. For example, are there issues related to its ownership of contaminated land, its disposal of hazardous waste, its management of toxic emissions, or its compliance with government environmental regulations?

Social criteria look at the company’s business relationships. Does it work with suppliers that hold the same values as it claims to hold? Does the company donate a percentage of its profits to the local community or encourage employees to perform volunteer work there? Do the company’s working conditions show high regard for its employees’ health and safety? Are other stakeholders’ interests taken into account?

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. They may also want assurances that companies avoid conflicts of interest in their choice of board members, don’t use political contributions to obtain unduly favorable treatment and, of course, don’t engage in illegal practices.

No single company may pass every test in every category, of course, so investors need to decide what’s most important to them and do the research.

On a practical level, investment firms that follow ESG criteria must also set priorities. For example, Boston-based Trillium Asset Management, with $2.8 billion under management as of March 2020, uses a selection of ESG factors to help identify companies positioned for strong long-term performance.3 Determined in part by analysts who identify issues facing different sectors and industries, Trillium’s ESG criteria include avoiding companies with known exposure to coal mining and those a certain percentage of their revenues from nuclear power or weapons. It also avoids investing in companies with major recent or ongoing controversies related to workplace discrimination, corporate governance, and animal welfare, among other issues.4

Pros and Cons of Environmental, Social, and Governance (ESG) Criteria

In years past, socially responsible investments had a reputation for requiring a tradeoff on the investor’s part. Because they limited the universe of companies that were eligible for investment, they also limited the investor’s potential profit. “Bad” companies sometimes performed very well, at least in terms of their stock price.

More recently, however, some investors have come to believe that environmental, social, and governance criteria have a practical purpose beyond any ethical concerns. By following ESG criteria they may be able to avoid companies whose practices could signal a risk factor—as evidenced by BP’s 2010 oil spill and Volkswagen’s emissions scandal, both of which rocked the companies’ stock prices and resulted in billions of dollars in associated losses.

As ESG-minded business practices gain more traction, investment firms are increasingly tracking their performance. Financial services companies such as JPMorgan Chase, Wells Fargo, and Goldman Sachs have published annual reports that extensively review their ESG approaches and the bottom-line results.