Who put the G in the ESG?

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New York – The story of Massey Energy, the West Virginia coal mining company that suffered a massive mine explosion this month and lost 29 miners, is now coming into the crosshairs of investors. In particular, shareholders are concerned with the fact that the CEO Don Blankenship is also the Chairman of the Board.  ESG, or Environmental, Social and Governance research, is the area where these extra-financial issues intersect.

In this case, ESG is really more like esG analysis, where governance has a greater weight in the analysis.  Examples like Massey Energy demonstrate the potential costs associated with the agency problem, where managers may have different goals than directors. In the Massey case, and others, the management and the board may be comprised of some of the same people. This means that, for example, the CEO could be more concerned with the quarterly financials, or other more personal management goals, rather than the worker safety or shareholders.

ESG research providers attempt to classify firms that exhibit these conflicts of interest and are therefore very helpful to investors (particularly activist investors) in their proxy voting.

While the agency problem specifically deals with how the board’s duty to the shareholders of a company, some ESG providers take this a step further and look at all the “stakeholders” in a company. These stakeholders include shareholders, but also include debt/holders, employees and the firm’s community. In this construct, we all have a stake in the firm’s impact on the environment, for example the carbon footprint of the firm’s production processes. The social element tends to focus on the firm’s impact in terms of human rights issues, at the one end, and the treatment of the staff, at the other. For this reason, some ESG firms manage funds for investors that have a particular value system, for example not investing in any product that is produced by companies that do not adhere to international child labor laws.

What is certain is that the area of ESG research is growing in its importance to investors and will continue to do so in the foreseeable future.

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