ESG Risk Depends on Management Control Quality

Abstract

Interest from investors in environmental, social, and governance (ESG) data has grown in part because of a string of corporate mis-steps associated with social and environmental impacts that have resulted in substantial losses for investors. These mis-steps clearly demonstrate that our current methods to measure ESG performance fail to capture the nature of many risks faced by companies. Nor do they gauge corporate resilience and the capacity of companies to mitigate the financial impacts of ESG-related risks. This chapter argues that investors need better corporate governance metrics that capture these sorts of environmental and social management challenges and signal how these issues will be internalized within the finances of a company. It further proposes a set of more granular metrics that look specifically at the ability of a company to mitigate environmental and social risk through more robust governance structures and management controls. Understanding whether governance systems are in place and positioned to identify and mitigate environmental and social risks (G^ES) will be important for investors seeking to avoid the next corporate mis-step and investing for long-term financial value.