ESG Investing, G is for Governance

What is governance transparency?

Increasingly, investors are aware that governance, the “G” in environmental, social, and governance (ESG) criteria, is a critical element in a company’s value and growth potential. Investors rely on a company’s transparency—through honest and rigorous reporting—to ensure that stakeholders have confidence in the decision-making and management processes of a company.

Socially responsible investors are becoming increasingly market-savvy. They conduct a kind of “background check” on companies by reviewing their quarterly and annual reports and consulting trusted ESG rating systems, such as Morningstar. On Magnifi you can easily search for stocks, mutual funds, and ETFs that include companies that score highly on governance transparency criteria (1).

Transparency: the most important governance principle

Corporate governance is the system by which businesses are directed and controlled. It involves both the board of directors and management. Corporate governance covers the areas of environmental awareness, ethical behavior, corporate strategy, and risk management.

The core principles of corporate governance include accountability, fairness, responsibility, and transparency. Each of these four principles is an essential part of good governance.

Key among these principles is transparency. Shareholders (and even outsiders) should be informed about the company’s activities, what it plans to do in the future, and any risks involved in its business strategies. Transparency means openness, a willingness by the company to provide clear information to shareholders and other stakeholders.

Disclosure of material financial matters concerning the organization’s performance and activities should be timely and accurate. This ensures that all interested parties have access to clear, factual information that accurately reflects the financial, social, and environmental position of the organization.

After the Enron scandal in 2001, transparency is no longer just an option, but a legal requirement that a company has to comply with. Transparency is a necessity for the whole company. However, its presence is even more important at the top where strategies are planned and all the major decisions are made.

Shareholders expect that the corporate board and upper management are open about their actions; otherwise, distrust will form and the stock price will likely suffer. Investors who value transparency in governance have the right to put their money in companies that share their values.

Why invest in governance transparency?

More and more investors are seeing the connection between environmental, social, and governance (ESG) performance, value creation, and risk reduction. It makes sense that companies with strong ESG performance tend to be more efficient and less wasteful. They enjoy greater employee commitment and higher productivity. And they are more respected and better able to build brand equity. All of that reduces operational and reputational risks.

There is a positive link between financial performance and strong corporate ESG policies and practices. Aaron Yoon, an assistant professor of accounting information and management at Kellogg and George Serafeim at Harvard Business School, recently examined this question by analyzing data on more than 3,000 companies. After positive ESG news about a firm came to light, its stock value tended to rise, although only if the news was related to the company’s sector (2).

You don't need to be an expert to invest.

These researchers looked at what categories of ESG news elicited the biggest reaction from investors, given that ESG covers a huge range of company activities. They found that investors didn’t respond to every piece of ESG news. But they did react strongly to news about how products affected customers, such as changes in safety, affordability, or consumer privacy. So, if companies are looking for a positive market response, it makes sense for them to invest more resources in those areas. Improving labor practices and lowering products’ environmental footprints also were linked to bumps in stock prices.

On the flip side of the investing coin, poor corporate governance can cast doubt on a company’s operations and its ultimate future profitability. In fact, S&P Global research on governance factors has shown a reality that companies should heed: Firms that rank below average in governance scores are prone to mismanagement, which puts their ability to capitalize on business opportunities at risk (3). Investors are taking notice—globally, nearly 75 percent of investors are more likely to divest from companies with poor ESG track records (4). Companies that are not transparent—not sharing information or sharing inaccurate data—lose capital, as investors are increasingly demanding more transparency over ESG issues and especially governance.

How to advance governance transparency with your investing

Unfortunately for many socially responsible investors, companies can score high on environmental, social, and governance (ESG) criteria but pollute or degrade the environment, or manufacture products that contribute to societal harm. So how can socially responsible investors pack their portfolios with high-value investments that match their values?

Investors can look for gaps in a company’s reporting; learn whether the company has a strategy to identify, evaluate, and address ESG risks; and decide for themselves whether promises the people in authority have made are being followed through.

Morningstar says it best: ESG investing is not just a one-size-fits-all approach (5). As an investor, you can follow any of their ESG investing approaches that make sense for your financial goals.

Keep your values top of mind. Avoid investing in companies and industries that do not follow your values, such as businesses tied to fossil fuels. Search for mutual funds and ETFs that exclude those businesses or industries.
Look for leadership. Look for companies that are actively improving their ESG, or mutual funds or ETFs that include these companies.
Focus on investments that express your values. You can look for investments that target clean water, women’s leadership and gender diversity, and more.
Periodically evaluate your investments. If you invest with a financial advisor, ask them about the environmental or social impact of your investments and potential ESG risks. If you are investing on Magnifi, you can ask your virtual assistant for a portfolio evaluation.
Be an active shareholder. Engage with the companies you’re investing in to advocate for sustainability and transparency. Learn more about being an active shareholder.

After all, socially responsible investors have the power to make companies sit up and take notice, especially as governance risks and opportunities will likely increase in the future as social, political, and cultural attitudes continue to evolve.

How to Invest in Governance Transparency

If you have a financial advisor, you can ask them how to prioritize investing in transparent companies with good corporate governance. A search on Magnifi suggests a number of investments that can help you access this rapidly growing style of investing:

References:

Mutual Funds and Exchange Traded Funds (ETF’s) are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from the Fund Company or your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.
Serafeim, George and Aaron Yoon, “Does Positive ESG News Help a Company’s Stock Price?,” Finance & Accounting, KelloggInsight, Kellogg School of Management at Northwestern University,” https://insight.kellogg.northwestern.edu/article/esg-news-market-reaction.
“What is the ‘G’ in ESG?,” February 24, 2020, S&P Global, https://www.spglobal.com/en/research-insights/articles/what-is-the-g-in-esg.
Gupta, Rajnish, and Chaitanya Kalia, “Transparency: a business imperative in a world of ESG-led investing,” February 10, 2022, EY, https://www.ey.com/en_in/tax/india-tax-insights/transparency-a-business-imperative-in-a-world-of-environmental-social-and-governance-led-investing.
“Navigate the Landscape of Sustainable Investing,” accessed January 5, 2023, Morningstar, https://www.morningstar.com/products/esg-investing.