Why corporate governance matters in ESG investing
Corporate governance is the often-overlooked G in ESG investing, an approach that incorporates environmental, social, and governance considerations into financial decision-making. Governance is what ensures that companies follow through on their social and ecological commitments.
For companies, governance can help guide management in operating a business responsibly through ethical leadership, clear accountability, and thoughtful risk management. For investors seeking both financial returns and positive impact, strong governance improves a company’s ability to grow sustainably while responding to the interests of those it affects.
Corporate governance typically includes the board of directors, executive leadership, and internal controls that shape how a company makes decisions and remains accountable. The board, often led by a chairperson, meets regularly with the CEO to review performance, approve budgets, and guide strategy, providing independent oversight beyond day-to-day operations and short-term earnings.
Key Points
- Good corporate governance addresses a company’s responsibility to both its shareholders and the broader community of stakeholders.
- Governance influences whether a company delivers on its social and environmental commitments.
- Governance under ESG goes beyond financial oversight to include ethical leadership and accountability.
What is corporate governance?
Corporate governance has traditionally focused on shareholder rights and financial oversight—rules and practices at the core of how companies operate. In the context of ESG investing, corporate governance builds on that foundation to address how companies interact with governments, suppliers, communities, and others affected by their operations, often referred to as stakeholders.
How corporate governance took shape
The concept of corporate governance has evolved over centuries as societies sought to rein in corporate power and protect investors.
- 17th–19th centuries: Trading giants like the Dutch East India Company and British East India Company drew early scrutiny, leading to the first efforts to limit corporate overreach.
- 1890: The U.S. passed the Sherman Antitrust Act to break up monopolies and regulate dominant conglomerates.
- 1930s: In response to the Great Depression, the Securities Act of 1933 and the Securities Exchange Act of 1934 were passed to require financial transparency and curb market manipulation.
- 1976: After a wave of corporate scandals, the Securities and Exchange Commission pushed the New York Stock Exchange to require all listed companies to form independent audit committees, and corporate governance appeared in the Federal Register for the first time.
These milestones show how governance practices have evolved in response to corporate abuses and economic crises—pressures that still shape oversight today.
Some of the more infamous corporate scandals have stemmed from governance failures. Volkswagen’s emissions test scandal and Cambridge Analytica’s misuse of Facebook data in the 2010s are prime examples.
Companies with weak governance scores were significantly more likely to have credit ratings below investment grade, such as BB+ or lower, according to a 2024 report by ISS Corporate Solutions, a corporate governance advisory firm. The finding suggests that poor governance may signal broader financial risk.
How board structure shapes corporate governance
Traditionally, corporate boards focus on fiduciary matters and issues such as executive compensation. Those matters are also important in ESG investing, but corporate boards focused on sustainability may have additional factors to consider.
Because ESG priorities vary by industry, there is no one-size-fits-all model for oversight. A mining company may need strong community relations to operate mines on lands close to residential areas, while a bank may need to focus on cybersecurity risks. Companies may structure ESG governance in several ways:
- Dedicated ESG committee. A specialized group focuses solely on sustainability, allowing members to develop and recommend ESG strategies to the broader board.
- Existing committee or committees. ESG responsibilities are incorporated into committees already handling areas such as audit, risk, or human resources.
- Full board. The full board of directors makes the decisions, rather than relying on the research of one or more committees. This structure is most common in small companies.
The composition of a corporate board of directors plays a central role in ESG and sustainability. It’s the primary mechanism for implementing governance. Board members should have some degree of independence from management and bring a diversity of backgrounds and skills. A range of perspectives can help the board avoid groupthink and improve oversight.
Why shareholder voting rights matter in ESG governance
Only shareholders can vote on corporate matters such as executive pay or environmental policies, either in person at the company’s annual meeting or by proxy. But as ESG concerns grow, some stakeholders have been buying shares to influence corporate behavior. Shareholder resolutions have included calls for changes such as:
- Eliminating dual-class share structures. These arrangements give certain shareholders, often company insiders, classes of stock with superior voting power.
- Say-on-pay. Pushing for shareholder input on executive compensation packages.
- Climate-related accountability. Calls for better disclosure of greenhouse gas emissions, climate risk assessments, and plans to reduce emissions to meet international climate agreements.
ESG-related shareholder proposals made up 62% of all proposals submitted in 2024, up from 44% in 2014, according to a report by ISS.
Transparency and accountability: Walking the talk
Transparency builds trust, and in ESG corporate governance, that trust is essential between companies and their stakeholders. It’s a balancing act; stakeholders aren’t privy to insider knowledge, and corporate boards are sometimes limited in what they can disclose because of regulatory or legal constraints.
Corporate governance transparency means providing clear, accurate, and timely information about financial performance and key risks. Examples include disclosures about business practices, supply chain relationships, and how well the company meets its operational goals. For ESG investors, transparency may also involve disclosures about the policies used to ensure ethical oversight, environmental performance, and workforce and community programs (“social initiatives”).
Publishing such information allows shareholders and stakeholders to hold companies accountable for their stated goals. Shareholders can push for ESG-related performance metrics, such as tying executive compensation to sustainability objectives, to help ensure company leaders follow through on what they’ve promised.
High-profile corporate collapses, such as Enron, Wirecard, and FTX, have all stemmed from governance failures such as falsified records, fraud, or poor internal controls. When paired with robust oversight, internal controls, and ethical leadership, transparency and accountability demonstrate a company’s commitment to effective risk management and long-term strategy.
These backstops can help mitigate corporate misconduct, reduce regulatory risks, and support sustainable business practices. They may also help companies perform better over time. Companies focused on the long term grew revenue 47% more on average than their peers, and with less volatility, according to a McKinsey study. Other research has shown that strong corporate governance is also linked to lower capital costs—that is, well-managed companies can raise money more cheaply because investors and lenders view them as less risky.
The bottom line
In an era when a company’s license to operate increasingly depends on social trust, governance quality separates industry leaders from laggards. For investors focused on long-term performance and sustainability, strong governance serves as a key due diligence filter, separating companies driven by quarterly earnings from those looking to make a lasting impact.
Corporate governance matters to investors because it provides a lens through which to evaluate company quality, risk management, and long-term performance. Companies with strong governance frameworks are better positioned to navigate the complex ESG landscape, manage stakeholder relationships, and achieve results that benefit everyone involved.
References
- Using Transparency to Build Trust: A Corporate Director’s Guide | corpgov.law.harvard.edu
- The Role of Corporate Governance in Strengthening Compliance Frameworks | papers.ssrn.com
- ESG and the Cost of Capital | msci.com