Is It Time to Evaluate Your Environmental, Social and Governance Policy?
An environmental, social and governance (ESG) policy helps to define standards for company operations. It is also often used by investors to screen potential investments. It can also be a tool that customers use to decide if they want to give you their business, and employees will use to decide whether or not they want to work with you.
Environmental criteria detail how a brand views climate change, pollution, deforestation and carbon emissions. Social criteria define how the brand views its relationships with employees, customers, suppliers and the community. Governance is about a brand’s leadership, executive compensation, transparency, audits, shareholder rights and internal controls. The importance of these three criteria are growing, with companies' ESG scores and rankings now commonly published in the public domain. ESG scores, drawn from annual reports, data on C-Suite executives, investment analytics, news articles and more, provide investors with a way to rank companies against ESG criteria.
Given the renewed focus amidst the events of the past year-plus, it may be time for a tune-up of your company's ERG efforts.
The Difference Between CSR and ESG
ESG can be seen as a broad rating of company commitment to environmental sustainability, the value it places on the people who interact with the it, and the corporate leadership. Corporate social responsibility (CSR), on the other hand, is indicative of internal commitment to the corporate values it espouses. CSR is about building accountability, whereas ESG criteria are about measuring accountability.
CSR statements may include a commitment to diversity, equity and inclusion, reducing environmental impact, increasing community outreach, promoting sustainability, and eliminating prejudice and corporate bias. A CSR statement tells stockholders, customers and the public about the values the company stands for.
Its ESG score, on the other hand, tells stockholders and investors, along with the general public, if the company does more than talk the talk. CSR is a committment to values, while ESG is a measurement of what has been done based on those values, both internally and externally. ESG investing, by extension, is also referred to as sustainable investing, impact investing, socially responsible investing and responsible investing.
A Renewed Focus on Social Issues During the Pandemic
Much of the focus has shifted to the social part of ESG as a result of the influence of the COVID-19 pandemic. Specht said that in the early years of ESG, the agenda was dominated by environmental and governance topics, but social topics took the spotlight during the COVID-19 crisis, said Ralf Specht, business leader, speaker, and author of the forthcoming book "Building Corporate Soul: Powering Culture & Success with the Soul System."
"The impact of this virus amplified existing social issues in many countries around the world," he said.
Specht said the importance of ESG has been growing ever since the term was coined in 2005. In 2004, UN Secretary General Kofi Annan invited 50 CEOs of major financial institutions to participate in a joint initiative.
"Twenty three institutions, representing $6 trillion USD assets under management, endorsed the initiative that was supposed to find ways to integrate ESG factors into capital markets," Specht said. "The 2005 report 'Who Cares Wins' proved that embedding ESG factors in capital markets makes good business sense and leads to more sustainable markets and a better outcome for societies."
A 2020 study by KMPG revealed that CEOs are still engaged with the issue, and in particular the social component. According to KPMG, 63% indicated that the pandemic has caused their focus to shift to the social component of their ESG program, although they still appear to be committed to environmental and governance topics as well, Specht said.
The report also indicated that moving forward CEOs are looking to double-down on the structural shifts that have emerged during the crisis — 71% say they want to lock-in climate change gains that have been realized during the pandemic, and 76% said they had a personal responsibility to be a "leader for change on societal issues."
Investors, Employees and Consumers Stand Up for Values
Sarah Kaplan, a professor at the Rotman School of Business at the University of Toronto, and director of the Institute for Gender and the Economy, said surveys show that not only will consumers support companies that espouse their values, they will cease to do business with those that don’t.
“The same can be said for workers," Dr. Kaplan said. "The Millennials, Gen Z and the new COVID ‘Gen C’ don’t want to work for companies that are associated with poor performance on corporate social responsibility.”
That means companies need to be public about the ways they are addressing topics such as climate change, social inequalities and pollution, she added. "The risk for companies is that, if they don’t back their statements up with real action, they will be accused of ‘greenwashing,’ ‘pinkwashing’ or ‘purpose washing.’"
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ESG rankings enable investors, customers and employees to easily see if the values a company publicly espouses are actually being put into practice. The events of the last two years, including the COVID-19 pandemic, the murder of George Floyd, economic uncertainty and social unrest, have forced companies to take a stand on issues that matter to their stockholders, customers and employees.
"In the 21st century, companies cannot only be driven by a blind allegiance to the bottom line without considering the impacts on all of the people and groups impacted by their operations," Dr. Kaplan said.
Stewart Rassier, global ESG strategist for Labrador US, a compliance communication agency, said investors are finally paying attention, CEOs and other senior leaders are taking positions on issues and the industry is getting better at measuring ESG performance.
“Five years ago, it was hard to get the investor relations team within a company or non-niche investor to pay attention to ESG," he said. "Today, the IR team is asking lots of questions and institutional investors such as BlackRock and State Street include ESG in their annual letter and investor calls.”
As investors, customers and employees expect companies to take stands on important issues, C-suite leaders are taking note. “Previously, only a handful of CEOs were known for being knowledgeable and vocal about environmental, social and governance issues,” said Rassier. “Today, close to 60% of companies have taken a stand on issues such as climate change, pay equity and social justice.”
Sustainability DNA Drives ESG
The biggest challenge of ESG is that although there are several ESG rating agencies such as RobecoSAM, MSCI, Sustainalytics, and Vigeo Eiris, there is no industry standard system that is used to rate ESG performance. Each agency uses its own methodologies, and there is no consistent quantification that can be used across the board, making it more challenging for investors to evaluate a company's ESG efforts.
Rassier said the top two ESG criteria appear to be climate change, and diversity and inclusion. “Beyond that, which issues we prioritize and rank depends significantly on the industry," he said. "An oil and gas company's approach to reducing greenhouse gas emissions and health and safety will be two top considerations. When assessing a professional services company, a stakeholder is more likely to weigh issues such as data privacy or talent development.”
Often it’s not what a company is saying as much as what they are not saying, said Rassier. “Broadly speaking we assess companies on their ESG performance and transparency. There is an assumption that if a company is not talking about an issue they are either performing poorly in that area or don’t have adequate management in place to understand the issue.”
A recent report by Accenture and the World Economic Forum revealed that ESG intentions are outrunning companies' ability to deliver. As a result, Accenture and the World Economic Forum decoded what they refer to as "Sustainability DNA," a set of 21 management practices, systems and processes that form the foundations of stakeholder-centricity. Companies that follow those management practices, systems and processes will be ahead when it comes to their ESG criteria, the report argued.
In order to determine companies' sustainability DNA, Accenture and the World Economic Forum created the Sustainable Organization Index (SOI), which ranked nearly 4,000 companies based on market-facing evidence of ESG-supporting practices in 146 areas. Companies in the top quartile reflected significantly higher performance compared to those with lower scores. The report indicated that embedding sustainability drives behavioral changes in three ways: by encouraging human connections, enhancing collective intelligence, and encouraging accountability.
The pandemic and events of the past year-plus have brought a renewed focus on the social aspects of ESG, and investors, employees and customers are paying attention. By following practices such as those put forth by Accenture and the World Economic Forum, companies can ensure their ESG rankings remain high, investors and stockholders remain loyal and customers and employees keep coming back.