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Focusing on the ‘S’ in ESG

Every business has operations intertwined with environmental, social and governance (ESG) concerns, which is why investors increasingly focus on these issues when deciding where to move capital. Knowing this, business leaders should strive to build an ESG proposition into every facet of their operations.

Part of this is driven by consumers who have higher expectations for corporate social responsibility. It encompasses many issues, from managing labor relations and taking political positions to reacting to social trends and making a strong commitment to diversity, equity and inclusion.

For investors deciding on what enterprises to fund, a focus on the “S” in ESG requires going beyond financials and considering how a company manages its relationships with society, customers, suppliers, employees and the political environment. The recent response of private companies to Russia’s 2022 invasion of Ukraine offers an example of the latter.

ESG takes environmental, social and governance issues and devises ways to measure their effectiveness in quantifiable terms. While social responsibility has proven the most difficult to measure, its rising importance in the business world has led to progress in this area.

The Importance of the “S” in ESG

Focus on the social component of ESG has frequently lagged the other two because environmental issues and governance failures typically grab the biggest (and sometimes terrifying) headlines.

However, more investors now focus on social responsibility when assessing a business for a variety of reasons. Social responsibility plays a key role in building trust between businesses, their employees and consumers. It also measures a company’s willingness to use its unique position to drive societal change and shape the future of communities.

This examination extends beyond the business itself. Investors and consumers (as well as potential employees) now may also examine a company’s business partners on issues such as diversity and inclusion. They may consider a company’s willingness to operate in certain markets where governments might have a spotty track record around worker protections and human rights.

This more holistic approach to assessing a business revolves around the consideration of non-financial information such as social responsibility. The key has been finding methods to measure a company’s social efforts in a way that businesses, investors, employees and consumers can quickly assess where an organization stands.

Measuring Commitment to Social Responsibility

As even casual observers of societal trends know, the definition of social responsibility shifts frequently. This makes measuring the “S” in ESG difficult.

However, five areas of social responsibility are considered an accurate way to measure how a business manages social issues and its commitment to achieving better social equity, according to international engineering and environmental consulting firm Antea Group.

Relationships

How a business manages its relationships with employees, customers, suppliers and business partners provides insight into its level of social responsibility. The measurable factors in this area include

  • Employee pay – Is it in line with the industry?
  • Employee turnover – A high rate indicates widespread employee dissatisfaction.
  • Longevity of business relationships – Do suppliers and other business partners continue to support a business over the long term?
  • Customer base – A solid and growing base of customers shows satisfaction with company products and services.

Community Relations and Human Rights

Measurable factors related to a company’s level of community relations include philanthropic activities in the area, the number of employees hired from the local community and local sourcing of suppliers and partners.

Support for human rights is more difficult to quantify. Investors will look for any internal human rights issues with companies. They also may expand this to scrutinizing a company’s partners throughout the supply chain, because they will expect companies to perform due diligence on all their business partners and the governments where they do business.

Workplace Health and Safety

Smart health and safety policies protect employees and help companies practice better risk management by reducing the chances for higher interest rates, lawsuits and loss of customers who perceive a company as putting employees at unnecessary risk.

The global pandemic has made this issue a higher priority. Measurable factors in this area include workplace accidents, workers’ compensation claims, and whether health and safety standards exceed what is required for the company’s specific industry.

Diversity and Inclusion

The organization’s commitment to diversity and inclusion offers a data-driven path toward measuring a company’s social responsibility. Efforts in this area are easily measurable by analyzing a company’s employees, salary levels and the diversity among people in positions of responsibility.

Diversity refers to a company’s commitment to hiring employees who reflect the communities they serve. This includes hiring people of different races, ethnic origins, gender and gender identity, sexual orientation, socioeconomic status, language, culture, age, and disability status.

Inclusion refers to an organization’s commitment to integrating a diverse workforce into every level of a company, ensuring that people of different backgrounds and identity groups work together to create better business outcomes. This involves making people feel their voice is heard, creating teams with diverse members and promoting people from different backgrounds into management positions.

Businesses also benefit from practicing equity, which focuses on eliminating outcome disparities among people in different demographics (such as women earning less than men or underrepresentation of certain races in some industries).

Political Affiliations

With campaign contribution reports being public information, a company’s political position is easy to discover. Investors look at the organization’s relationships with political candidates and parties from a standpoint of potential risk. Depending on the location and industry, many businesses may face boycotts based on their political alignment, which can hurt brand reputation.

The Changing Scope of Social Responsibility

While a focus on ESG has become more prevalent in the business world in recent years, many still lack sufficient focus on the areas of social responsibility despite its scope continuing to expand.

Harvard Law School explains that this “reflects the evolving business environment of the 21st century, where businesses and markets are increasingly interconnected and interdependent.” This has resulted in even more focus on supply chains and how the adoption of technology impacts all business sectors.

Investors, employees and consumers also now better understand that a business’s actions in the different areas of social responsibility typically reflect a company’s culture. A toxic culture leads to poor social performance and vice versa.

The pandemic also increased scrutiny in this area, as many businesses faced a backlash for continuing to require employees to come to work, especially in the early days of the pandemic in 2020.

Harvard Law School suggests that thinking of the “S” as representing stakeholders might help people better conceptualize this component of ESG. “Ultimately, the question of how a company’s key stakeholders have fared as a result of their business operations is at the core of measuring ‘S’,” Harvard writes.

Harvard Law also added that while companies have long recognized the importance of key stakeholders such as suppliers, customers, employees and partners, “it is not simply the practice of engaging with those stakeholders that is relevant – but proof that their views have been considered in Board level decision-making.”

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