Environmental, Social, and Governance (ESG) refers to the three factors used to assess a company’s commitment to operating in a sustainable and ethically responsible manner. The ESG movement emerged from the practice of Socially Responsible Investing (SRI), where investment capital favors companies that are environmentally and socially responsible, addressing issues such as climate change and diversity. ESG postulates that companies should be managed in consideration of goals beyond only profitability. Perhaps the Social factor in ESG will have the broadest impact on companies as they consider how social justice issues and the COVID-19 pandemic is changing their responsibility to employees.
The Emergence of the Importance of ESG in Business
ESG efforts have existed since the 1950s and became broadly acknowledged by companies during the last decade. Governance reform was instituted in the aftermath of the 2008 financial crisis and the Deepwater Horizon oil spill in 2010 called worldwide attention to the truly massive impact an individual company can have on the environment. (https://en.wikipedia.org/wiki/Financial_crisis_of_2007%E2%80%932008, https://en.wikipedia.org/wiki/Deepwater_Horizon_oil_spill)
More recently, institutional investors such a Blackrock and Morgan Stanley have communicated to their portfolio companies the importance of ESG issues, stating they will vote against directors if their companies do not address material concerns. In August 2019, the Business Roundtable announced a new statement of purpose saying that corporations should be responsible to customers, employees, suppliers, and communities, beyond the historic view of being responsible only to shareholders. (https://www.businessroundtable.org/business-roundtable-redefines-the-purpose-of-a-corporation-to-promote-an-economy-that-serves-all-americans)
Ninety-five percent of millennials, now the largest generation in the U.S. workforce, cite investing with a focus on ESG as a central goal as evidenced by the growth of sustainable investments by over 400% from 2018 to 2019. Attention to ESG-related practices will accelerate and become the new norm this decade. (https://www.morningstar.com/articles/961765/sustainable-fund-flows-in-2019-smash-previous-records, https://www.morganstanley.com/pub/content/dam/msdotcom/infographics/sustainable-investing/Sustainable_Signals_Individual_Investor_White_Paper_Final.pdf).
The table below shows the issues associated with the three ESG factors that will require long-term and sustained efforts across society and the business community. The issues are often considered in the context of managing risk that if not addressed, will have wide impact on the viability of businesses.
“Employees are Our Most Important Asset”
Many CEOs have made this statement over the years. Social issues in the ESG framework directly address crucial elements in the employer/employee relationship. A review of the proxy statements of Russell 3000 companies (R3K) for fiscal year 2019 show that the Social element of ESG is by far the most measured and reported.
Workforce diversity and pay equity have led the way in Social issues, gaining significant visibility in the U.S. and worldwide. The recent Me Too and Black Lives Matter movements have also brought attention to systemic gender and racial discrimination in our society, and companies are responding by examining their recruiting, advancement, and compensation practices for bias. A small number of public companies have linked the pay of their CEOs and management teams to diversity goals, a trend where we expect to see growth. Sixty percent of U.S. organizations are also working to resolve pay inequities based on gender, race, and other protected classes. (https://www.kornferry.com/about-us/press/worldatwork-and-korn-ferry-release-results-of-2019-survey-of-pay-equity-practices).
The Benefit to Companies to Address ESG Practices
Proponents of ESG argue that including the three factors in managing businesses will lead to greater profitability. A study conducted by Institutional Shareholder Services this year validated this relationship, suggesting that attention to ESG factors relates to prudent risk management, which positively influences profitability. (https://www.pionline.com/esg/iss-study-links-esg-performance-profitability#:~:text=A%20new%20study%20found%20firms,an%20economic%20value%2Dadded%20lens.)
Beyond minimizing risk, companies that proactively address ESG, especially social issues such as pay equity and workforce diversity, can position themselves as employers of choice in the eyes of their employees, job candidates, and shareholders. Demonstrating leadership in ESG will ultimately become a differentiating factor for companies, and those that embrace ESG stewardship will have a competitive advantage going forward.
- Joe Kager, Managing Consultant at The POE Group. Joe is a Certified Compensation Professional with over twenty-five years of experience in compensation and human resources. Call him at 813-546-8628, or email him directly at joe.kager@poegroup.com