ESG is emerging as an increasingly important metric for businesses of all sizes. Learn more about the "Social" aspect of ESG and how it can fit into your small business planning.
Investors and business stakeholders have a difficult job: predict which companies have the greatest potential return and the lowest risk. Financial statements tell part of the story, but there’s so much more involved in business success or failure.
Environment, Social, and Governance (ESG) evaluations offer investors deeper insights into potential risks and allow them to choose companies that align with their values. ESG reporting can be used as public outreach, and proper management of ESG factors can be profitable in many ways. ESG evaluations are gaining traction, and they will only become more critical as time goes on. This post will explain the social aspect, or the “S”, in ESG. How is it measured, and what do you need to know to get your business on track?
What Is Environment, Social, and Governance (ESG)?
ESG is a framework to evaluate risk based on environmental, social, and governance practices. ESG takes concepts like “sustainability” or “social responsibility” and adapts them to quantifiable goals and performance indicators. Measurable benchmarks, specialized data collection and analysis, and strategic planning form the basis for ESG strategies. ESG scores evaluate three areas:
- Environment: What is the company’s environmental impact, and how are they working to be more sustainable?
- Social: How does the company treat the people it interacts with such as employees, customers, suppliers, and the surrounding community?
- Governance: What is the leadership structure and how is the company run?
“S” Is For Social… But What Does That Mean?
If you ask anyone what “social responsibility” means, you will likely get many different answers. Social responsibility is contextual and shifting, which makes it very difficult to define, let alone measure. Corporate Social Responsibility (CSR) is similar to ESG evaluation– especially the social aspect – but not the same. As we discussed in a previous post, “CSR is the ideal and gives context about sustainability agendas and corporate responsibility culture. ESG is the action and measurable outcome. To simplify, CSR can be thought of as the qualitative side and ESG as the quantitative side.”
ESG frameworks highlight the particular social interactions of a company that can be quantified to anticipate risk. It’s complex – but not impossible – to show how your company handles social issues and what goals you’ve set to increase social equity.
Social Factors in Practice: 5 Areas of Interest
The social aspect of ESG can be broken down into many parts, but the following five areas are commonly addressed.
Though it may not seem like it, your company’s relationships with employees, suppliers, and customers can be viewed through a quantitative lens. For example, are the wages that your company provides in line with your industry? Do employees like working there, and how high is employee turnover? How do your suppliers and customers feel about working with your company, and will they continue to support your business?
The question isn’t only if people feel good about your company for emotional or promotional reasons. The way a business treats employees impacts employee retention and productivity. From a profitability perspective, happier employees are more productive, and low turnover is less costly than continual new hires. A company’s relationships with the larger social circle, including customers and suppliers, can also have a direct financial benefit.
Community Relations and Human Rights
Community relations pertain to how your company benefits or harms the surrounding community. Measurable aspects are hires from within the community, philanthropy, and local sourcing. The Environment aspect of ESG has some crossover as well since business practices can impact local environments.
More broadly, human rights are an essential pillar of Social evaluation. ESG strategies need to scrutinize internal policies and look for human rights violations throughout the supply chain. Though a business can’t be held responsible for every organization it works with, investors expect due diligence to safeguard against supporting businesses with poor human rights records. Areas to account for can take the form of a particular supplier, a particular material, or working within a specific geopolitical area.
Workplace Health and Safety
Environment, Health and Safety (EHS) management is a significant factor in evaluating “S.” EHS is concerned with the health and safety of workers and their surroundings. Since the pandemic, public and investor scrutiny of EHS has become even more critical. The public has condemned businesses that appeared to put people at unnecessary risk and praised others for their vigilance. Scrutiny of EHS practices in the workplace will likely remain permanently elevated going forward. Measurements can include workers’ compensation claims, workplace accidents, policies around Personal Protective Equipment (PPE), and other health and safety concerns specific to your industry.
Diversity and Inclusion
Diversity isn’t just a politically correct talking point; it directly impacts the profitability of a business and is increasingly being regulated. Forbes reported that the Senate Committee on Financial Services recently considered proposals for diversity legislation. Proposed legislation included mandated reporting on gender, race, ethnicity, and veteran status of leadership and various measures to increase employee diversity. Businesses should prepare to be accountable to the public and regulatory bodies, and implement meaningful diversity goals and strategies. Manjit Jus, Global Head of ESG Research and Data at S&P Global, advises:
Gender diversity enhances corporate governance, talent attraction and human capital development — all important factors driving long-term competitiveness. Corporate policies promoting gender diversity are a reflection of a well-managed company that realizes diversity’s value in stimulating creativity and increasing productivity, in tandem with employee well-being.
Political affiliations and contributions are two of the most public and easily identifiable aspects of Social evaluation criteria. Boycotts based on political alignment have a long history and can cause serious injury to brand reputation. Investors will want to understand where your company intersects with political parties, leaders, and legislation, and evaluate the political risks your company may face in the future.
Investors may also want to ensure that there are no significant conflicts with their own political positions. As with all aspects of ESG, politics can’t be performative; they will be reviewed based on quantitative measurements and held up against the rhetoric of your business.
The “S” in ESG Matters
Just as with the other aspects of ESG, Social measurements and criteria offer investors greater confidence that your company won’t fall prey to the risks inherent in your industry. There’s also something to be said for generating goodwill both inside and outside of your organization and giving investors a company they can feel good about supporting.
Keeping an eye on how the people in your labor force, community, and industry are being treated allows companies to get in front of potential disasters and make a positive impact.
Readers should consult their own attorneys or other tax advisors regarding any financial or tax strategies mentioned in this article. These materials are for informational purposes only and do not necessarily reflect the views or endorsement of Santander Bank.
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