ESG Essentials for Corporates: The social angle #1 - The S in ESG

With climate change capturing headlines over the last couple of years, the social aspect of ESG# seems to have somewhat lagged behind corporate environmental action – despite widespread interest around topics such as consumer protection, product safety, labour standards and safety at work, diversity & inclusion, and respect for human rights throughout the supply chain.

The S in ESG is undoubtedly much harder to define, assess and report compared to collating data on carbon emissions or clean energy use, and therefore makes it difficult to tell the “full story”.

This article looks at the broad range of social issues corporates ought to address, it investigates the correlation between “doing good for society” and corporate performance, and outlines the key challenges – and pitfalls – of assessing and reporting on social factors. Finally we look at ways in which firms can achieve a proper (more complete?) assessment of their social impact that not only helps investors to make informed decisions, but also, more importantly, helps companies do better for society.

Jargon Buster

GRI: The Global Reporting Initiative was founded in 1997 and set-up by the Global Sustainability Standards Board. It aims to provide guidelines for sustainability reporting to organisations internationally.

CSR: A broad concept, Corporate Social Responsibility is a company’s commitment to operating responsibly, incorporating ethical and moral considerations in their activities.

SRI: Socially Responsible Investing is a concept that incorporates ESG considerations and criteria into investment decisions.

IAHR: The Investor Alliance for Human Rights aims to encourage institutional investors to respect human rights in their operations.

PRI: The UN Principles for Responsible Investing is an organisation propagating principles of responsible investing, persuading investors to implement ESG factors. It has over 2,000 participating signatories from over 60 countries representing more than US$80 trillion of assets.

CHRB: The Corporate Human Rights Benchmark was launched in 2013. It assesses companies based on a set of human rights indicators.

A brief history of corporate social responsibility

Although the social focus of sustainable investing has received the least attention of ESG’s three components, socially responsible investments have a long history. As far back as the eighteenth century, religious organisations, such as the Quakers or Methodists, withheld investment or business from morally questionable activities such for example gambling, tobacco and alcohol production.

The first socially screened mutual funds arose in the 1970s in the US. A notable example of socially responsible investing in the latter half of the last century is seen particularly in the approach to apartheid in South Africa: investors across the board withheld investment from the country and the subsequent economic turmoil this created contributed to the system’s dismantling.

In recent years, a growing number of organisations and multilateral principles have fused social responsibility and investments. The voluntary UN-backed Global Compact and Principles for Responsible Investing and the Corporate Human Rights Benchmark are just a few examples of socially relevant commitments. While each promotes socially responsible behaviours, they go about it in different ways: UNGC encourages large, usually publicly traded, companies in the world to adopt a broad set of environmental and social principles and annually report on their adherence to these principles. UNPRI specifies a series of investment principles for implementing ESG, helping companies follow a line of action to meet ESG objectives and report on their performance. In contrast, the CHRB analyses the largest publicly traded companies (irrespective of their choice) on their compliance with human rights standards.

Yet, despite CSR’s long history, the performance of many companies remains behind expectations. For example, in 2019 the CHRB reported that half of companies failed to meet any of the five basic criteria for human rights. The vast majority of the 200 companies they analysed – the largest listed companies from high-risk sectors – were failing to implement the UN Guiding Principles on Business and Human Rights (UNGPs). However, the top 100 companies showed improvement from 2017-19, moving from an average score of 18% to 32%, suggesting that – while there is still a long way to go – businesses are starting to acknowledge, the crucial role they play (and the public expects them to play), in delivering positive social outcomes for their workers, their customers and the communities they operate in.

Spelling out the S

Social factors impact every business, every day, everywhere in the world. Areas such as workers’ rights, gender pay equality and diversity are typically the first associated with the S in ESG, but corporate social responsibility goes much further than a firm’s relationship with its employees: it encompasses all corporate interactions with suppliers, politicians, customers, communities and society as a whole.

Investors and the public are increasingly looking for evidence showing how businesses are addressing a broad range of social issues such as whether a company provides a safe and healthy working environment for its employees, how it supports social mobility, how it addresses workforce diversity; or if it donates time, money or resources to give back to communities as well as how it ensures that its products and services don’t pose any safety risks - and these are only a very few examples.

Equally, delivering on the social component requires corporates to be nimble – to continually assess and understand the expectations of its stakeholders, which may well differ depending on geographies, to quickly and effectively respond to changing cultural demands, attitudes or preferences.

What’s more, consumers are aware of their power and are prepared to use it. A recent study found that over half (55%) of UK consumers believe their individual protest actions, such as boycotting a company or speaking-out on social media, can make a difference in how companies behave. And over a third (37%) claimed they have stopped doing business with a company as a result of its actions

Positive social impact leads to better corporate performance

While a large number of companies have shown their motivation to “do the right thing” during the pandemic, and social enterprises (both of these we’ll be covering in the next two articles of our ESG series) are boosting the concept of a good corporate citizen, there’s a broad swathe of evidence that socially responsible corporates perform better and yield higher returns for their investors:

  • A number of studies show supply chains that meet human rights, operate good labour practices and closely collaborate with their supply chain partners are more stable and hence perform better.
  • Equally, research confirms that good working conditions increase staff satisfaction and loyalty and as such boost productivity.
  • A review of 92 research studies about the impact of human capital on corporate success, conducted by the Investor Responsibility Research Center Institute (IRRCI), found positive correlations between how companies manage workplace relationships and their financial performance.
  • An analysis of 4,100 global public companies revealed that companies with no women on their boards tend to underperform and displayed higher financial volatility compared to their mixed board counterparts.
  • Research by Accenture suggests that fusing ‘old school’ profitability measures with social and environmental efforts incites a revenue increase of 5-20% for participating companies and a supply chain cost reduction of between 9-16%, while improving local welfare, labour standards and improving customer health.
  • A review of Corporate Responsibility studies found clear evidence that the social dimension in ESG increases firm value through lower risk.

Corporate social responsibility and environmental justice

Social considerations must also play a crucial part in any corporate (and governmental) efforts to tackle climate change: Millions of people, particularly in vulnerable communities around the world, are bearing the brunt of soil degradation, loss of forests and rising sea levels – the deforestation through wildfires in the Amazon rainforest severely impacting the livelihood of the indigenous population and the growing desertification across Africa hitting the poorest countries are only two examples.

Reflected in the Sustainable Development Goals (SDGs), not only intergovernmental efforts are taking shape to address environmental injustice, but also public-private partnerships are committing to ambitious goals: the 2010 Consumer Goods Forum for example, an organisation bringing together CEOs of consumer goods retailers and manufacturers has pledged to achieve net-zero deforestation by 2020.

Companies looking for other corporate partners or non-governmental organisations (NGOs) to collaborate with on achieving the SDGs can connect via the UN’s SDG Partnership Platform. Similarly combining social considerations with tackling climate change are members of the global “We Mean Business Coalition”, which so far counts 1,351 companies as its members.

While a steadily growing number of companies are proactively engaging with communities, supply chain partners and NGOs in order to draw up green measures that are fair or help reduce social inequalities, “social laggards” are facing increasingly intense pressure from activist groups, that look at environmental action through a human right lens: The Environmental Justice Foundation has garnered the attention of governments and regulators across the globe with its investigative reports about human rights and environmental violations, which in many cases have led to a tightening of existing regulations or to new laws and hefty fines for corporate perpetrators.  

In the US, just recently, the “Environmental Justice for All Act” was unveiled in the US senate, which aims to provide fairer policies and more open processes to communities that historically have been subjected to systemic injustices and greater environmental hazards. If the bill comes into law, it will, amongst other powers, allow private citizens and organisations that experience discrimination in environmental programmes to seek legal remedies.

The challenge with S: assessing and reporting

Reporting methods on environmental factors, such as carbon emissions, fossil fuel reserves and clean energy use, have more or less become mainstream. Most companies, however, haven’t yet mastered similar data granularity for their social performance, typically facing the following hurdles:

  • Contrary to the majority of environmental factors, the majority of social issues need to be assessed qualitatively rather than quantitatively.
  • The reporting of social issues and measures tends to be more localised and is harder to define, especially when you compare to environmental issues where the carbon footprint provides for a well-understood, comparable metric. Hence a lot more thought and analysis is required if companies are to avoid ‘social washing’ situations.
  • Bearing the fruit and seeing the impact of social measures tends to require a longer lead time compared to environmental action. Therefore companies need to find a way to report and sufficiently measure progress over years.
  • The diverse range of social factors requires businesses to generate many different sets of data, which is as time-consuming as it’s costly.
  • Up until now, there has been a lack of industry frameworks that harmonise how companies ought to capture social performance.

Telling the full story

Acknowledging that “social issues are less tangible, with less mature data to show how they can impact a company’s performance,” the PRI published a guide “ESG integration: How are social issues influencing investment decisions?” collating case studies which show how investors and businesses alike can assess social factors.

Some investors are also utilising Abraham Maslow’s famous human hierarchy of needs to measure relative social impact: Companies that serve the higher, self-fulfilment needs of customers tend to receive higher valuations than those that serve the basic needs (food, security).

Maslow's hierarchy of needs:

Recommendations on the most effective reporting stress the need to focus on impact and not just efforts: An often cited study by the NYU Stern Center for Business and Human Rights found that only 8% of the more than 1,700 “S” indicators examined evaluated the effects of company practices, leaving corporate decision makers (and investors) in the dark about the social value for money of their social measures.

While industry associations and networks offer support, directly learning from peers how to tell the full story is another good way of tackling the “S challenge”: A look into the annual reports of CSR leaders such as Unilever or the Lego Group showcase excellent impact reporting. Sportswear firm, Adidas, hit by negative press over child labour incidents in its supply chain, is now scoring top points on human rights indicators, having taken resolute action as well as providing transparent data about the impact of the firm’s social responsibility policy.

Going one step further: the purpose led organisation

A recent global survey of nearly 30,000 consumers found that 62% of those want companies to take a stand on current issues such as sustainability or fair employment practices. The study also highlighted that firms that stand for something bigger than what they sell – and communicate their purpose clearly – are more likely to attract customers. What’s more, such companies report 30% higher levels of innovation and 40% higher levels of workforce retention than their competitors.

In recent years, a number of companies have transformed from businesses with a strong CSR focus to purpose-led companies. “Purpose is thinking about business in a much wider sense than before. It is about our role in – and connection to – society,” NatWest Group’s CEO, Alison Rose, commented when NatWest Group set out its new commitment in February this year to be a purpose-led organisation that will champion potential, helping people, families and businesses to thrive. In doing so, NatWest focuses on three areas where we believe we can make the biggest impact: supporting enterprise, building financial confidence and taking a leading role in tackling climate change (for more information please visit: https://www.natwestgroup.com/our-purpose.html).

Successful purpose-led businesses are following three key principles: 1) Assessing how their strengths can be used to make a difference for society, 2) Using their purpose as a guide for each business decision, and 3) Proactively engaging with the public (for example charities or customers) via stakeholder panels to foster an on-going dialogue – helping to anticipate changing views and preferences – and to jointly develop social initiatives or even co-create new products and services.

#  ESG  Environmental. social & governance

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