What is ESG?
ESG is a set of metrics that a company and others can use to assess how
- E: environmental issues like carbon emissions, and the use and availability of clean water,
- S: social issues like indentured and slave labor, and employee health and safety, and
- G: governance issues like who has decision-making power within an organization
affect company performance, and in turn how its operations impact the environment and society. There is a dual utility to ESG metrics. They can be used both to look inward at a company’s performance, and outward at how the company impacts the world.
The others that can use these metrics are the company’s stakeholders — groups that have a stake in the company’s performance or impact. These include
- Employees deciding where to work
- Customers and clients deciding where to buy
- Suppliers that want to be purposeful about the companies in whose supply chains they participate
- Communities, governments, and others.
Although ESG metrics can be used by anyone to make a decision about a company, the acronym ESG is most commonly used to describe an approach to investment decision-making.
ESG investing looks at a company’s performance against a set of defined ESG metrics, and evaluates the company against the investor’s own criteria for those metrics. The metrics may focus on the company’s performance, its impact, or both.
Which ESG Metrics Matter?
The list of potential ESG issues and metrics is vast. Thus, it is important to focus on metrics that make a difference, either to performance or impact, and from the perspective of the company or a particular stakeholder. Investors analyzing how ESG performance impacts a company’s financial results can use the work done by the Sustainability Accounting Standards Board, now under the umbrella of the International Sustainability Standards Board, to map material ESG topics to particular industries, which I discussed in an earlier blog on ESG strategy.
Stakeholders that are assessing either impact, or performance other than financial, will determine the ESG issues that are important to them in making their decisions, and the right metrics to apply to their analysis.
There are many reasons to use ESG metrics for making investment or other decisions about a company, like whether to work there or buy there, including
- You want alignment with your values
- You are keen on good governance
- You care how the company treats people
- You want to do business with a company whose products and production processes have positive environmental outcomes.
How dependable are ESG metrics?
ESG metrics are as good as the data collection, control, verification and reporting practices of the company being evaluated. The standards for these practices are evolving and largely voluntary. Even in an imperfect state, however, they do serve a purpose. They provide a lens for evaluation that doesn’t not narrowly focus on profit, which is only one isolated, though important, indicator of success.
Is there potential for conflict or competition among the ESG pillars?
There is potential for conflict among the three ESG pillars. In a recent blog on humane design, I wrote about a hypothetical company using dirty technology that results in significant carbon emissions. If that company either voluntarily decides to close its facility, or is forced to close by regulation, or by community, investor, or other stakeholder pressure, what happens on the S, or social side of the equation?
Will the displaced workers have other jobs? How long will it take for them to transition? Will they be able to afford private medical insurance during the transition? In sum, how much of their loss will they have to shoulder alone?
Further, if the facility is a key employer in the community, there will be a knock-on impact to the entire community. Lost jobs means less money circulating through the community, which may force other businesses to close.
Thus, one can easily imagine a scenario in which the proponents of plant closure for good environmental reasons are at odds with the workers who will be displaced, as well as the community in which the workers live.
So, there is potential for conflict, but the conflict does not exist because of ESG. Instead, taking an ESG approach to resolving the conflict will, at a minimum, highlight the fact that there are multiple stakeholders, and multiple interests to be considered when making significant decisions like this.
Is ESG appropriate for regulation?
My answer is a resounding yes when it comes to voluntary reporting, mandatory disclosures, and the verification of information that a company makes available publicly. To minimize greenwashing, publishing misleading information, or touting aspirational statements in lieu of verified data, companies need a set of mandatory reporting and disclosure standards.
A unified scheme with one set of rules and requirements would serve business well. Businesses should not be burdened with having to comply with differing requirements, varying calendars, and potentially inconsistent and overlapping requirements. It is expensive to do so. Imagine a world in which companies could spend the money that currently goes to inefficient compliance on innovation and solving the world’s big problems.
How Can Clear Strategy Help?
Clear Strategy can help you understand the ESG criteria that stakeholders, including non-regulators, which I will discuss in an upcoming blog, use to evaluate your company. We can also help you use ESG strategically to make important decisions, and plan for your strategic success. Contact us today at firstname.lastname@example.org.