The Character of the Corporation: The Story of "S"
What does "social" in ESG encompass?
Defining the “S” in ESG (environmental, social and governance) issues and responsibilities in corporate America seems to be a moving target.
Even the U.S. Securities and Exchange Commission has no definition for “social” responsibilities, according to a spokesman with the agency.
Directors face a conundrum. There are no legal criteria to measure if a company is doing ESG right, but there is growing pressure to report on it. Many agree that “environmental” and “governance” seem easier to define. But the “social,” defined by Merriam-Webster as “relating to human society,” is a challenge given its “ambiguity,” says Georg Kell, the founding director of the United Nations Global Compact, the world’s largest voluntary corporate sustainability initiative working with thousands of corporations in 160 countries.
For the Global Compact, the “S” is largely about the treatment of workers, explains Kell, who is also chairman of Arabesque Partners, an asset management firm focused on ESG investing.
Labor principles under the “S” as outlined by the Global Compact and the United Nation’s International Labour Organization include:
• The freedom of association and collective bargaining;
• The elimination of all forms of forced or compulsory labor;
• The elimination of child labor (under 18 for “hazardous work,” 13 for “light work”); and
• The elimination of discrimination in the workplace (gender, religious affiliation, political affiliation).
These principles are not only supposed to be followed by corporations but by the vendors in the supply chain as well. How far up the chain? That is uncertain.
There’s a lot of uncertainty when it comes to defining the “S,” so Directors & Boards decided to reach out to a wide swath of people across the governance spectrum. The one consensus among directors, legal experts, investors, and academics, was that the “S” is about people.
The following offers a variety of viewpoints on what the “social” in ESG encompasses:
“The ‘S’ in ESG is a lot like the Supreme Court’s definition of pornography: ‘I know it when I see it.’ Also, there are a bazillion different ways of measuring ‘S,’ and many of these definitions lead to wildly contradictory rankings. That leads to an environment in which there is almost infinite flexibility in defining ‘S.’”
— Joseph A. Grundfest, William A. Franke Professor of Law and Business and a senior faculty member at the Rock Center on Corporate Governance at Stanford Law School; and Directors & Boards editorial advisory board member
“Increasingly, the broader financial community is expanding its evaluation of companies beyond traditional financial returns to include non-financial key performance measures related to environmental, social, governance issues. I serve on the board of directors at three public companies and for me the ‘S’ encompasses a broad array of social responsibility issues. (This includes) the presence of a corporate culture that fosters engagement and innovation, a focus on meaningful employee relations and diversity, the health and safety of our employees, contractors, suppliers and the general public. (It also encompasses) the company’s philanthropy and its involvement in local communities where our employees work and we do business, thereby giving stakeholders a more complete picture of our company’s total performance, including its long-term strategy and ethical sustainability for the future.”
— Lionel Nowell, director for American Electric Power Company, Inc.; Bank of America Corporation; and Ecolab Inc
“It’s not social, really it’s societal. It’s another way of talking about the purpose of the corporation, creating goods and services and selling them at a fair price in open competition.
“In doing that, (the corporation) should do it at a fair price and it also provides a profit to the shareholders. The objective not solely the profit to the shareholders, but to meet the societal purposes.”
— Martin Lipton, founding partner of Wachtell, Lipton, Rosen & Katz, specializing in mergers and acquisitions and corporate policy and strategy matters; and Directors & Boards editorial advisory board member.
“From an investor perspective, the ‘S’ can represent a variety of issues and causes based on an individual’s preferences and beliefs. For example, some investors may be focused on specific issues like the opioid crisis or animal testing, while other investors may focus on a range of social issues based on broader ethical or religious beliefs.
“From an ESG benchmark construction standpoint, (the Financial Times Stock Exchange) Global Choice Index Series (Vanguard’s ESG exchange-traded funds tracked indexes within this series), screens for companies based on their impact on society and the environment. The index series screens companies based on three product categories (non-renewable energy, vice products and weapons) and two conduct categories, controversies (based on the UN Global Compact Principles) and a company’s diversity practices.”
— Doug Grim, senior investment strategist at The Vanguard Group
“Each company defines the ‘S’ in ESG differently, depending on the nature of the business. Broadly speaking, the ‘S’ for ‘society’ encompasses people and community. For most major companies, diversity and inclusion are priorities.
“For a global company like HP Inc., where I’m a director, the ‘S’ also extends to a focus on the supply chain requiring that companies comply with a code of conduct that protects workers, guarantees human rights and staunchly opposes slavery and human trafficking. HP Inc. has also adopted a skill building program for factory workers as well as a program that enables women to build their careers.”
— Aida Alvarez, director for Hewlett Packard
“(It’s about) making the community better off. It’s a belief that if you do the right thing, be an exemplary citizen of the community, that’s the best way to build a strong long-term business.”
— Hamilton E. “Tony” James, chairman of Costco, executive vice chairman at investment firm Blackstone and author of Rescuing Retirement: A Plan to Guarantee Retirement Security for All Americans
“The S or social in ESG has become a priority for companies today as social issues are now a key area of focus for their institutional investors, customers, and employees — and ESG-focused shareholder proposals are increasingly used as a referendum for emerging social and cultural issues. What do we mean by social issues? The answer will vary by industry and company, and the social issues are not static — they evolve. Examples of social issues today include opioid accountability, gun safety, drug pricing, diversity, discrimination, income disparity, gender pay gaps, product safety, fake news, data security and privacy, ethical sourcing — the list goes on. Leadership by the world’s largest asset managers has placed these and a range of ESG issues front and center today.”
— Dennis T. Whalen, leader of the KPMG Board Leadership Center
“The ‘S’ in ESG is not about giving monies to society, it’s about how we make monies in a way that’s conscious of society. You’ve got to change the way you make money, not just how you give away money. We have to be conscious of its impact on society. If we just make money and write a check, it’s like going to confession after you’ve made a mistake.”
— Indra Nooyi, former chairman; CEO of PepsiCo, Schlumberger director; and Directors & Boards editorial advisory board member
“The ‘S’ means a lot of things, but typically it refers to human capital. There are many other aspects such as data privacy, which could also be a social issue. ‘S’ is the least understood and it will be the focus of the next five years. The ‘S’ in ESG is the next frontier for developing frameworks to think about the real implications on sustainable value creation and time horizons for manifestation of risks” It can’t just be window dressing. Commercials like Gillette’s “The Best Men Can Be” and Nike’s Colin Kaepernick’s ads, for example, allow a company to “define” their values, but management needs to “be able to demonstrate that this is really the company’s values.””
— Rakhi Kumar, senior managing director and head of ESG Investments and Asset Stewardship at State Street Global Advisors
“Sometimes, for our clients, it’s a look at sustainability, not a social or moral issue. Sometimes it’s ‘S’ in terms of strategy.” He says gun safety or opioid crisis issues may lead to strategic, rather than moral decisions. If a gun retailer does not take steps toward gun safety in their stores, will that affect their sustainability in the market?
“The traditional ‘S’ meaning social has lost meaning. The ‘S’ is in the eye of the beholder at this point.”
— Patrick McGurn, special counsel and head of strategic research and analysis at Institutional Shareholder Services; Directors & Boards editorial advisory board member