The Character of the Corporation: To Figure Out the “S” in ESG, Look Within

Directors need to assess how their core business connects to society.

Figuring out the “S” for social in environmental, social and governance, or ESG, is critical if companies are going to meet growing demands from investors and other stakeholders.

But evaluating the “S” is challenging, to say the least.

“When it comes to evaluating companies on their toxic waste emissions ‘E' or vulnerability to fraud and corruption ‘G', investors now have tools to assist them,” according to a recent study from the New York University's Stern Center for Business and Human Rights, coauthored by Casey O'Connor, a Sani Fellow at the Center, focusing on sustainable investment research. “But our analysis of 12 leading ESG frameworks shows that the ESG industry is still falling short of this objective when it comes to ‘S'.” The report found that:

“'S' is defined in a multitude of (often vague or limited) ways, making it difficult to draw conclusions about company performance. The highest number of ‘S' indicators (35%) examined social issues generally, using vague terms such as ‘social,' ‘human rights,”' or ESG without greater definition. Another 20% focused on a limited set of common labor issues such as occupational health and safety, freedom of association, compensation and benefits, or diversity and equal opportunity.”

The mushrooming of frameworks without consistency, the authors maintains, “means companies must generate many different kinds of data, in formats specific to each framework to which they report. This requires companies to understand the landscape of frameworks, make judgments about which ones merit participation, fill out multiple questionnaires, and respond to requests for additional information, all while preparing their own annual sustainability reports.”

The authors offered an example of a food and beverage company that would need to report data on more than 700 different indicators to satisfy the 12 frameworks. The Sustainability Accounting Standards Board, which has developed industry-specific sustainability standards, wrote, “similarly reports that one S&P 500 company complained of developing responses to more than 650 requests from ratings groups in a single year. The process took several months and involved over 75 people.”

So what can boards do?

O'Connor offers some advice.

“There are two big takeaways from our research that I think would be useful to directors trying to grapple with ‘S',” she tells Directors & Boards.

• First, when determining which social factors to consider, it is important to focus on the social consequences that most directly flow from the core operations of a business. When approached this way, the specific issues that constitute ‘social' will change significantly from industry to industry. Practically speaking, directors can most easily identify the issues they ought to focus on by looking at the principle profit drivers of their industry and assessing when and how those are in tension with desired social outcomes.

• Second, when it comes to measuring social performance it is critical to move beyond assessing the existence of governance structures to evaluating their effectiveness. This requires systematic measurement of the outputs and outcomes those governance structures are intended to achieve. When approached this way, social performance metrics will focus on a combination of operational outputs that demonstrate social considerations are well integrated into daily business decisions (see a list of indicators we've developed for the apparel sector here, and outcomes such as wage levels, hours worked, or worker safety.