ESG is dead. Long live ESG.
Recently, the subject of ESG has garnered significant attention from regulators, corporate leaders, investors, and politicians. Depending on who you ask, ESG is a business essential, a passé term, a danger, or a distraction.
So, what is ESG? And what is it not? At its most basic, ESG refers to the performance criteria through which a company communicates its impacts and dependencies on the environment (E) and society (S). The ‘G’ refers to how well a company demonstrates that someone is appropriately responsible for managing corporate opportunities and risks. ‘E’ criteria might include data on a company’s carbon emissions, waste to landfill, or natural resource use. ‘S’ metrics might include rates of employee turnover, gender pay gaps, or human rights standards. ‘G’ factors may include board structure or composition, executive compensation, and compliance.
Investors use ESG ratings to allocate capital, firms use ESG ratings to communicate performance to stakeholders, and analysts use ESG ratings to compare companies and track change over time. So far, this may seem straightforward, but it gets more complicated.
Here is the key: a wide range of ESG criteria are used to generate ratings by a diverse set of ratings agencies. These ratings function akin to credit ratings, except ESG agencies perform their analysis on non-financial data, and historically set their own criteria for what to prioritise and how. The challenge is that there are many ESG ratings agencies and a potentially endless set of possible ESG metrics, from carbon footprint and water usage to fair wages and KPIs on diversity, equity, and inclusion. ESG does not currently benefit from a single, universally accepted set of standards regarding what data matters most, let alone how to measure, report, and interpret that information. Confusion is inevitable. (My colleagues refer to it as the battle of the acronyms in a recent piece on corporate sustainability accounting).
Today’s jargon does not help. You may hear the term ESG used alongside, or even interchangeably, with other terms including corporate social responsibility (CSR) or ‘sustainability’. This is usually incorrect and only deepens the muddle. ‘CSR’ implies voluntary activities and may even refer to philanthropic efforts by a company. ‘Sustainability’ is a broader term, referring to the degree to which a company’s social and environmental impacts and dependencies are reflected in corporate strategy and business models. Richard Barker and I cover this in our forthcoming book, Financial Times Guide to Sustainable Business, building from our experience as co-directors of the Oxford Leading Sustainable Corporations Programme, whose elumni are now 5,000 strong executives, strategists, and changemakers across the globe.
It is more accurate to say that ESG criteria are non-financial information used by investors to complement their understanding of a company’s financial performance. Because ESG is about public facing KPIs, a common critique of ESG reporting is that it has become a ‘beauty contest’, a mere compliance exercise or a public relations gimmick. You will not be surprised that this is indeed sometimes the case. However, at their best, ESG metrics should reflect a company’s performance on key social and environmental criteria, and the integration of these into the company’s value proposition. The point of reporting, after all, is to drive decisions and resource allocation.
Why ESG Now?
For corporate leaders, the scope for linking ESG criteria to strategy is enormous: Modern companies have raised living standards for billions of people across the globe. In this sense, today’s corporations are doing exactly what they were designed to do: deliver food, housing, clothing, transport, and a wide range of products and services to the greatest possible number of people at the lowest price.
However, these gains have often been achieved at significant social and environmental cost. Sometimes called ‘negative externalities’, these are costs that result from the company’s actions but that the company does not have to pay. Well-chosen ESG data can alert companies, investors, and the public to negative externalities, inefficiencies, and risk. When you connect ESG metrics to the impacts upon which your company relies to create value, they can serve as a powerful tool for building stronger, more resilient businesses in healthy societies on a healthy planet. In this way, they can be a powerful tool for value creation.
In some cases, this will be data your company does not yet collect. It should begin to do so. In other cases, you will have access to historical data on which you can draw for analysis. In either case, there is an essential need for boards and executive teams to identify the subset of metrics that matter most to your business and focus on building excellent data on those.
(In Strategic purpose - a call for new governance practices Rupert Younger argues it is time for the renewal of the governance structures of organisations and outlines 10 specific recommendations for board members.)
Not all ESG issues are equally important for all firms, and companies cannot take meaningful action on all areas at once. When ESG data is integrated into a process of strategy and capital allocation, rather than remaining a more passive, backwards-looking report, it can provide you with a window into one of the most significant innovation opportunities of our time: how to employ, feed, clothe, house, and transport a growing population on a planet whose social systems are stressed and whose environmental systems are in crisis.
ESG: The Insights You Need from Harvard Business Review
Given the current high level of interest – and confusion – about ESG I was delighted to be asked to write the introduction to ESG: The Insights You Need from Harvard Business Review.
In the book researchers and practitioners set out their views on what ESG means for business. It doesn’t tell you what to think about ESG. Rather, it offers you a deep dive into the state of the conversation and a range of views to consider on the topic, so you can develop your understanding of what ESG means for your business and how to move forward.
The book offers an opportunity to consider many of the questions I ask participants on my programmes:
- If ESG is about gathering and reporting data on key ESG metrics, how is the data being used in decision making in my organisation?
- What does my organisation’s ESG data tell me about strategy and value creation in my company?
- How confident am I that my board and leadership team can identify our company’s top three environmental impacts? Our social impacts?
- Do we have the data we need to build strategy that reflects our company’s key environmental and social impacts?
- Is my company’s governance fit for delivering value that reflects our key environmental and social impacts?
The conversation around ESG’s role in business is moving and changing quickly. In a few years’ time, it will look very different. Leaders who can integrate social and environmental impacts and dependencies into their strategy now, and build the governance required to scale the solutions that result, can go far beyond current debates about ESG to build the world’s next generation of strong, innovative, and resilient companies. This is the motivation behind the Oxford Sustainable Business Programme, a new programme I am teaching in partnership with Oxford University's Smith School of Enterprise and the Environment.
Background
This is an excerpt from Mary’s introduction to the new book from HBR Insights, ESG: The Insights You Need from Harvard Business Review which will be published 13 August.
Many thanks to HBR Insights for allowing us to republish it here.
