We Could Drop the S from ESG

Member Article

 

Lewis Williams Founder, Cadence Leadership Approved Advisor LinkedIn

 

Not everything that matters can be measured. Not everything that we can measure matters.

It’s worth pausing and thinking about this, particularly when the general consensus in the commercial world is “what gets measured gets managed”. There are two points to note about this. Firstly, the long-attributed source of this statement, management theorist Peter Drucker, never actually said it. But secondly, just because metrics are available that make an aspect of business easy to track and manage, it does not guarantee any improvement in big picture outcomes. Nor does it ensure an alignment with the purpose of the organisation.

The emergence of an increased focus on an organisation’s environmental, social and governance (ESG) obligations, first coined in a 2004 report titled “Who Cares Wins” by Ivo Knoepfel, has been an extremely welcome development for socially conscious investors and market observers. It looks beyond traditional financial measures, like pure profit and returns on investment, and considers how organisations are responding to climate change, managing supply chains, how they treat their employees, how the board oversees CEO behaviour, business ethics, and compliance with statutory obligations. Potential investors can now consider a broader range of factors before making an investment decision.

Breaking down the various components of ESG, intuitively the environmental and governance aspects are easier to observe metrics on compared to social aspects. In a recent edition of the publication Listed@ASX, portfolio manager Hamish Tadgell of SG Hiscock & Company said, “S has been slower to evolve, not because it is any less important, but because it tends to be more qualitative and driven by culture and values and in many respects is harder to quantify”. Hamish went on to explain that the reporting of social measures is still, “relatively unsophisticated,” and that listed companies, “tend not to include…information that may be less flattering or harder to interpret or scale.”

So how does one get a clear handle on things including the way an organisation prioritises its culture, treats its employees, and manages its intangible assets like reputation and brand? The clues are there, but you need to go looking, according to leadership consultant Peter Armstrong. “It’s not only about the projections or artefacts that you can see that represent the culture. It’s about the espoused values, both written and unwritten, and the automatic assumptions people make when they act”. The pandemic has not helped organisations in this regard. Armstrong adds, “The environment in which they [organisations] operate is changing very rapidly and the values that companies need to simulate and process are shifting faster than they can deal with it.”

The use of multiple reference points is a good way to undertake diligence on the social obligations of an organisation. The makeup of senior leadership teams through a diversity lens is a good start. The results of regular engagement surveys can unlock trends that measure the alignment of culture with purpose and values. Is the organisation on track, or losing its way? Does leadership publicly take ownership if something goes wrong? Does the organisation demonstrate it has asked itself not only “Can we do this?,” but “Should we do this?” when undertaking a new line of business? How are staff rewarded and recognised, and has this changed in any way due to the pandemic? Does the whistleblower process achieve what it is meant to do?

There are numerous other signals, but until there are statutory reporting requirements for social data it will be very much up to the organisation itself as to what it reveals to potential investors.

Is this good enough? Would isolating the S from ESG accelerate the focus on it, or does it then run the risk of falling away? In a June 2020 paper titled “Time to Rethink the S in ESG”, the Harvard Law School Forum on Corporate Governance argues that due to the pandemic, “the S has been dragged into the spotlight and will now attract significantly greater attention from investors than it has to date.” The paper argued that S should be re-badged as ‘Stakeholder’ and grouped under five key headings: workforce, engagement and training; customers; community and society; data and IT security, and human rights – such is their significance and potential contribution to corporate failure. They conclude that the expectations of ratings agencies and investors will continue to increase, and there could be important first-mover advantages to those organisations willing to embrace the S as openly as they do its E and G siblings.

Ultimately, there is a tremendous opportunity for organisations of all sizes to sell their “S story”. The more successful leaders are at storytelling, the more likely they will be able to attract potential investors and supporters. Because much of the S relates to people, it shapes as an opportunity to be more relatable if presented well, and less jargonistic than the E and the G.

The good news is, the mainstream, as well as the investment community, are listening.

 

How does this relate to advisory boards?
Advisory boards have a unique opportunity to work with businesses on early-stage growth paths, a time when strong cultures are formed. An advisory board member who instils best practice application of ethics and incorporates all stakeholders into decision-making can put a business on the right ESG path – noting that all three components are very intertwined.

 

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