Environmental, Social, and Governance (ESG) is a set of principles that guide the way that a company operates to ensure that the business:
- Is resilient, with strong innovation and talent pipelines;
- Has a framework for making strategic decisions about where to lead and how to operate;
- Is protected against business and sociopolitical risk;
- Is connected to global megatrends to retain long-term relevance;
- Is led and governed well with the right checks and balances;
- Has belief in doing good = doing more;
- Has a brand and reputation insurance policy during a crisis.
Origins of ESG are with investor assessment of climate risk – and the result is a mass perception that ESG is about saving the planet. If your business has a large physical footprint and a product set or mix that negatively impacts the environment, then yes – climate risk should be top of mind.
However, the principles of ESG have evolved dramatically to guide leaders in addressing the issues directly tied to the business and, most importantly, to key stakeholders – investors, customers, partners, employees, community and government officials, industry groups, and more.
The backdrop: ESG and public companies
Public companies (and private companies preparing for IPO) are under great ESG scrutiny – especially in high-risk industries like banking, oil and gas, airlines, industrials, transportation, and biopharmaceuticals. In some states, countries, and stock exchanges, certain ESG disclosures are mandated and must be publicly reported as part of a proxy statement or ESG report. Some examples:
- The United Kingdom, France, Switzerland, and other European countries have put requirements in place requiring companies to report against the TCFD framework;
- The European Union’s Corporate Sustainability Reporting directive requires a formal set of annual non-financial disclosures;
- NASDAQ requires board diversity disclosures requiring all listed companies to have, or publicly disclose, why they don’t have at least 2 diverse directors including a female director and one from an underrepresented population;
- The U.S. SEC has released new requirements for investment firms’ ESG disclosures and has been working for over a year on requirements for businesses to disclose how they identify and manage climate risks, how risks affect the company (including reputation), scenario analysis (including crisis management), and how the Board oversees climate risk;
- And there is currently a public-private movement toward standardized global disclosures and reporting requirements for companies. Deloitte outlines a case for standardization.
ESG matters to private companies – even without requirements
Private company leaders may believe that applying ESG principles is a nice-to-do – and that they have time before they are required to disclose or undergo the same level of public company scrutiny. Not true.
A PwC study indicates that 9 out of 10 private equity firms said that they have adopted or are developing responsible investment policies – and more than 1/3 have teams dedicated to ESG. And it’s not just the big private equity names like KKR, TPG, Carlysle, and Blackstone – there’s a movement in the middle market to incorporate ESG policies.
MidOcean Partners is a private equity and alternative investment firm investing in middle market companies in the consumer and business services sectors. Its ESG policy is prominent on its website and while there are no standards or data requirements, there are clear areas that the firm values, including:
- Environmental policy;
- Social (tax revenue, labor, human rights, pay for performance, community impact);
- Governance (anti-fraud, anti-corruption, executive remuneration, shareholder communication, board composition, risk management).
It also outlines its ESG considerations during pre-investment, support for portfolio companies’ remediation plans, and overall ESG governance. And it includes an early positioning document in line with TCFD requirements.
And some of this ESG action is a push from their LPs. According to a 2022 Bain & Company survey of private equity limited partners (LPs), ESG considerations affect most investment decisions:
- ~70% said that their organizations’ investment policies include an ESG approach;
- ~85% have an ESG policy implemented with private equity;
- #1 reason LPs surveyed gave for incorporating ESG considerations into their investment policies or approach are that they view them as additive to the investment performance and want to offer clear ESG communication to stakeholders.
Family-owned companies aren’t exempt either. In the war for talent, ESG embedded in the business strategy and operating model creates confidence and differentiation. A 2022 PwC survey indicates a positive correlation between a company’s ESG performance and employee satisfaction, retention, and attractiveness to younger talent pools. Plus, let’s not forget customers. More and more companies involve their suppliers in their ESG work to expand their own ESG impact and ensure alignment of operating values. Surveys like Ecovadis are issued by companies’ procurement teams to suppliers, asking detailed questions about environmental impact, diversity, equity and inclusion, talent management, human rights, data privacy, and more.
Understanding your own landscape: ESG’s current state
Private companies are likely doing more than their leaders give them credit for. Ernst & Young estimates that there are 600 reporting frameworks for companies to use to evaluate and report on their ESG performance.
For private companies, there are platforms that offer simple assessments to gauge whether leading indicators of ESG are embedded into business strategies and operating models. Here is an example from the JASPY platform, that offers 35 indicators to compare with your peer group and gauge where and how they are focused.
If the 35 indicators trend positive, it’s an indicator that your company is on the right track and in a position to make additional choices. It’s the opposite if your company answers “no” to key indicators – and a signal that there’s work to be done to get basics in place. These indicators include:
ESG Strategy and Management
- ESG purpose statement;
- Public benefit corporation, B-corp, or Social Purpose corporation;
- ESG annual report;
- Reporting frameworks;
- Materiality assessment;
- Public ESG pledges or commitments.
- Net zero commitment;
- TCFD reporting;
- Scope 1 emissions tracking;
- Energy, water, and waste to landfill tracking;
- Environmental risks;
- Occupying a green building;
- Data center energy use carbon reduction policy;
- Travel policies.
- Workforce composition;
- Diversity, equity, and inclusion metrics;
- Human capital management strategy;
- Employee training and hours per employee;
- Human rights policy;
- Corporate citizenship;
- Occupational health and safety program.
- Code of conduct;
- Confidential ethics reporting process;
- Board oversight of ESG;
- Executive compensation tied to ESG;
- ESG in employee performance evaluations;
- ESG in supplier screening and code of conduct;
- Executive remuneration;
- Separation of power;
- Voting rights;
- Multi-generational innovation plan.
Placing ESG bets: brand building & long-term value creation
All companies – public and private – make choices about where to place their ESG bets. With so many ESG categories, companies can’t afford to be amazing at everything.
That’s why it’s recommended that companies understand issues most important to their stakeholders – which can be done formally or informally by:
- Conducting a survey or materiality assessment;
- Using professional judgment;
- Evaluating the issues that your industry has prioritized;
- Combination of all three.
These types of formal and informal surveys can be conducted for you through technology providers like Datamaran, and consulting firms like FrameworkESG and Real Chemistry (for life sciences). And they are becoming more of a mainstay in ESG spotlighted industries. For example, a June 2022 Harvard Law School study found that 47% of biotechnology company CEOs said that they have conducted a materiality assessment and 35% said that they intend to over the next year.
With prioritized sets of issues, leaders can make decisions about areas of urgency and opportunity, including considerations for where to:
- Lead (areas that will offer a brand boost and create long-term value);
- Be at parity (areas considered table stakes);
- Lag or fast follow (areas less important to your stakeholder group);
- Draw the line on non-negotiables (things that won’t change because of core company beliefs – this is most frequently seen in the governance category with over-boarding, separation of power, and voting rights).
While there are issues that are industry specific (like access to care and health equality in life sciences, and more stringent human rights in consumer-packaged goods) there are some ESG topics that cut across industry. We’ve seen these topics rise to the top in finance, biopharmaceuticals, industrial, consulting, managed services, consumer products, food and beverage, and real estate companies. These include:
- Climate/environmental baseline;
- Documenting human capital strategy and related performance data;
- Diversity, equity, and inclusion;
- Occupational health and safety;
- Code of conduct and related training and processes;
- Multi-generational innovation plan;
- Industry-specific issues like access to care and health equity in biopharmaceuticals, customer mix in banking, or product footprint in industrial manufacturing.
Walk the talk
Whatever actions your company decides to take, it’s absolutely essential to walk the talk. ESG is still relatively young in its maturity and the factors that stakeholders use to assess companies’ ESG commitments are still evolving. This creates opportunities for companies to “greenwash” or make ESG-related claims about ESG performance for marketing purposes and financial gain.
To avoid any perception of greenwashing:
- Ensure that ESG goals, data, and performance results are squeaky clean. If an auditor reviewed them and a Wall Street Journal journalist wanted to write a story about your results, what would be reported?
- Have a reputation insurance policy in place for any product claims or outbound marketing your company initiates. Reputation is often a material issue for companies and inconsistency with claims can be harmful.
For example: If you’re a safety company, ensure that your occupational health and safety program is top-notch. Imagine being a salesperson promoting safety and when the customer comes to tour your plant, they find a lack of PPE or other unsafe working conditions.
If you’re an environmental services company, ensure that you have a baseline and improvement plan for your environmental footprint and that your EHS management protocol is sound.
If you are a biopharmaceutical company serving underrepresented populations, ensure that your workforce represents the people you serve.
At the end of the day, ESG is a set of principles that guide the way a company operates. Being intentional and consistent builds confidence and a favorable brand reputation and ensures that long-term value is created for all.
Cover image source: Artem Podrez