The “S” in ESG

the s in esg

Discussions about ESG issues often focus mostly on the “E” (environmental), with far less attention paid to the Social “S” and Governance “G” pillars. This may be partly, or even mostly due to the fact that it is relatively easy to define and measure things that fall under the Environmental pillar, such as a company’s greenhouse gas emissions, waste reduction programs, or carbon footprint. In contrast, the scope, costs, and risks associated with the Social pillar, and to some extent Governance, are more difficult to define. However, that challenge does not mean “S” and “G” concerns can be downplayed. 

An article by the Stanford Social Innovation Review (SSIR) titled “Fixing the ‘S’ in ESG” quotes a fund manager as saying, “Planet isn’t necessarily more important than People, it’s just easier to measure. Investors like measuring things that they can put into their models, and carbon is easy to quantify” (emphasis is ours). The article goes on to cite a 2021 Global ESG Survey by BNP Paribas that showed 51% of investors surveyed said the ‘S’ is the most difficult to analyze and embed in investment strategies, stating “Data is more difficult to come by and there is an acute lack of standardization around social metrics…”

In our opinion, the SSIR article does an excellent job of explaining the challenges of “fixing the ‘S’ in ESG” by first acknowledging there is a problem right out of the starting gate: there is no universally agreed-upon definition of what the Social pillar covers. Furthermore, the article notes that equity investors want to maximize returns, not just mitigate risks, and “S” often focuses on where companies fall short in terms of how they treat their employees, suppliers, and communities, which does not necessarily point toward sources of alpha.

On a related note, another recent article (published on GreenBiz) argues that investors cannot realize the full potential of sustainable investing unless “they fully embrace a core concept for corporate sustainability — the responsibility to respect human rights.” This is more than a feel-good statement. Human rights violations can involve environmental harm, child labor, and inhumane working conditions, among other things, that can have a material impact on a company’s reputation, customer loyalty and stability.

This article points out that ESG practices often conflict with a stated respect for human rights.  “In 2021, companies implicated in serious human rights abuses in Asia and Africa were included in key ESG indices and funds,” noting that unfortunately, even the renewable energy sector is not immune to this problem. Allegations of abuse in the sector include dangerous working conditions and poverty wages. As an example, achieving net-zero emissions requires expanded production of certain key minerals, worker abuses that are often associated with the mining sector have persisted.

The SSIR article acknowledges that of course, human rights violations, labor relations, and supply chain risks can have a materially negative impact on a company’s brand, reputation, and profitability. But it also points out that many aspects of the Social pillar can have a positive impact on financial performance, but that these are not accounted for in today’s ESG data. The rest of the article (it’s fairly lengthy, but worth the read) suggests how to “fix the ‘S’” by standardizing, quantifying and reporting.

Of course, companies are not going to voluntarily disclose human rights violations in a CSR, so we need other ways of uncovering these issues—OWL ESG uses machine learning and other tools to attack this problem. We also need better communication on the positive aspects of “S”, such as the benefits of an engaged, committed workforce that lowers recruitment costs and boosts productivity. We seek to provide practical, understandable metrics on these and other issues under the Social pillar of ESG.