Environmental, Sustainable, and Growth (ESG): A new challenge ahead

Significance of Environmental, Social, and Governance (ESG)

 With the passage of time, a new paradigm emerges. Now the need for ESG, across any economic sector become necessary to adapt their externalities is for preserve their social license. The acronym “ESG” (environmental, social, and governance) was coined in 2005, and from then until recently, its affluence has been continually growing. To illustrate, the term ESG searching increased fivefold growth on the internet since 2019, similar to “CSR” (corporate social responsibility). Traditionally the focus was more reflective of corporate participation than changes to a core business model have deteriorated. Across industries, geographies, and company sizes, organizations have been allocating more resources toward improving ESG. Above 90 percent of S&P 500 companies now publish ESG reports in some forms, and about 70 percent of Russell 1000 companies. As per certain authorities, reporting ESG elements is either mandatory or under active consideration. The Securities and Exchange Commission (SEC) is planning new rules that would require more exhaustive disclosure of climate-related risks and greenhouse gas (GHG) emissions. Additional SEC regulations on other facets of ESG have also been proposed or are pending. The rising contour of ESG has also been seen in the massive amount in investments, in spite of a decrease in the rate of new investments.  Inflows into sustainable funds rose from $5 billion in 2018 to above $50 billion in 2020, further about $70 billion in 2021; these funds grew $87 billion of net new money in the first quarter of 2022 itself, followed by $33 billion in the second quarter. Midway through 2022, global sustainable assets are about $2.5 trillion. This represents a 13.3 percent fall from the end of Q1 2022 but is less than the 14.6 percent decline over the same period for the broader market.

 A major part of ESG growth has been driven by the environmental component of ESG and replies to climate change. But other components of ESG, in particular, the social dimension also grew fame. It is observed that social-related shareholder proposals rose 37 percent in 2021 to the previous year. After the onset of the war in Ukraine created a human catastrophe, together with the cumulative geopolitical, economic, and societal effects, which made critics justify the importance of ESG has reached the highest point. Their resistance will move progressively to the more foundational elements of a Maslow-type hierarchy of public- and private-sector needs in the future, present fixation with ESG may be remembered as merely a trend that has been used in the past. Others have justified that ESG embodies an odd and unstable combination of elements and that consideration should be only focused on environmental sustainability. The tests of the veracity of ESG investing have been bourgeoning. While some of these urgings have also been directed to policymakers, analysts, and investment funds, and in the additional piece “How to make ESG real” is focused at the level of the individual company.

Is ESG truly valuable to companies, the business necessity, and strategic rationale?

A critical lens on ESG

There is both types of thought, one is justifying, and the other is criticisms of ESG are not new. As ESG has gone mainstream and gained backing and ground, it has steadily come across doubt and criticism as well. The prime main objections are in the following vital types:

 ESG is creating distractions so avoiding

Probably the most projecting negation to ESG gets opposite of what critics perceive as the substance of what businesses are hypothetical to do: “make as much money as possible while conforming to the basic rules of the society,” as Milton Friedman put it before a half-century ago.” If as above perception, ESG can be presented as something of a public-relations move, or a means to leverage on the higher motives of customers, investors, or employees. It is expressed somewhat “good for the brand” but not initial to company strategy. It is additive and occasional. ESG ratings and score provider MSCI, for example, found that nearly 60 percent of “say on climate” votes. in 2021 were only one-time events; fewer than one in four of these votes were scheduled to have annual follow-ups. Other critics have troupe ESG efforts as “greenwashing,” “purpose washing,” or “woke washing.” An Edelman survey found that about three out of four institutional investors do not trust companies to achieve their stated sustainability, ESG, or diversity, equity, and inclusion (DEI) commitments.

 ESG is not viable as inherently very tough

Other critiques of ESG argued that beyond meeting the technical requirements of each of the E, S, and G components, striking the balance required to implement ESG in a way that resonates among multiple stakeholders is simply too hard. When solving for a financial return, the objective is clear: to maximize value for the corporation and its shareholders. But the remit is broader and the feasible solutions too complex. Solving for multiple stakeholders can be anxious with trade-offs and may even be impossible. How to find a manager whom we pay the incremental ESG dollar, and the customer, by way of lower prices. Similarly, to the employees, through increased benefits or higher wages? To suppliers? Toward environmental issues, perhaps by means of an internal carbon tax? An optimum choice is rarely discreet, and even if such a choice existed, it consists doubt that a company would have a clear mandate from its shareholders to make it.

 ESG is not computable at least to any workable grade

People also raise question about ESG, mainly as replicated in ESG scores, is impossible to exactly measure. Differently E, S, and G dimensions can be assessed if the required, auditable data are captured, some critics argue that cumulative ESG scores have insignificant meaning. The absence is further heightened by variances of weighting and methodology across ESG ratings and score providers. For example, while credit scores of S&P and Moody’s correlated at 99 percent, ESG scores across six of the most prominent ESG ratings and scores providers compare on average by only 54 percent and range from 38 percent to 71 percent. Additionally, organizations such as the Global Reporting Initiative (GRI) and the Sustainability Accounting Standards Board (SASB) can measure the same singularities contrarily; GRI considers employee training, in part, by amounts invested in training, while SASB measures by training hours. It is to be expected, therefore, that different rating and score providers—which incorporate their own analyses and premiums—would provide diverging scores. Moreover, major investors often use their own proprietary methods that draw from a variety of inputs (including ESG scores), which these investors have honed over the years.

 Measured ESG cannot sure any value addition in financial performance

One more opposition to ESG is not causative of positive correlations with outperformance could be clarified by other factors. It is hard to protect if ESG ratings across ratings and scores providers, measuring different industries, using distinct methodologies, weighting metrics inversely, and examining a range of companies that operate in various geographies, all produced a near-identical score that almost perfectly matched company performance. Links with performance could be explained by multiple factors (for example, industry headwinds or tailwinds) and are subject to change. Several studies have questioned any causal link between ESG performance and financial performance. While, according to a recent meta-study, the majority of ESG-focused investment funds do outperform the broader market, some ESG funds do not, and even those companies and funds that have outperformed could well have a choice elucidation for their outperformance.  higher ESG scores. Some have said rightly asserted harshly: “There is no ESG alpha.”

The above contentions, recent events, and churned markets have led some to call into question the applicability of ESG ratings at this point. It is true that the recognized, pressing need to strengthen energy security aftermath of the invasion of Ukraine may lead to more fossil-fuel extraction and usage in the immediate term, and the global collaboration required for a more orderly net-zero transition may be risked by the war and its aftermath. It is also likely that patience for what may be called “performative ESG,” as opposed to what may be called true ESG, will likely wear thin. True ESG is consistent with a judicious, well-considered strategy that advances a company’s purpose and business model swiftly.

But several companies now are making major decisions, such as discontinuing operations in Russia, protecting employees in at-risk countries, organizing relief to a record degree, and doing so in response to societal concerns. They also continue to commit to science-based targets and to define and execute plans for realizing these commitments. That indicates that ESG considerations are becoming more vital in companies’ decision-making. The fundamental issue that underlies each of the above accounts is a failure to a gross adequate account of social license—that is, the perception by stakeholders that a business or industry is acting in a way that is fair, appropriate, and deserving of trust. It has become dogma to state that businesses exist to create value in the long term. If a business does something to destroy value (for example, misallocating resources on “virtue signaling,” or trying to measure with precision what can only be imperfectly estimated, at least to date, through external scores), our expectation does not that criticisms of ESG could resonate, particularly when one is applying a long-term, value-creating lens.

It appears critics overlook that a precondition for sustaining long-term value is to accomplish, and address, massive, paradigm-shifting external cities. Companies can conduct their operations in a seemingly rational way, aspire to deliver returns quarter to quarter, and determine their strategy over a span of five or more years. But if they assume that the base case does not include externalities or the erosion of social license by failing to take externalities into account, their forecasts—and indeed, their core strategies—may not be achievable at all. Amid a thicket of metrics, estimates, targets, and benchmarks, managers can miss the very point of why they are measuring in the first place: to ensure that their business endures, with societal support, in a sustainable, environmentally viable way.

SG rating effect can be Does change matter?

 Accordingly, the responses to ESG critics coalesce on three critical points: the acute reality of externalities, the early success of some organizations, and the improvement of ESG measurements over time. And the case for ESG cannot be dismissed by connections between ESG scores and financial performance and changes in ESG scores over time. \ Externalities are increasing. Company actions can have meaningful consequences for people who are not immediately involved with the company. Externalities such as a company’s GHG emissions, effects on labor markets, and consequences for supplier health and safety are becoming an urgent challenge in our interconnected world. Regulators clearly take notice.  Even if some governments and their agencies demand changes more quickly and forcefully than others, multinational businesses, in particular, cannot afford to take a wait-and-see approach. To the contrary, their stakeholders expect them to take part now in how the regulatory landscape, and broader societal domain, will likely evolve. No less than 5000 business which they have made net-zero commitments as part of the United Nations’ “Race to Zero” campaign. Workers are also increasingly prioritizing factors such as belonging and inclusion as they choose whether to remain with their company or join a competing employer. Many companies, in turn, are moving aggressively to reallocate resources and operate differently; nearly all are feeling intense pressure to change. Even before the Ukraine war induced dramatic company action, the pandemic had prompted companies to reconsider and change core business operations. Many have embarked on a similar path with respect to climate change. This pressure, visceral and tangible, is an expression of social license—and it has been made more pressing as rising externalities have become more urgent.

Some companies remarkable have preformation prove ESG success is indeed possible

Social license is not steady, and companies do not gain and earn the continued trust of consumers, employees, suppliers, regulators, and other stakeholders based merely upon prior actions. Indeed, earning social capital is analogous to earning debt or equity capital—those who extend it look to pass results for insights about the present performance and are most concerned with intermediate and traditional sources of capital, where there are often creative financing alternatives, there are eventually no choices for companies that found not a societal bar which mars the prospect of business natural as usual, even after conditions of catastrophic climate change.

Because ESG efforts are a journey, bumps along the way are to be expected. No company is perfect. Key trends can be overlooked, errors can be made, rogue behaviors can manifest themselves, and actions can have unintended consequences. But since social license is corporate “oxygen”—thus impossible to survive without it—companies cannot just wait and hope that things will all work out. Instead, they need to get ahead of future issues and events by building purpose into their business models and demonstrating that they benefit multiple stakeholders and the broader public. Every firm has an implicit purpose—a unique raison d’être that answers the question, “What would the world lose if this company disappeared?” Companies that embed purpose in their business model not only mitigate risk; they can also create value from their values. For example, Patagonia, a US outdoor equipment and clothing retailer, has always been purpose-driven—and announced boldly that it is “in business to save our home planet.” Natura &Co, a Brazil-based cosmetics and personal-care company in business to “promote the harmonious relationship of the individual with oneself, with others and with nature,” directs its ESG efforts to initiatives such as protecting the Amazon, defending human rights, and embracing circularity. Multiple other companies, across geographies and industries, are using ESG to achieve societal impact and ancillary financial benefits, as well.

Dimensions can be enhanced gradually While ESG measurements are still a work in progress, it is important to note that there have been advancements. ESG measurements will be further improved over time. They are already changing; there is a trend toward the alliance of ESG reporting and disclosure frameworks (though further consolidation is not inevitable). Private ratings and scores providers such as MSCI, Refinitiv, S&P Global, and sustain analysis Analytics, for their part, are competing to provide insightful, standardized measures of ESG performance. There is also a trend toward more active regulation with increasingly granular requirements. Despite the differences in assessing ESG, the push longitudinally has been for more accurate and robust disclosure, not fewer data points or less specificity. It is worth bearing in mind, too, that financial accounting arose from stakeholder pull, not from the spontaneous regulatory push, and did not materialize, fully formed, along the principles and formats that we see today. Rather, reporting has been the product of a long evolution—and a sometimes sharp, debate. It continues to evolve—and, in the case of generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS) reporting, continues to have no similarity. those differences, reflecting how important these matters are to stakeholders, do not negate the case for rigorous reporting—if anything, they strengthen it.

Though While the acronym ESG as a construct may have lost some of its luster, its underlying proposition remains essential at the level of principle. Names will come and go (ESG itself arose after CSR, corporate engagement, and similar terms), and these undertakings are by nature difficult and can mature only after many iterations. But we believe that the importance of the underlying ideas has not peaked; indeed, the imperative for companies to earn their social license appears to be rising. Companies must approach externalities as a core strategic challenge, not only to help future-proof their organizations but to deliver meaningful impact over the long term.

 The way  to make ESG real

 While ESG is likely to evolve both in substance and name in the coming years, its underlying impulse is here to stay. Here’s how companies can take a more systematic and rewarding approach to ESG. The ‘how’ of a company’s ESG proposition starts with recognizing what companies should be solving for maintaining and reinforcing their social license to operate, in the face of rising externalities. Rising scrutiny of how companies address ESG means that a robust approach is more critical than ever, irrespective of whatever name one may choose to give to the attempt to be done. Being forward-looking in ESG necessarily calls for considering the needs of a range of stakeholders and society more widely. Stakeholder demands are unstable, and these shifts can over time dramatically affect competitive dynamics. Nor is the rate of change linear. As external shocks such as the COVID-19 pandemic and the war in Ukraine have shown, companies find it hard to move rapidly unless they have an ESG framework that is derived from, and deliberately advances, their strategy. Anticipating risks and opportunities and considering what value stakeholders have at stake requires continuous, judicious analysis; ESG is a process, not an outcome. The approach of forward-looking companies is marked by four reinforcing parts of mapping, defining, embedding, and engaging. The term “mapping” is used frequently in other competitive contexts. Mapping for ESG requires a thorough and inclusive exercise. The critical analysis is to figure out how the organization’s specific business model matches against each ESG dimension.

THE RISK OF STAKEHOLDER

Comprehensive ESG mapping attempts to consider about the important stakeholders and its value.  Purpose is an enabler; it is much easier for a company to operationalize ESG when it has a clearly articulated corporate purpose, chained to the business model. It will not come as a surprise that forward-looking companies actively engage with their shareholders, whose capital is at risk. To unlock opportunities for all of their stakeholders, however, these companies tend to listen to a broad range of constituencies. Employees rank highly on any list of essential stakeholders. The benefits of engaged employees include heightened loyalty and a greater willingness to recommend the company to others. Engaged customers are also essential. Consumers hold companies and their brands accountable for the impact of their conduct on employees, society, and the environment. Though customer preferences can vary, there are indications about what is likely to matter more for consumers in the years ahead. Our research on Generation Z (born 1995–2010) shows that young consumers are particularly mindful of ethical consumption, transparency, authenticity, and equality. It is observed that purpose-driven brands achieve above double the brand-value growth of brands that attention purely on profit generation.

Recognizing superpowers and weaknesses

The second element of mapping is to identify a company’s superpowers and vulnerabilities. Superpowers are a company’s unique capabilities to have a differential impact. Vulnerabilities are the foundational expectations that critical stakeholders will require a company to address, in light of its specific business model. Identifying superpowers and vulnerabilities requires answering questions such as the benefit to society that no one else can,  the areas of discord, the need to change practices to align strategy with our societal impact, the way to be irreplaceable, and the “home field” advantage. In the instant case,  Natura &Co is a Brazilian-based manufacturer and distributor of cosmetics and other personal-care products, with significant operations in Latin America, Europe, and the Middle East. Its superpower is channeling its “home turf” of the Amazon rainforest; it can tap into its highly motivated base of stakeholders to protect biodiversity and advance global solutions to climate change.

Forward-looking companies test and strengthen their ESG proposition by conducting exercises such as an “ESG teardown.” Teardowns—dismantling a product or service to learn more and to compare it with the offerings of rivals—have long been used in manufacturing. ESG teardowns analyze what a company is doing now, and the reason.  Often, the exercise will surface reasons for some initiatives that include “it seemed like a good idea at the time,” or “many companies seemed to be doing something similar.” Perhaps these explanations make sense in some cases, yet it is not possible to make a distinctive contribution by merely copying others—and at all events, companies have unique superpowers and vulnerabilities. Forward-looking companies carefully consider the dimensions in which they have a particular ability to excel and can distinguish them from dimensions where their abilities are comparable to others. For example, a multinational pharmaceutical company may focus on social metrics (such as accessibility and affordability), a renewables company may prioritize environmental metrics (such as reductions in greenhouse-gas emissions, for scopes 1, 2, and 3), and a food company may elevate an equal mix of environmental (emissions reductions, water use, and waste) and social metrics (nutrition, product quality, and safety).

Thorough analysis of ESG quantifies both downside exposure to and upside opportunities. Forward-looking companies measure gaps between their aspirations and achievements. They also focus most intently on mapping how well ESG is reflected in core business practices. One test that all companies can apply after they have arrived at a new ESG strategy is to determine and parse the internal commitments that they have not yet met and try to know their fault to meet them. Companies can also inquire about whether board meetings are now being conducted differently, with the company’s ESG strategy applied to decision making; whether operating-level meetings are conducted differently; the extent to which ESG considerations are a factor in budgeting, capital allocation, and product choice; and whether some stakeholder groups are expressing particular concerns.

Benchmarking regularly and judiciously

Finally, forward-looking companies are exacting about their choices of metrics and peer sets. They are also creative about analyses and research which includes academic research and thinkers. One informative inquiry tracked the degree to which companies “walked the talk” in their disclosures about broader stakeholders. It found that, controlling for sector-specific effects, stronger stakeholder language about the importance of stakeholders paired with stronger operating performance across a number of metrics over a three-year period.

Forward-looking companies’ selection of peer sets is not constrained by traditional categorizations. While corporations may define themselves by sector, a wide range of stakeholders adopt a much broader approach. Prospective employees, for example, look across industries for companies they would consider joining. There is, as well, a layer of nuance in choosing appropriate peer sets. Looking across geographies and industries is often instructive, but different geographies and industries require different analyses. These companies recognize that they cannot be distinctive by pursuing every initiative that qualifies as ESG. Oppositely because they have a clear understanding of their strategy, and their own strengths and gaps, they focus on identifying initiatives that matter most to their business models. ESG is an essential strategic concern, which means it affects how and where a company competes.

 Considering high rises and long strides

There are two critical decisions that companies confront as they seek to enhance their readiness to address externalities along the ESG dimensions. The first is to decide on high jumps: the levels a company must reach to meet its ESG bar. This is higher than a regulatory bar, such as disclosure standards, environmental compliance, tax obligations, and wage scales—all of which must be met in every case. ESG is “next level” performance; it addresses, for instance, societal insistence on a living wage, environmental demands for net-zero emissions, and communal principles of diversity. These expectations will likely continue to move higher in spite of a degree of volatility is to be expected in this regard as well). The second step is to decide on a company’s long jumps: the one or two ESG areas where the company can take a leadership role and, ideally, affect other players in its ecosystem and beyond. Long jumps are reached by drawing from a company’s superpowers. Depending upon a company’s ecosystem, it may be uniquely positioned to facilitate notable social impact among multiple businesses worldwide. For example, Maersk founded the Mærsk Mc-Kinney Møller Center for Zero Carbon Shipping, which consists of 18 strategic partners from across the shipping value chain that accelerate carbon-neutral solutions for the shipping industry.

The concepts of high jumps and long jumps on the one hand, and superpowers and vulnerabilities on the other, are distinct. While both are rooted in a company’s unique business model and endowment, high jumps and long jumps are the specific courses of action a company takes in light of its superpowers and vulnerabilities. For example, Walmart has the prominent superpower of a large, robust network of suppliers. It uses this superpower to make a long jump in sustainability. The company instituted Project Gigaton, a collaborative program that enables suppliers to reduce their carbon footprints by a collective one billion metric tons (one gigaton) of greenhouse gases by 2030. Thousands of suppliers take part in Project Gigaton by setting targets, reporting on progress, and sharing knowledge. By 2020, the project had already reached more than 40 percent of its goal.

Discerning methodically ESG balancing of factors

Forward-looking companies do not ignore trade-offs when approaching ESG. Rather, as they consider their unique business models, they are clear about benefits and costs—including the costs of inaction. One example is how a company may approach employee compensation. Paying above-market compensation could seem, at first, to be value-destroying for shareholders, by potentially reducing investors’ returns, particularly in the short term, yet employee satisfaction can clearly drive better financial performance. Many companies find that by treating employees better, including by paying them well, they can not only increase productivity but also foster greater trust. Research suggests that this can become a source of competitive advantage. But capital and time are finite. At some point, investing a marginal dollar in one constituency (say, employees, by means of higher salaries) could require increasing prices for another constituency (consumers). Elevating management time for one ESG initiative (for example, reducing waste) could detract from time that can be spent on other initiatives (for instance, community education). There is no one, clearly marked path that every business can follow. But there generally is a common marker that distinguishes how forward-looking companies execute ESG: they consider thoroughly, choose deliberately, and then act boldly. As part of that approach, forward-looking companies assess scenarios for not investing in a given area; they analyze the values at risk to determine the costs of standing still. They recognize that social expectations constantly evolve.

 Measuring and assessing

A key part of making ESG real is not to measure for the sake of measuring but instead to measure what matters. Effective performance management in ESG, like effective performance management in other contexts, approaches shorter-term metrics with a view toward achieving longer-term, strategic goals. It uses clear milestones, pays careful attention to meaningful KPIs, and elevates objectives that tie directly to the business model (for example, water-use reduction, removal of antibiotics from fresh produce, or replacement of diesel machines with electric machines in warehouses). Assessing progress is most effective when it is done regularly and, with robust data analytics, information can be updated very rapidly. Companies that have a considered process in place to measure their ESG performance are better positioned to respond even in times of rapid change. As the saying goes, “there are decades when weeks happen, and weeks when decades happen.” An informed perspective enables forward-thinking companies to move quickly as realities shift...Just as forward-looking companies make informed choices about ESG based upon their unique business model, they also act purposely to operationalize ESG throughout the organization.

Syncing ESG with operations

It can be compelling to approach corporate purpose and then ESG chronologically: that is, to consider that companies should first clarify their purpose, and then create ESG initiatives that accord with their purpose. But it is rare for large, established companies—which operate under a range of priorities, urgencies, and constraints—to be able to operate in this way. The question is often, ‘So where do you start and how do you sequence?’ The logical part of our mind would have us start with purpose, then derive the strategy: anchor it in purpose, and transform the organization on that basis. Our experience is different.  The purpose is to contribute to the common good. But we did not spend time in the first three years of the turnaround on refining our purpose. We spent the time saving a ship that was sinking, by addressing key operational-performance drivers.” It means none but allows companies should move ESG to the back burner. There are opportunities for companies to think comprehensively about how they can advance major ESG initiatives as part of their core strategic plan, across 5Ps. 

Sources of opportunities: portfolio strategy and products: the products and services an organization provides, and the “where to play” and “how to play” choices it makes to best serve its customers: people, and culture: the talent—and the talent management approach—a firm deploys: processes and systems: the operational processes it adapts to meet ESG-related targets; performance metrics: the target metrics and incentives used to measure what the company wishes to achieve, how it is progressing, and the way it creates and distributes incentives to realize ESG initiatives; positions and engagement: how the organization aligns its external positions and affiliations to be consistent with, and consistently deliver on its ESG priorities; Depending upon the company and its business model, the range of key stakeholders can include key regulators and governmental actors, as well as other companies, and the range of initiatives can be far-reaching. Companies that have demonstrable success in ESG make deliberate choices in this regard. It can be tempting to approach corporate purpose and then ESG sequentially. But large, established companies which operate under a range of priorities, urgency, and constraints can really operate in this way.  

 Implementing through on initiatives to ensure impact

Forward-thinking companies then follow through on their initiatives. When ESG fits squarely within the strategy, it is likely to have strong support from stakeholders within and beyond the organization. Consider the clothing and outdoor-gear company Patagonia, which has made protecting the natural environment part of its core mission. Initiatives such as facilitating connections to environmental groups; pledging 1 percent of sales to the preservation and restoration of the natural environment; and using only renewable electricity for its retail stores, distribution centers, and regional and global offices function in concert. One powerful way companies can follow through is with incentives. This includes monetary incentives; indeed, a growing number of corporations are crafting compensation packages, particularly for senior leaders, that condition a portion of compensation on achieving specific ESG objectives (for example, emissions reductions). But monetary incentives are not the only way to encourage positive behavior, nor always the most effective.

An additional lever is “nudging,” which has been validated by behavioral science. Nudges can encourage energy savings and waste reduction, for example, by promoting inclusive behaviors, reminding employees to be mindful of their carbon footprint, or encouraging them to recycle. Forward-looking companies find that by consistently sharing with employees and other stakeholders how the organization is progressing along their prioritized objectives, such as diversity or sustainability—information that can be presented clearly in standardized reports—they can make ESG initiatives part of the business’s daily operations. Companies can celebrate teams that deliver on ESG expectations, or they can spotlight employees who contribute measurably to the organization’s ESG initiatives.

 Discerning what the numbers do and do not say about ESG

Forward-looking companies find that their ESG metrics become more robust—and more refined—the longer and more consistently they use them. They also think carefully about which external ESG rating agencies or score providers they should track most closely. The optimum is usually two or three and, in particular, the two or three that are most practicable for a business model and help companies meet their objectives. Forward-looking companies are careful not to conflate achieving high scores with realizing the specific, strategic goal. Developments on ESG metrics are shifting in real-time. The US regulatory environment is fluid. Outside of the United States, the International Financial Reporting Standards (IFRS) completed its consolidation with the Value Reporting Foundation in August 2022, formalizing the new International Sustainability Standards Board (ISSB).9 ISSB houses the Sustainability Accounting Standards Board standards and the Integrated Reporting Framework. Implementation is usually done via the International Organization of Securities Commissions, whose members set standards as listing requirements on their exchanges. Each of these organizations has the mandate to protect investors and markets. As well, the European Union has asked the European Financial Reporting Advisory Group to propose reporting standards for its Non-Financial Reporting Directive, with a view of materiality on both the investor and civil-society level. Because the European Union supports the IFRS/ISSB initiative, there are grounds to hope that any overlap between IFRS and the European Union will be limited. Though it is not certain that the trajectory will continue, ratings have been converging. The next, great challenge will likely be impact-weighted accounting that reflects a company’s financial, social, and environmental performance. While it is relatively easy to map and measure how ESG initiatives align with a business model, it is much harder to track—and analyze—the maintaining of social license.10 Companies that are focused on making ESG real have learned, first, to encourage open dialogues with stakeholders rather than to shy away from them; second, to speak directly to stakeholder concerns by showing how their ESG efforts connect to and advance the company’s strategy; and, third, to maintain a regular cadence in ESG reporting.

Using ESG engagement to sharpen strategy

Forward-looking companies think carefully about communications—not just in terms of what resonates with investors, but with a range of stakeholders; and not just communications for the sake of announcing to others but in order to learn, become smarter, and improve as an organization. Employees are a key constituency and are invariably an important source of insight. Companies can also continuously improve by engaging through trade groups and alliances (the choice of which is itself a rigorous and iterative process), both to better inform their own views and to accelerate impact at scale. Having an informed sense of opinion helps inure companies to become overly defensive. Committed performers embrace the reality that engagement can be a little bumpy. Dick’s Sporting Goods, for example—the largest sporting-goods retail company in the United States—endured tremendous pushback when it announced in 2018 that it was discontinuing the sale of assault-style firearms and high-capacity ammunition magazines. The company absorbed both immediate top-line losses and a drop in its share price. Yet the company continued to engage openly with consumers, employees, and investors, stuck to its purpose, and soon saw its earnings and market capitalization surpass previous levels.

 Showing investors, the business proposition

Investors increasingly seek more information about and insist upon more accountability for ESG. They also need to know how a company’s ESG initiatives complement and strengthen its strategic plan. Forward-looking companies demonstrate clearly how specific ESG initiatives flow into the business model and have hard metrics to demonstrate progress. They can also take committed actions such as establishing a task force to identify and collect ESG data points for reporting, dedicating full-time outreach and communications employees to the investor relations team, thoroughly integrating sustainability into company reports (including the annual report), and describing specific ESG initiatives and performance against those initiatives in investor presentations.

Companies have also incorporated ESG directly into capital raising, particularly by issuing green- or sustainability-linked bonds (SLBs). These securities feature structural or financial provisions on predefined KPIs, measured against sustainability targets. For example, England-based fashion house Burberry announced a medium-term sustainability bond in 2020 to finance sustainability-linked projects. That same year, Novartis priced €1.85 billion of SLBs, linked to specific ESG targets. The key, of course, in choosing whether to use such instruments is to consider how they could complement and advance a company’s ESG priorities. Regardless of the capital mix, there are clear advantages to greater transparency. Stakeholders, particularly (but not only) investors and regulators, expect and increasingly demand detailed disclosures. While regulations vary across countries and jurisdictions, the global trend is toward more robust information. Companies that succeed in implementing business-driven ESG initiatives, meeting hard targets along the way, demonstrate to stakeholders that they can build and sustain value in the context of regulatory change. ESG is already core to their operating model.

Making cadence core to the dialogue

Finally, forward-looking companies find that not just the quality of interactions with stakeholders and the detail of information shared with them but also the pace of communications is essential. Delaying ESG reporting could be interpreted as a signal of lesser commitment.

Manual not requiring a steady ESG cadence is a developable skill, and it is improved the more it is practiced. Mohandas Gandhi once observed that “your actions become your habits; your habits become your values; your values become your destiny.” That is very much the case with ESG reporting. When ESG is core to the business model, reporting on ESG becomes part of the ordinary course of doing business. External shocks are less likely to present an undue burden on ESG reporting. Just as well-managed companies have accounting information quickly available because it helps them discern their business performance, forward-looking companies have ESG data at the ready before and during challenging periods. Most companies are engaged in an ESG journey. But a culture of continuous improvement in ESG is unlikely to take hold at a company unless ESG is not just taken seriously but systematized and tightly linked to the company’s purpose. Forward-looking companies approach ESG in a rigorous, evidence-based, and well-considered way. They increasingly and deliberately incorporate and advance ESG considerations as core to their business model—to enable a more sustainable business and to make ESG real.

Organizations have been allocating more resources toward improving ESG (environmental, social, and governance) efforts, but the acronym has consistently encountered doubt and criticism—namely, for being perceived as a distraction and intrinsically too difficult., and coauthors rebuke those claims, asserting that ESG is now more essential, relevant, and quantifiable than ever. Does ESG really matter to companies? What is the business-grounded, strategic rationale? This month, our featured stories look at the why of ESG (that is, why ESG matters to companies), as well as the how of ESG (that is, how companies can take a more systematic and rewarding approach to ESG). Other highlights in this month’s issue include the following topics: ten imperatives that should guide organizations seeking to outgrow and outlearn their peers.                                                                                                                                                                                                             

why companies should focus on resiliency and cost but also make intentional bets for longer-term growth, the technology trends that matter most for companies in 2022

CONCLUSION

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