Environmental metrics aim to assess effects on the physical environment, including physical waste produced and energy consumed.1 Social metrics are to evaluate diversity and inclusion efforts, as well as impacts on the surrounding community. A commitment to social goals acknowledges that a business goes beyond its physical walls and works within the larger world. Governance criteria are used to analyze the strength of leadership within a firm, including the processes, practices, rules, etc. utilized to govern the company at large. This criterion includes the ability to oversee and maintain a commitment to environmental and social initiatives.2 To summarize, Environmental and Social can be thought of as the goals, while governance provides the means for achieving them.
Business leaders around the world have largely come to a consensus that some form of corporate ESG reporting is essential.3 Many investors have begun using an ESG framework to get a more robust understanding of the risks and opportunities associated with the companies they choose to invest in.4 Considering the pandemic, racial justice movements, and concerns about climate change, ESG has become an important part of recruitment and retention efforts as many employees have prioritized working for a company that shares their values over other factors.
This way of thinking aligns with treating the company as a community through increased trust and transparency across all levels of employees. In addition, the SEC has proposed new rules and disclosure obligations that would require consistent and reliable ESG reporting across the economy.
ESG may soon be a requirement for many businesses, and voluntary participation in reporting and goals has been shown to create value for firms, furthering the case for participation. The first of five main opportunities for value creation is top-line growth created by extending into new markets, as well as growth within current ones. Initiatives have also resulted in cost reductions due to cutting material costs and other operating expenses by up to 60%.
As ESG concerns rise on the agendas of various government agencies, avoiding regulatory and other legal interventions is another huge advantage of implementation. Improved work culture and employee satisfaction is another worthwhile benefit, resulting in efficiency boosts and increased retention rates; both of which are correlated with higher returns.5
ESG reporting includes both qualitative and quantitative assessments to track a company’s progress toward its defined initiatives. The World Economic Forum (WEF), in collaboration with the Big 4 accounting firms, published a joint report detailing metrics for assessing ESG commitments across all categories.6
For assessing corporate governance, they separated metrics into six broader categories: purpose, quality, remuneration, stakeholder engagement, ethical behavior, and risk and opportunity oversight. For the aspect deemed ‘planet,’ categories of assessment include climate change, nature loss, water availability, air and water pollution, solid waste, and resource availability. Lastly, ‘people’ is divided into subcategories dignity and equality, health and wellbeing, and skills for the future.
One of the most difficult parts of implementing ESG is the lack of quantitative measurements available for tracking progress. To combat this, the WEF report includes specific metrics within defined subcategories for assessing each element of ESG. Although the metrics don’t provide definite measurements for every category, they provide more guidance and can be adjusted on a business-to-business basis. Governance can be assessed by the quality of processes put into place, as well as broader metrics like the number and handling of incidents, as well as financial metrics tracking allocation to specific ESG projects.
Reporting on environmental metrics is more defined but requires investment in specific infrastructure. Assessing the greenhouse gas emissions and nature loss caused by a specific business is no easy task, but it provides valuable information for stakeholders and potential investors. Once the processes for measurement are in place, they can be used to make improvements and even increase efficiency.
Social impact measurements must include internal and external forms of measurement. Internally, measurements of equality and diversity can be easily tracked using percentages over time, as well as the number of incidents reported. External impacts can be more difficult to track, so companies must find a way to assess their impact on the communities they reside in, as well as their commitments to broader social movements.
To further define ESG reporting metrics, NASDAQ has created OneReport- a tool and compilation of resources to streamline and simplify the process. The tool is a complete guide to ESG reporting from end to end and helps businesses navigate various ESG framework options and facilitate publishing to various platforms.7
The first step in developing an ESG strategy is building out a plan including risk areas, short-term remedies, longer strategic plans, and a rough blueprint for which to tackle first. Two processes commonly take place to implement such a transition.
The first, the top-down approach, begins with an initial assessment to identify potential ESG risks to the company. The assessment is then reviewed to see how the identified risks interact with existing company processes and operations. Next, the bottom-up approach takes the results of the top-down assessment and uses them to set goals for engaging stakeholders and defining important values. The follow-through on these findings utilizes already familiar company processes such as oversight, allocation of resources, monitoring progress, reporting, and revising goals.8
Concerns about sustainability in the business world are present and growing. Investors, employees, customers, and other stakeholders are taking notice of companies’ commitment to ESG and the values they represent. A commitment to ESG includes changing focus to reflect a broader array of goals beyond profit, as well as refining business practices to help achieve set goals. In addition to keeping up with stakeholder demand, ESG initiatives offer value creation in a wide variety of areas throughout the business process.
Sustainability cuts and maximizes resource efficiency, while progress on social goals can increase employee satisfaction and retention. Effective corporate governance is the glue that holds all this together. Leadership is responsible for shifting focus towards ESG initiatives and creating a way for progress to be effectively tracked. There are many tools out there for firms to utilize in beginning an ESG transition that help with developing processes and instituting measurement tools. As ESG reporting becomes commonplace, businesses should get a jump on their journey towards corporate accountability.
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Footnotes
[1] https://www.cfainstitute.org/en/research/esg-investing
[2] https://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/five-ways-that-esg
[3] https://www.weforum.org/agenda/2022/05/business-leaders-at-davos-how-to-deliver-esg
[4] https://www.cfainstitute.org/en/research/esg-investing
[5] https://www.mckinsey.com/~/media/McKinsey/Business Functions/Five-ways-that-ESG-creates-value
[6] https://www3.weforum.org/docs/WEF_IBC_ESG_Metrics_Discussion_Paper.pdf
[7] https://www.nasdaq.com/solutions/corporate-esg-solutions/nasdaq-onereport-esg-reporting#process
[8] https://fortune.com/2022/04/20/esg-sec-cyber-environment-leadership-corporate-governance-investing
By Jordan Maisch
