At Tier2Tek, we often believe ourselves to be a middleman. An entity able to wax both poetic and layman, connecting a divide between incredibly intricate terms and the easier-to-digest definitions we present. As a business-to-business company, we often deal with having to understand new terms and business facets from both sides. We have to be able to explain it to any level of preexisting knowledge. Just a few weeks ago we delved into the new and fascinating term of workplace frugality and how it’s affecting labor. This week, we will look at ESG.
When a new term peeks its head through the business lexicon, we have to be one of the first organizations to both understand and adapt to it. And after arduous research, we have to be able to present it in layman’s terms. No one wants to read a confusing babble of definitions with more definitions. So, what exactly is ESG, and does it actually matter to your business?
Is ESG just another trend waiting to be replaced by another, or is it here to stay?
What Does ESG Mean?
Let’s start with the basics before delving into the fine print.
ESG is an acronym that stands for Environmental, Social, and Governance. Ultimately, these three terms act as a framework for businesses to address holistic issues and efforts. A company can express its work towards sustainability and corporate philanthropy to shareholders through the acronym. In a corporate world where social issues and pollution reduction are at the forefront, organizations need to establish an initiative implementing ESG in order to maintain investor attention.
At the end of the day, ESG is a catch-all acronym that asks what a company is doing to help the world and company sustainability outside of the products or services it produces.
At the heart of acronyms are multiple definitions. To define ESG is to define each part individually. Let’s break it down.
E – Environmental
According to a 2021 study by Business Insider, 65% of millennials feel that humans are the number one cause of climate change. 81% believe the planet is warming. If both of these issues are true, businesses are the biggest factor to blame.
Industry has been the main factor of environmental harm since its inception. It’s even arguable that industrial forces have led to other environmental hazards (like creating gasoline-based vehicles for modern consumption). Therefore, creating a sustainable business and production process that doesn’t work to harm the environment is a key factor to positive attention in 2022.
If you are going to back a business as an investor, you want to make sure the business will not be on the negative end of eco-friendly solutions. Negative additions to greenhouse gas emissions, compliance with regulations, and the treatment of animals are quick ways to tank a company in the current age. Why invest in those that don’t adhere?
S – Social
Much like helping environmental issues, having a strong and positive social presence can help build a company to new heights. In the current decade, having a stance on social issues (and helping the adjacent causes) is more important than ever before. Consumers want to purchase from companies that stand by their morals, and actively look to help push for change.
Socially Responsible Investing (SRI) is a fairly recent investment strategy that involves investing in companies with strong and positive cultural stances like inclusion and social justice. Furthermore, these investors look for companies that not only back issues but fight for them. Not just saying words of encouragement and identifying a stance, but actively pushing them.
SRI is just part of the ESG process for investors.
The Pepsi Example
Think that establishing a progressive culture is pointless regarding business? Think social change and business shouldn’t intermingle? Let’s look at the Pepsi example.
In 2017, the Black Lives Matter movement was reaching a tipping point. Protests were raging throughout the country. Pepsi, seemingly inspired by latching onto a movement for sales instead of actually backing change, produced a commercial with Kendall Jenner.
The infamous Live for Now commercial was so bad and controversial that it has garnered its own Wikipedia page.
The ad involved Jenner walking through a protest to give a police officer Pepsi. Giving the cop a Pepsi seemingly ended the entire conflict, generating smiles in a time of intensity.
The admittedly “tone deaf” ad cost PepsiCo around $5 million, an exec told PEOPLE. More importantly, it crushed the company’s public appearance. Though stocks remained the same, would a move like this (especially for a smaller company) scare away investors?
Absolutely.
They would have been better off avoiding trying to make a statement at all. If you don’t have anything nice to say, don’t say anything.
G – Governance
Governance is a bit less progressive than the other parts of the acronym.
Overall, governance involves how well the company is run and how ethical it is in its practices. For example, does the company provide equal opportunities for its leaders? Does the company provide accurate and transparent accounting methods?
This concept is nothing new for investors. Sound investors do not want to get behind companies that may end up with damming lawsuits or social downfalls. It’s unwise to back an organization with sketchy or unethical business practices. It’s that simple.
Basically, the ESG acronym fits main investment risk-reward factors into three broad categories. For an investor to make a sound decision, they must look at a company for its environmental practices, social outreach, and business ethics.
Who Cares Wins – A Brief History of ESG
The idea of companies caring about social movements can stretch back as far as capitalism itself, but it did not become a mainstream philosophy until the middle of the 20th century.
- In the 1960s, two sides of the coin reared their heads. In a decade filled with movements and protests including segregation and the Vietnam War, you saw companies both working towards progression and setting it back. Very few companies were outspoken about the war and other movements, but some still did speak for peace.
On the other hand, many chemical companies played roles in the production of Agent Orange, a devastating chemical used in the war. Those United States companies are still facing lawsuits from victims in Vietnam, Cambodia, and Laos, as well as United States veterans. In this case, being on the wrong side of ESG proved to be detrimental, even 60 years later.
- In 1992, the United Nations held a convention on climate change, also known as the Earth Summit. During this event, 154 countries signed an international environmental treaty to help stop environmental damage. Climate change became a front-running concern for not only governments but humans as a whole.
- In 2000, the United National Global Compact is introduced, bringing the core concepts of ESG to the forefront of the incoming century. The Global Compact involved asking companies to align strategies and operations with universal principles on human rights, labor, environment, and anti-corruption, and take actions to advance those goals. As of 2021, over 13,000 companies and 160 countries have signed the pact.
- In 2004, ESG was officially coined. A report “Who Cares Wins– Connecting Financial Markets to a Changing World” was published and provided guidelines for companies to incorporate ESG into their operations.
- In 2011, the Sustainability Accounting Standards Board (SASB) is launched to standardize sustainability accounting and measurements across 77 industries.
- In 2015, the Paris Agreement is created at a United Nations convention. The agreement covers climate change and advancements in environmental safety.
Furthermore, the Sustainable Development Goals (SDGs) are created at a United Nations General Assembly. The goals are 17 interlinked global missions designed to be a “shared blueprint for peace and prosperity for people and the planet, now and into the future”. - In 2020, a global pandemic and a wide array of social movements strike the world. Though not directly connected to ESG, it’s important to note. Both social integrity and inclusivity become the main concepts of all consumer practices, pushing them to become important for business practices.
The Ongoing Impact of ESG
As of 2022, the concept of ESG amongst investors is no longer an underlying factor. It has become a mainstay amongst the investment community, causing plenty of ESG investment vehicles to emerge. Green bonds, mutual funds, ETFs, and index funds have been created, allowing investors to align their decisions closely with their personal beliefs on parts of ESG decisions.
MSCI created an ESG rating scale, rating over 8,500 companies with number and letter grades on their ESG positivity. Other companies have also created their own ESG scales.
Not only does this create a competitive basis around ESG, but it gives potential investors an easier way to look at companies through a progressive lens.
Henceforth, ESG itself is not going anywhere. Investors understand the importance of the motives and movements on forthcoming company success. Therefore, they will only look to invest in companies that have clear and established motives within each department.
How Does this Affect My Business?
If you are a larger company, then the idea of ESG is fairly obvious. A larger organization lives and dies by shareholders. If you lose investments through a bullheadedness to move toward ESG-friendly motives, then you experience the negative aspects of losing investors. It’s that simple.
On the other hand, the concept of losing or gaining investors makes no difference for companies that aren’t public. So, if you are a small business, why should ESG matter?
Should you, as a small and private business, care at all about ESG?
The simple answer is yes. Even though you may not adhere to ESG positivity to promote investment growth, the importance of each letter in the acronym is still critical. If investors care so much about the three letters, then they are obviously important factors for any business, anywhere.
Adhering and establishing a strong presence in all three letters of ESG is crucial for the growth of a business, not just gaining the attention of investors.
Create a Likeable Company
Data science company, RepTrak, analyzed the importance of ESG to average consumers in 2020. They found that ESG was the 9th most important factor to the general public in willingness to buy a product or service. ESG was 5th in willingness to recommend a business to a friend.
It’s also important to note that in the study, reputation was seen as the 3rd most important factor in the willingness to purchase and 1st in willingness to recommend.
Simply put: if the average consumer wants to stand behind eco-friendly and social-justice efforts, then they are more likely to support a company that also stands behind them. Creating a corporate culture that is both genuine and forward-thinking will only boost overall sales. The modern human wants to help better the world. Therefore, if your company is looking to better the world, too, consumers are more likely to buy from you.
It’s a simple A-to-B process. Care about ESG factors and consumers will care about you, just like investors.
Boost Employee Motivation
Establishing a brand is not just important for company success; it’s important for workplace cohesiveness. Consequently, an employee wants to know and understand the meaning of a company before they work for it. Having a strong culture inside the workplace is one of the most crucial employee retention strategies.
Ultimately, you want to have a team that shares similar ideals and motives. Once these concepts have been agreed upon, you can begin hiring like-minded employees. Not having a clear sense of identity can lead to employees wanting to venture elsewhere.
A 2019 study by GlassDoor found that 77% of workers consider a company’s culture before applying. Establishing a culture is key to keeping fantastic workers.
Reduce Production Costs Through Sustainability
Environmentally-friendly products are often seen as more expensive versions than their hazardous counterparts. While this may be true in some cases, a company can actually reduce production costs by adhering to a more friendly process. Breaking into the E part of ESG can help reduce costs, making it a double positive. Help the environment and help your business.
For example, simplifying packaging immediately reduces both production price and recyclability. Furthermore, recycling water and other materials can reduce the cost of having to collect fresh materials. Energy-efficient lighting, like solar panels, can also significantly drop overhead costs.
The stigma of enivoronmental-friendliness being an expensive endeavor needs to be squashed.
Avoid Other Charges and Legal Fees
The G in ESG (governance) helps reduce companies’ risk of adverse government action. It can also help contribute to forthcoming or ongoing government support. Consequently, companies that administer distasteful or unethical legal and accounting practices often find themselves charged with various legal fees and fines.
It’s not our place to discuss what exactly determines an unethical practice, but the importance of both ethicality and inclusivity should be important for any business. Take humanity out of business, and you are left with a shell of profit. No one wants to give their money (both consumers and lenders) to a company that stands by hate, discrimination, or other unsatisfactory practices.
Furthermore, going green can help reduce the cost of waste management and disposal. Companies also avoid any potential fees from unlawful disposal or environmentally-based practices.
Conclusion
ESG is a collection of ideals and standpoints within corporate culture that are not going anywhere. Upcoming generations have shifted towards a mindset that is both forward-thinking and progressive. No longer is business and society separated by a thick line. Now, a company must possess positive attributes within the factors of ESG to maintain public success.
Henceforth, investors will not place money behind companies that do not contribute to a multitude of ESG factors. If a company won’t succeed due to bad social or environmental practices, why get behind them?
The argument over Wealth Maximization is over. The goal of a business is no longer to just sell a product but to also use its influence and power to help better the crumbling world around us.
If you own a private business, dealing with investors is not an issue. Consequently, you should still look at your company culture and motives with the intention to establish them. Not only does a strong basis of ESG help get the attention of investors, but it helps establish a strong brand and market presence. Do not find yourself losing out to competitors because you have not openly backed your cultural ideals.
Is ESG important to business? Absolutely, regardless of size or market placement.
In 2022 and beyond, it is crucial for a company to build a brighter future, not just a profit. The Friedman doctrine is both outdated and false (as it always was). The point of business is not just income, but to exist for transactions. The idea of allowing business to exist in humanity was never just for profit. If so, creating faulty products just to sell would never be looked down upon. Business was created to provide services and goods to people in exchange for profit.
Businesses were allowed in order to provide for the people, and therefore, for the world they exist in.