Why businesses need to up their commitment to the “S” in ESG

The “S,” or social, in ESG is typically the most neglected of the three components that make up sustainable and impact investing. S&P Global defines S as “a company’s strengths and weaknesses in dealing with social trends, labor, and politics.” This broad definition includes a range of issues including workplace health and safety, harassment and grievance policies, wages and working hours, supply chain practices, and DEI (equality, diversity, and inclusion).

Why Is the S Neglected?

One reason is that while we now have robust metrics and frameworks to track a company’s carbon footprint, human capital management policies and procedures and the downstream effects of a company’s culture on employees are more challenging to measure and have not received the same attention as environmental factors.

The social component of ESG is also arguably the most political. If, as many traditionalists believe, a business’s sole focus should be maximizing financial returns, anything beyond that, like human rights or social justice issues, are thought to be a breach of fiduciary responsibility. In fact, we are seeing a backlash to the growing popularity of sustainable and impact investing, particularly social issues.

The June 2023 Supreme Court ruling that ended race-conscious admissions programs at Harvard University and the University of North Carolina has spurred legal attacks, or the threat of them, on corporate diversity programs. In July 2023 thirteen state attorneys general sent a letter to the CEOs of the top 100 corporations arguing that the ruling could also apply to employers. By mid-2023, DEI-related job postings fell 44% from the same time a year prior, and many businesses, including Meta and Google, were slashing their DEI programs and initiatives. As part of the contentious March 2024 spending bill, the US House Office of Diversity and Inclusion was axed.

In response to these challenges, many businesses and universities are scrutinizing their social policies and wondering whether it’s time to retrench or cut back rather than move forward. This article presents three reasons why going backwards is not a viable option and choosing to recommit makes good business sense.

Reputational Risk

One of the key drivers in the push for sustainable and impact investing has been public opinion—for example, consumers and other stakeholders who push to boycott a product or service, or post negative online reviews of a company based on its use of child labor, safety problems, or other workplace issues. For instance, S&P Global Market Intelligence found that people were more likely to shop at Walmart after it stopped selling certain guns and ammunition. Younger consumers in particular are taking a more active role in scrutinizing products and services, and can be unforgiving in how they use their purchasing power.

Trent Romer, third-generation co-owner of Clearview Bag Co, Inc. from 2000 to 2021, told me the story of how he tackled reputational risk to his family’s plastic bag manufacturing business. Concerned by the damaging effects of plastic on the environment and growing consumer outrage, Romer began to educate himself and his employees on how his company could be both more sustainable and profitable. Over five years, he and his brother restructured the company, starting with creating a recycling process that repurposed materials and reduced waste by 25%.

He introduced certified compostable materials and, together with employees and customers, created a new vision: healthy planet, healthy people, healthy company. The company became more profitable, grew overall value, increased customer and employee satisfaction, and increasingly attracted outside investment opportunities. Romer wrote two books about his experiences and advises other business owners, further burnishing the company’s reputation as a sustainability leader in a tough industry. Longer term, Romer talks about the challenges for small to midsize businesses in managing the challenges of the regulatory landscape.

Regulatory Risk

The regulatory pace for ESG disclosure is accelerating, even in the U.S., despite fierce opposition from some sectors, particularly the fossil fuel industry. In 2020, for the first time the SEC specifically addressed the social component by approving amendments to Regulation S-K. Public companies are required to disclose human capital measures or objectives related to business management, including development, attraction, and retention of personnel. The SEC has hinted that it will be looking more closely at these issues in the future.

In 2021 (and updated February 28, 2023) Nasdaq adopted diversity disclosure rules that require companies listed on its U.S. exchange to “publicly disclose board-level diversity statistics annually using a standardized template; and have, or explain why they do not have, diverse directors.”

In March 2024, the SEC adopted rules that will “enhance and standardize climate-related disclosures by public companies and in public offerings.” Required disclosure covers actual and potential material impacts of any identified climate-related risks on the registrant’s strategy, business model, and outlook, beginning with annual reports for the year ending December 31, 2025. 

The EU has been passing much stricter regulations over the past ten years, and U.S. companies doing business there need to pay attention. Starting in January 2025, the Corporate Sustainability Reporting Directive (CSRD) requires any EU listed company or non-listed company generating more than €150 million on the EU market or with over 500 employees doing business in the EU to report on all ESG issues.

The global ESG regulatory landscape is still fluid, varying by country and required disclosures, and in the U.S. heated controversies around regulations will continue. But it is increasingly clear that going backwards is not a long-term answer, and businesses that understand opportunity risk will have the advantage.

Opportunity Risk

Climate change, AI, pandemics, supply chain disruptions, political unrest—the global economic and business challenges are enormous, as are the opportunities. A July 2023 report by McKinsey looked at what it calls “a rapid evolution in the way people work and the work people do.” The following two findings alone should make companies and investors wake up to the importance of S: by 2030, roughly “30 percent of hours currently worked across the U.S. economy could be automated,” leading to “an additional 12 million occupational transitions,” a much higher number than projected in 2021. That means millions of workers having to switch jobs or careers, with most of the disruption falling on low-wage workers and women.

An article for the Harvard Law School Forum on Corporate Governance makes the compelling argument that companies and investors who understand how to integrate social factors into their business models and portfolios will gain a competitive advantage and be better poised to thrive in a rapidly changing global economy.

And what about younger employees—the ones who will be leading the innovation charge? Deloitte’s Global 2022 Gen Z and Millennial Survey presents a snapshot of what they want: “Higher compensation, more flexibility, better work/life balance, increased learning and development opportunities, better mental health and wellness support, and a greater commitment from businesses to make a positive societal impact.” And 52% want to see more diverse and inclusive workplaces.

In an interview I did with Anna-Lisa Miller, Executive Director of Ownership Works, a nonprofit organization that partners with companies and investors to provide all employees with the opportunity to build wealth at work, she explained how paying attention to the S can result in wealth creation for everyone. After one company offered shared ownership, the value of the business increased, employee engagement and productivity rose, and employee retention skyrocketed.

In Part 2 of this topic I will cover some of the best frameworks being used to track the S in ESG and look at how businesses are incorporating social KPIs into their overall business strategy–a crucial component in driving employee innovation in the workplace and addressing some of the most challenging issues in advancing basic human rights.