Those critics seem to be coming out in droves this year. Some, like former Vice President Mike Pence in his Wall Street Journal piece, seem clearly motivated to politicize the work. Some, like Tesla CEO Elon Musk via his anti-ESG remarks, seem petulant in the face of constructive criticism. Our friends at r3.0 identify that ESG can provide only the beginnings of true sustainability calculations. But we were intrigued to read this headline in The Economist: “ESG should be boiled down to one simple measure: emissions.”
The magazine makes three arguments, none of which bears much scrutiny and all of which confirm a failure of the author’s appreciation of the complexities of what ESG aims to solve.
First, the illustrious magazine suggests that “because [ESG] lumps together a dizzying array of objectives, it provides no coherent guide for investors and firms to make the trade-offs that are inevitable in any society.” This argument waves a white flag of surrender—precisely not what the world needs
In the face of complexity, this argument waves a white flag of surrender—precisely not what the world needs in the face of complex, existential problems like climate change.
The appropriate response to this complexity is to ask, ‘What is it that my firm is accountable to doing?’ ESG encourages companies to ask this question—and to answer it transparently. Given the extraordinary range of potential ESG measures, it’s helpful for companies and their leaders to be able to narrow their scope.
This is where corporate social purpose comes in. It’s folly to think every firm can contribute positively to every possible issue or area of negative impact. It is appropriate to hold companies accountable to the impacts that are material to their social purpose, attributable to their value chain, and important to their local communities.
Second, The Economist argues that ESG is “not being straight about incentives… It is often very profitable for a business to externalize costs, such as pollution, onto society rather than bear them directly.” We are grateful to the vaunted weekly for putting such precise, clear language to the very problem ESG aims to solve!
‘Externalized costs’ may well be the clearest descriptor of the causes of the climate emergency and the horrific downsides of colonialism. That capitalism has been allowed to go unfettered, thanks to decades of ‘free market’ neoliberal economics, despite the clear and increasingly present danger of companies’ negative environmental and social impacts, is exactly what ESG aims to point out, measure, and call attention to solving.
ESG helps us to articulate and understand the risks inherent in the status quo, thereby showing business leaders where they might focus their efforts to mitigate that risk, in turn establishing a more resilient and valuable business. ESG shows us the risks of the status quo. Social purpose provides the space to do better.
Social purpose has a role to play here, too: whereas ESG tends to prioritize risk mitigation, social purpose tends to focus attention toward positive impacts. This is certainly more uplifting and engaging for leaders! Valuably, though, it also helps companies to do their part in solving for the challenges of the day—and of the world.
The Economist’s third argument is that “ESG has a measurement problem: the various scoring systems have gaping inconsistencies and are easily gamed.” Whereas “credit ratings have a 99% correlation across rating agencies… ESG ratings tally little more than half the time.”
Credit ratings solve for complicated calculations, weighing a long but quantifiable and finite list of criteria to provide a comparative ranking for individuals, companies, and even whole national economies. ESG, distinctively, strives to solve for complex problems. The difference? Complex problems are dynamic; they change even as we strive to solve them. The very nature of the climate emergency, for example, is changing even as we try to measure it. The Economist is right to point out that we’re fortunate to have a useful proxy measure for climate impacts in carbon emissions. Measuring emissions (scopes 1, 2, and, yes, Economist, the ever-vexing Scope 3!) is a global imperative. And it’s insufficient.
There are basic social foundations like paying a living wage or non-discrimination that all companies should meet. Beyond those, social impacts are incredibly complex, varying for each organization, at each point of scale, in each local community or market, and through time.
We ought not to pretend that any company can avoid all negative impacts today (we need systems change for that), but they must begin that journey. We must hold companies accountable to make positive contributions for those impacts that are most material.
As to ‘G,’ there are well understood, widely accepted best practices in corporate governance. Yet this too evolves as communities’ expectations shift. Whereas in past decades considerations of good governance may have stopped with transparency into leaders’ decision-making or proxy voting, today, governors must also consider how consciously they use their power and privilege vis-à-vis their companies’ various stakeholders.
Companies don’t exist in a vacuum, separate from people and planet. They’re deeply intertwined with the communities from where they hire their employees and to which they vend their products and services. Stakeholder-centricity has emerged as a vital consideration precisely because we all recognize this interconnection: people and communities will do better when companies offer meaningful benefits to them, and companies will do better when they have the support and loyalty of those same people and communities.
Circular? Yes. That’s the nature of interrelatedness. Simplistic? Perhaps. But it’s also both intuitive and proven: dozens of studies like this one have proven the long-term value returns to businesses of stakeholder centricity.
So How Should Leaders and Corporate Directors Be Thinking About ESG?
Start with social purpose. To start with social purpose is to go beyond the reactive, (often) public relations-driven, risk mitigation value of ESG. Social purpose provides a lens through which decision makers can see the positive contributions their company can make. If leaders and governors have not articulated the social purpose of their business, then they’ll be challenged to understand which metrics and factors are most important for them to track and consider. How will they know if they are making progress if they can’t articulate the change they want to make in the world?
Second, with your direction of travel clear, look for successive wins, rather than transformative moments. Sure, occasionally a significant inflection point comes along. (Indeed, at Junxion, we try to find those opportunities through our TurningPoint planning approach.) But for many companies, incremental progress on issues that matter is valuable, so long as it helps them realize their social purpose. And momentum tends to build on the foundation of early successes. Start with the challenges you can solve and the positive contributions you can control. Build from there.
Third, let’s recognize that ESG is still an emerging field. As such, there are many different tools, approaches, models, and frameworks. Some are better suited to one industry than another. Some are more academically rigorous. Double materiality and context-based materiality are steps in the right direction. Others have emerged from deep, grassroots understanding of local and regional problems. So it’s complicated. That doesn’t mean it should be dismissed or diluted, as The Economist seems to argue, for that would throw the baby of progress out with the bathwater of complexity.
The new report from the United Nations Research Institute for Social Development– (UNRISD) is the result of a four-year project with r3.0 to define what ‘Sustainable Development Performance Indicators’ actually are. With implementation manuals due in September, ESG data can now be linked to understandings of thresholds—such as a living wage or 1.5 degrees of global heating—and can help companies to measure their true sustainability impact. Their assessments can finally “carry a message that can be acted on,” to quote Donella Meadows, one of the authors of the seminal 1972 Limits to Growth.
No reasonable person expects any individual business to solve for all the world’s problems. ESG begins to help us to assess how well companies are doing. A clear social purpose helps to identify the contribution each business should be making.
And threshold-based sustainability metrics—building on ESG data—can help you meaningfully measure and communicate your progress.
Rather than arguing for unproductive reductionism, perhaps The Economist should aim higher. The challenges facing humanity need us to be bold and ambitious, to muster the very best of our intelligence and capacity.
Let’s Be Audacious, Together…