The Value of ‘S’ in ESG, and the Mirage of Measurement

t’s been a little over a month since world leaders from 193 United Nations member states convened in New York for a meeting of the UN General Assembly with a specific focus on the 2030 Agenda and the Sustainable Development Goals (SDGs). In short, this is a multi-stakeholder commitment made in 2015 to set quantifiable goals for a world where ‘no one gets left behind.’ It is undoubtedly the most comprehensive and collaborative blueprint to date for eliminating extreme poverty, reducing inequality, and protecting the planet. It represents a powerful vision for a better world but one that is severely off track at the halfway mark.

The 2023 results to date showed that only 12% of metrics are on track and 33% have either remained unchanged or regressed over the last 8 years. The seriousness of this was best surmised by UN Secretary-General António Guterres who said, “Unless we act now, the 2030 Agenda will become an epitaph for a world that might have been.”

The good news is that this meeting of leaders and visionaries created a refreshed sense of unwavering support by world leaders in their sweeping political declaration to make this a priority. The bad news is that there remains a gaping sense of exactly how to make this happen. The logical argument by politicians is that the lag in progress is due to the reverberating impacts of the global pandemic, ongoing geopolitical crisis, the climate crisis, and the economic rollercoaster of recent times. Indeed, for many global citizens surviving day-to-day life, the big dreams of the UN are undoubtedly elusive in nature. It can seem a futile exercise to ponder broad-scale societal change and a better future in a world where survival alone is a feat.

The Rise and Hope of ESG:

For business leaders, the story is equally complex. The rise of Environmental, Social, and corporate Governance (ESG) has taken center stage across the business world. Although the term itself has fallen out of favor through political division, the paradigm upon which it is set continues to grow. Investors globally are embracing this phenomenon and investing on a massive scale. A PWC report predicts by 2026, ESG will account for a whopping $33.9 trillion, equating to 21.5% of total assets under management.

Yet its rise in fiscality and discourse has not transmitted to a cohesive response. A recent study by GRI standards has revealed that four in five companies now include a commitment in their sustainability reports to the Sustainable Development Goals (SDGs), yet fewer than half set measurable targets for how their actions contribute towards their achievement. The challenge ahead is that purpose needs to be more than romanticism. It needs to be performance-led and its impact accurately measured.

So as world leaders return to business as usual with a reaffirmed commitment to sustainability, hampered further by the devastating events of October 7th in Israel and the onset of war and extreme crisis in the Middle East, the one step forward, two step backward cliché is undoubtedly again a looming reality. In a world so divided by crisis, businesses have a more critical role than ever in investing in people, jobs, and skills to develop human capital, end extreme poverty, and create more inclusive and united societies.

The question remains: against a backdrop of growing challenges with inflation, supply chains, and broad geopolitical instability, how can ESG create improved cohesion?

The Role of Purpose in Performance:

Most successful leaders envision a talented workforce united by a shared purpose. ESG has, in many ways, created a vehicle to help companies better articulate the link between commercial businesses and value creation for the common good. It hardens the value of social capital, which is of ever-increasing importance. A survey by Morgan Stanley found that 86% of employees believe that companies should be held accountable for their impact on the environment and society.

However, sentiment alone is not enough. There needs to be a clear understanding of how purpose is material to the performance of the business. One tactical way of addressing this is the linkage between ESG goals and executive incentivization, of which the Harvard Law Forum Of Corporate Governance has reported a rapid rise over the last several years. In 2022, there was a nearly 23% increase in the proportion of S&P 500 companies applying ESG metrics in incentive plans, a jump to 70% prevalence from 57% in 2021.

It is anticipated that this phenomenon will begin to trickle down to medium and small-sized companies. However, incentives are only truly effective if they drive behaviors that permeate company culture and affect how employees think about their work and organization from a shared perspective. Research has unequivocally shown that even good management practices are not adopted by many organizations because of cognitive, knowledge, and capability barriers.

At the core of this is a heightened focus on human capital and employee engagement. In its most fundamental sense, the ‘S’ in ESG is the pivotal force by which the other constructs of environment and government exist, yet often the least understood.

A Measurement Mirage:

A 2017 study by the NYU Stern Centre for Business & Human Rights reviewed reporting and ‘gaps’ relating to the ‘S’ based on frameworks set out by 12 different bodies (including Bloomberg, Dow Jones, FTSE, GRI, and SASB). The report found the measurement of ‘S’ usually focused on what was “most convenient” as against what was “most meaningful.” This report, although originally commissioned to inform governments, has proven equally valuable in the business context to understand better the fundamental link between organizations and the well-being of their employees and its impact on society at large.

The measurement of something like social phenomena is no easy feat. When it comes to reporting, ratings, and rankings, there has been no shortage of attempts. The ESG world is arguably a dizzying array of metrics, assessments, and stated factors to create fungibility between corporations and financial assets. Yet when it comes to the most valuable asset of all, human capital, there has been a visible lack of precise measurement. A lack of materiality in measurement often challenges the ‘Social’ premise of ESG.

Yet in cherry-picking the easily quantifiable elements of social impact without holistic context, what can exist instead is a measurement mirage which is far more problematic in the longer term. The challenge is exacerbated by the plethora of external agents and frameworks, which in the absence of global standardization, are costly to implement and field limited improvement. Instead, theorists point to the need to curate reporting frameworks that match unique organizational needs in a holistic way.

In its most straightforward explanation, reporting must capture and assess social impacts, not just their efforts. The data itself needs to be broad-reaching, which goes far beyond just company disclosure. There needs to be clear objective standards for evaluating “S” which are regularly reviewed and updated.

Despite attempts to drive a political wedge in ESG sentiment, it is clear this is a growing and not shrinking phenomenon. In times of fraught fraction, organizations through ESG can unite society through sustainable development of society and a shared future. At the core of this is the pivotal role of employee engagement, which can be achieved through the tacit connection of purpose to performance and accurate measurement of the fundamental role of human and social capital.