Authors: James Reda, Kevin Schmid, Tom Tropp
For decades, for-profit corporations relied on the creation of shareholder value as their fundamental measure of success, while most nonprofits tended to look at internal performance metrics. Now an additional metric has emerged that evaluates how well organizations align with environmental, social and governance (ESG) principles.
Over the past few years, for-profit and nonprofit organizations have navigated a shifting landscape for ESG concerns. The common denominator and a key motivator for both is that ESG has become increasingly important to some of their most important stakeholders. Employees, investors, customers and donors are considering the level of commitment to these principles when deciding where they want to invest their time and money.
Defining ESG and its purpose
Encompassing a broad set of issues, ESG speaks to the totality of an organization's impact beyond mission-related operations and short-term financial performance. But part of the challenge of putting principles into practice is the constantly evolving meaning of this term. In early 2021, the U.S. Securities and Exchange Commission (SEC) provided a helpful overview that describes the range of factors ESG can encompass, from an investor's perspective.
The growth of ESG funds and investment strategies reflects the desire of many institutional and individual investors to put their financial resources to work at socially responsible companies. One primary motive may be a two-fold determination to "do well" and to "do good" at the same time.
Another may spring from the belief that, over the long term, companies more closely aligned with ESG principles are likely to outperform the market.
ESG Categories and Criteria1:
- Environmental The company's impact on the environment, or risks and opportunities associated with the effects of climate change on the organization, and its business and industry
- Social The organization's relationship with people and society (e.g., diversity and inclusion, human rights, employee health and safety, community investment) and how other supply chain companies address such issues
- Governance How the company is run (e.g., transparency and reporting, ethics, compliance, shareholder rights) and the composition and role of the board of directors
Societal influences on ESG motivations
Besides investors, other stakeholders are pushing for boards and executive committees to pay more attention to ESG principles. These organizational leaders are also responding to the intent of many employees to ensure their work efforts and retirement savings support a healthy environment and society.
Customers are the other group that drives alignment with ESG principles, especially the business-to-business cohort that also faces calls for greater accountability. Relatedly, requests for proposals submitted to suppliers and service providers more frequently cover ESG, including questions around diversity and inclusion.
While the trend toward accountability started several years ago, a few recent developments have accelerated the focus on ESG. One is a growing consensus that climate change poses a serious and imminent threat, not only to the environment but also people's safety and wellbeing. Another is George Floyd's murder and the strong global reaction. Protests may have been the most visible response, but the trauma inflicted on the nation has led to serious soul-searching among individuals, communities and organizations.
The immediate outcome of these reckonings is greater scrutiny of companies and nonprofits. At issue is the extent to which their policies, practices and culture help promote the success and wellbeing of all their employees, following the principles of diversity, equity and inclusion, as well as their other key constituencies.
Aligning actions with the employee value proposition (EVP)
ESG concerns tend to resonate most strongly with millennials, who are now a significant share of the working population. Compared to their older peers, this generation expresses a greater tendency to insist on closer alignment between their personal values and their role as an employee. Other traits associated with millennials include the inclination to be less deferential toward their employers and other institutions, and to show more willingness to hold them to account.
In the current job market, where organizations often compete aggressively to attract and retain talent, an EVP that reflects a purpose over profit ethos can be an asset. Yet the employee experience must match the employer commitment, or it could have the opposite effect.
A recent assist for ESG from the federal government
Consideration of ESG concerns has ramped up with the transition from the Trump administration to the Biden administration. Most notably, this shift is visible in Department of Labor decisions on allowable investment strategies for employee retirement funds, and the SEC's recent move toward issuing rules requiring corporate disclosures of ESG-related activities.2
The focus of the SEC on greater transparency related to ESG will lead publicly held corporations to raise the priority status. More broadly, the Biden administration's stated intent to act on climate change favors industries and companies that are pursuing solutions. In turn, this may make them more attractive to investors.
In this reconfigured environment, ESG-related initiatives gain the attention of boards and C-suites with relative ease. HR teams also tend to recognize their value, given the positive impact they can have on employee recruitment and retention.
Applying ESG principles throughout the organization
The tallest ESG challenge remaining for leadership may be determining the best way to actively engage other groups across the organization in initiatives. A few key insights may help.
Local and global synergies
Commitment to ESG principles is a force multiplier. So teams and organizations at the forefront can inspire others to emulate them, and those that are behind the curve can learn from the leaders.
It also helps to recognize that ESG is a global phenomenon. While points of emphasis and historical context may vary from place to place, there's significant overlap and interaction on ESG concerns across countries. Organizations that operate globally will benefit from finding ways to encourage and manage ESG initiatives globally.
Ways and means for ESG success
Every organization has inroads for maximizing their positive impact on ESG concerns. Opportunities exist within their own domain and through their investments, volunteer initiatives and other means.
Almost all organizations have a carbon footprint, employ people, and use the resources of suppliers and service providers. Getting started involves identifying key vulnerabilities and points of leverage, and then designing and implementing initiatives to help address them.
There's another factor that may be the most vital. Passion counts in making a positive ESG impact. The employees who bring their hearts to this initiative also bring an enormous advantage. Encouraging them to take the lead on issues they feel strongly about is a powerful and rewarding way to tap into their energy.
When enlisting employees as leaders, it's important to facilitate effective coordination and alignment across the organization. A combined top-down and bottom-up approach, in which the organization sets overall goals and employees lead at the local level, may produce the best outcomes.
Past insights as prologue for future success
Some observers may dismiss the current ESG focus as a fad. A couple decades ago, many corporations focused on Six Sigma. It had a profound and lasting impact on entire industries, and the companies that mastered application of its principles gained a strategic advantage. While the novelty of Six Sigma may have peaked, the approach remains relevant and is embedded into expected business standards.
Like Six Sigma, approaches for ESG are less clear-cut at the beginning, but once adopted, can increase stakeholder value. A large and growing number of investors, employees and customers already believe ESG principles are fundamental to empowering organizations and societies to thrive in the coming years. If employers agree, then figuring out how to master the application of those principles should be a priority for all.
This article is part of the 2021 Q4 Gallagher Better WorksSM Insights Report: Building a Better Employee Experience that explores longer-term strategies centered on paid time off, mental health resources and hybrid work environments, as well as trending approaches for more immediate challenges like vaccination mandates and incentives.
1U.S. Securities and Exchange Commission, “Environmental, Social and Governance (ESG) Funds: Investor Bulletin,” February 2021
2U.S. Department of Labor, “US Department of Labor releases statement on enforcement of its final rules on ESG investments, proxy voting by employee benefit plans,” March 2021