Understanding the Rise of ESG – What Business Leaders Need to Know
In just the past year, searches in Google for “ESG” have more than doubled. If you’re a business leader who has not yet become acquainted with this trending acronym, you should get to know it. For those already familiar with ESG, you’re likely wrestling with it in different ways – namely, how to approach it and what it means for your business. Below, we take a look at what ESG is and why business leaders need to understand and address it.
What is ESG?
ESG stands for the Environmental, Social, and Governance factors associated with business operations and asset management and represents the three pillars of sustainability. While definitions for sustainability may vary from person to person, the 1987 Brundtland Report to the World Commission on Environment and Development framed it as meeting the needs of the current generation without compromising the ability of future generations to meet theirs.
Although ethics-based, values-based, and responsible investing and operating approaches have been around in various forms and to varying degrees for hundreds of years, the term ESG was born of the World Bank’s 2005 Who Cares Wins Conference, which brought together a wide range of global finance professionals, research analysts, government leaders, and regulators together to examine the applicability and role of ESG.
Why is ESG Important for Businesses?
Some think of ESG as the proper balance of people, profits, and planet in a company to achieve sustainable growth. The ability to maintain that balance is certainly a strong indicator of an organization’s long-term success. Businesses should also embrace ESG initiatives because strong ESG performance is becoming increasingly important to consumers, investors, and other key stakeholders.
Consumers are showing that ESG considerations are influencing their buying decisions more and more. This PWC review of ESG factors finds that consumers are more attracted to brands that live up to a purpose and values they can get behind. In 2019, approximately one-third of consumers demonstrated a willingness to pay 25% more for sustainable products. Research also shows that Gen Z (32% of the global population) is willing to pay more than 50% higher prices for sustainable products and services. This is not a passing trend.
Investors are also placing greater focus on ESG as a factor in what they put their money behind. They look to metrics like the SRI (Socially Responsible Investment) Score and a host of other indicators, such as whether the company has an ESG policy in place, any past legal issues associated with ESG factors, and specific attention to business ethics.
They focus on ESG because, as a McKinsey study points out, “paying attention to environmental, social, and governance (ESG) concerns does not compromise returns—rather, the opposite.” Key factors cited include an increase in top-line revenues via new market segments, expense reduction through resource and process efficiency gains, government and community subsidies and support, and better utilization of capital with long-term investments.
Are DEI Initiatives a Part of ESG?
DEI (Diversity, Equity, and Inclusion) is indeed an important factor when it comes to ESG, especially for the Social and Governance components. American Century Investments notes that they factor DEI into their investment analysis because they “ believe companies lacking transparency in this area or trailing their peers’ DE&I efforts may see negative impacts to their long-term competitiveness, brand reputation or financial condition.” Among other things, they examine organizations’ policies, attrition rates, hiring practices, and formal DEI practices. They also look for diversity across all levels of management and, for one, immediately flag companies with no women on their board of directors.
As we detailed in a post on Diversity and the Bottom Line, diverse organizations have better visibility into a broader array of community and environmental issues, tend to be much more transparent, and are better able to avoid and address conflicts of interest. This, in turn, leads to good governance and improved risk mitigation. DEI also supports better decision-making, higher profitability, and long-term sustainability for organizations.
ESG Excellence Means Better Business
To paraphrase former Unilever CEO Paul Polman, companies can actually profit from solving the world’s problems, instead of creating them. ESG provides a framework that organizations can apply to achieve this aim. And in case the statistics cited thus far haven’t yet convinced you of ESG’s merits, consider this study point from John Hancock which notes that “solid ESG practices resulted in better operational performance in 88% of companies, the stock price performance of 80% of companies was positively influenced by good sustainability practices and lowered the cost of capital of 90% of companies, and companies with strong sustainability scores showed better operational performance and were less of an investment risk.”
In an upcoming post, we’ll focus on how to start an ESG program that aligns with operational goals. In the meantime, contact us with any ESG questions you may have. We’re here to help.
vcfo is a professional services firm making companies stronger by bringing the wisdom and experience of senior level Finance, HR, and Recruiting executives to each client engagement. Our team of consultants guides CEOs and business owners in making strategic decisions, optimizing operations, and providing people support. If you want to learn more about enhancing your operations by starting an ESG program, please reach out to our team for a consultation.
Since 1996, vcfo has supported more than 5000 clients nationwide with offices in Austin, Dallas, Denver, and Houston. It has been our privilege to work with many great teams in our 25 years.