Every business is deeply intertwined with environmental, social, and governance (ESG) concerns. It makes sense, therefore, that a strong ESG proposition can create value. For years corporate leaders have acknowledged that business should play a role in addressing urgent challenges like climate change and cybersecurity. But for all their good intentions, these executives have also recognized that ESG matters are a secondary concern for their biggest investors. Executives may want to manage for the long term, but they believe that the market demands they keep their eye on quarterly results.
The movement to reform capitalism has seen a wave of converts in recent years. The Business Roundtable, representing CEOs from some of the largest companies in America, issued its Statement on the Purpose of a Corporation in the summer of 2019. This act signaled their alignment with a broad coalition of entertainment and business leaders seeking for capitalism to better serve society and the environment, in addition to shareholders. Investors with $100 trillion of assets under management have signed on to the United Nations Principles of Responsible Investment, which advocates for a greater focus on ESG issues in investing.
In order to meet the ESG opportunity, a comprehensive data strategy is required to effectively understand and measure how ESG impacts your organization. The legal operations function is critical to the success of these initiatives due to both its capacity to identify risk and the growing use of AI applications across litigation, investigations, and the proactive monitoring of live communications data. However, none of these initiatives will succeed if the organizations overall data strategy lacks alignment. Communication and collaboration between business functions is essential given the nature of the opportunity. Just as ESG is an inextricable part of how you do business, its individual elements are themselves intertwined. For example, social criteria overlaps with environmental criteria and governance when companies seek to comply with environmental laws and broader concerns about sustainability.
- E (environment) criteria includes the energy your company takes in and the waste it discharges, the resources it needs, and the consequences for living beings as a result. Not least, E encompasses carbon emissions and climate change. Every company uses energy and resources every company affects, and is affected by, the environment.
- S (social) criteria addresses the relationships your company has and the reputation it fosters with people and institutions in the communities where you do business. S includes labor relation and diversity and inclusion. Every company operates within a broader, diverse society.
- G (governance) is the internal system of practices, controls, and procedures your company adopts in order to govern itself, make effective decisions, comply with the law, and meet the needs of external stakeholders. Every company, which is itself a legal creation, requires governance.
To do better, we can’t just develop increasingly precise measures. Many ESG measures already very effectively capture inputs, but they presume causality – that adding women to top management teams, say, will produce better outcomes. But measures that capture inputs (such as the number of women on those teams) don’t capture outcomes (such as decision-making that reflects diverse perspectives) and impacts (such as the social value created by such decisions). Better reporting and data governance practices must be incorporated into the broad ESG strategy in order to visualize the impacts as they occur. The demand for a smarter, more socially conscious form of capitalism is a momentous shift in corporate thinking, and its success can only be achieved if the demand for better corporate practice remains. This is key area where legal innovation can provide value beyond its historical purpose as a cost function. ESG links to cash flow in five important ways: facilitating top-line growth, reducing costs, minimizing regulatory and legal interventions, increasing employee productivity, and optimizing investment and capital expenditures.
A strong ESG proposition helps companies tap new markets and expand into existing ones. When governing authorities trust corporate actors, they are more likely to award them the access, approvals, and licenses that afford fresh opportunities for growth. ESG can also drive consumer preference. Customers are willing to pay to “go green.” A stronger external-value proposition can enable companies to achieve greater strategic freedom, easing regulatory pressure.
Strength in ESG helps reduce companies’ risk of adverse government action. It can also engender government support. Regulation’s impact varies by industry. For pharmaceuticals and healthcare, the profits at stake are about 25 to 30 percent. In banking, where provisions on capital requirements, “too big to fail,” and consumer protection are so critical, the value at stake is typically 50 to 60 percent. In addition, a strong ESG proposition can help companies attract and retain quality employees, enhance employee motivation by instilling a sense of purpose, and increase productivity overall. Employee satisfaction is positively correlated with shareholder returns. It’s long been observed that employees with a sense not just of satisfaction but also of connection perform better. The stronger an employee’s perception of impact on the beneficiaries of their work, the greater the employee’s motivation to act in a prosocial way.
Global sustainable investment now tops $30 trillion – up 68 percent since 2014 and tenfold since 2004. The acceleration has been driven by heightened social, governmental, and consumer attention on the broader impact of corporations, as well as by the investors and executives who realize that a strong ESG proposition can safeguard a company’s long-term success. The overwhelming weight of accumulated research finds that companies that pay attention to environmental, social, and governance concerns do not experience a drag on value creation – in fact, quite the opposite. A strong ESG proposition correlates with higher equity returns, from both a tilt and momentum perspective. Better performance in ESG also corresponds with a reduction in downside risk, as evidenced, among other ways, by lower loan and credit default swap spreads and higher credit ratings.
So how do we ensure that companies follow through on their commitments? Companies should be required to publicly report on their ESG impact with clear metrics. Organizations that align their ESG strategy with enterprise data intelligence initiatives will reap the rewards of a more environmentally and socially conscious market. More broadly, the opportunity at hand is one where individuals from a variety of business functions can find greater meaning in their work. An engaged and fulfilled workforce is one that can meet these challenges and succeed.
