Will ESG solve the world’s problems?
Should companies be responsible to deliver value from areas beyond their core business operations - and deliver broader impact? Or, should that be the focus of impact-oriented entities? I was asked this question by a management team and I want to share my general thoughts in this short post.
As much as it is hyped up, I believe ESG will make limited progress against society’s broader challenges. However, it will speed up the spread of awareness about the positive and negative impact of business on people and the planet.
The scene is riper compared to past cycles of hype, such as SRI and CSR eras. The power of social media and the already heightened sensitivity among general public due to high profile social in(justice) events, coverage of devastating climate incidents will push awareness and increase expectations on business operations to focus more on their impact well beyond ESG measures.
It is widely accepted that the financial and technical capabilities of impact-oriented entities that are not-for-profit are not sufficient to solve environmental and social problems. The limitations of the capabilities of such entities prolongs the existence of environmental and social issues, particularly of those caused by business. And this creates increased risks for both investors and businesses alike. Furthermore, certain sectors (such as fossil fuel-based sectors) and business approaches (such as paying minimum wage and not living wage) are viewed as the culprits of increasing environmental deterioration and exacerbating social problems, such as growing income inequalities. These convictions are spreading and becoming stronger, and all of this is speeding up the expectation that business can do better to mitigate society’s broader challenges.
In the impact world, every business has a place on a spectrum between finance-first and impact-first. Businesses will need to realign their operations, products, and procedures to improve their appeal and manage their risks. As such, the question “Should companies be responsible to deliver value from areas beyond their core business operations - and deliver broader impact?” is already answered by the market in an affirmative way.
The key difference between ESG and impact investment is that, impact investment actively expresses an intentionality to make a positive change on a measurable outcome. Whereas ESG is viewed as a macro level risk monitoring and mitigation approach. It is the change on that outcome that is widely defined as an impact. And this change is often linked to a business’s contribution towards the achievement of an outcome related to one of the seventeen Sustainable Development Goals (SDGs).
There are three main categories of impact that result from such a change on an outcome: (a) reduction of a harmful approach (i.e. reduction of carbon emissions in an given operation), (b) improving something by doing better than what is required or the norm (i.e. paying higher than minimum wage to improve livelihoods or equality), or (c) contributing to solutions (i.e. usually related to SDGs, such as innovating a plant based product that replaces plastic). Such approaches would rank high on ESG standards, but are not expected of companies that claim to have great ESG performance. One could say, ESG is “watching out for not doing bad”, and impact is “intending to do good”.
Taking ESG reporting a step further, numerous initiatives are underway to incorporate a business’s impact into a business’ financials. A leading example of this is the Impact Weighted Accounts Project at the Harvard Business School, led by Sir Ronal Cohen. The Project so far has looked at employment, operational and product impact. The team has created a calculation methodology that allows for comparison between different companies in financial terms as opposed to social or environmental norms. Sustainability Account Standards Board (SASB), International Sustainability Standards Board (ISSB) and other international bodies are working on similar disclosure and calculation methodologies, indicating that ESG move is very likely to go beyond self-assessment to a standardized and required approach that encompasses impact.
The question “should companies be responsible to deliver value from areas beyond their core business operations- and deliver broader impact” is looking at the issue in the old corporate social responsibility fashion, adding impact as a side-car to business operations. The real expectation from businesses, increasingly, is that they incorporate impact into their business practices and as such transform their businesses into an operation that generates benefit/reduces harm for all stakeholders through its core business.