Factors that go beyond the bottom line are increasingly important in how companies conduct business. Today, organizations must consider the impact that they have on the environment and society at large, as well as how they govern themselves. Taken together, these components comprise ESG (Environmental, Social, and Governance), a collection of measurable standards that companies are navigating to monitor and demonstrate the value that they create to a broader group of stakeholders beyond traditional financial measures.
Performance in this space is critical for attracting potential investors and insurers, as financial institutions are drawn to firms that take responsibility for their impact on society and the environment. Increasingly, clients ask us how to improve their ESG profile. In response, we developed methods for implementing and reworking existing technology strategies, all of which enable real impact.
To learn more about the current ESG landscape and the concerns that companies have about speculative requirements, we spoke with Eric Chambers, Head of Solutions Consulting, here at TheoremOne.
What does ESG mean for companies, broadly speaking?
Eric: Bigger picture, it's about greater accountability for companies to demonstrate the value they create, and not only to their financial shareholders. We're focused on societal and multi-stakeholder impact as a measure of success and contribution that companies provide. I like to think of it as a re-imagining of what people have traditionally thought of as reporting for the sustainability, impact, and corporate social responsibility contributions of a company. Historically, companies would report on their impact with selective, non-financial information, and rigorous standards and practices for impact reporting were not well developed. Now, given that climate change is arguably the biggest threat modern humans have ever faced, there's tremendous pressure to standardize reporting through ESG audits of companies and their non-financial impact reports. To some degree, there is a public call to increase transparency on the adverse effects that companies place on society through operations.
Is there a framework for measuring this impact?
Eric: The World Economic Forum has already established a relevant framework that they call “stakeholder capitalism.” Many companies have committed to being transparent and accountable beyond just financial measures. I've noticed that major management consultancy and professional services firms—like McKinsey and Boston Consulting Group—have established ESG strategy practices, which are driving a well-deserved focus on ESG accountability and strategy formulation in the largest global firms.
It's something that everyone is taking very seriously. It's also a strategic corporate priority. A lot of companies are being told from the top down by C-suite executives that they want to make ESG transparency and reporting a top priority in the next two years and beyond.
What are the measurable ESG criteria? Are they universal, or do they adjust based on industry, size, or other factors?
Eric: There's no one-size-fits-all to developing an ESG strategy or reporting framework within companies. And part of that is because there hasn't been a set standard for ESG regulation, but it's in the works between a consortium of compliance bodies and standardization organizations. Much of it is contextual, so it depends on your industry and regional jurisdiction. I've been on many calls where executives have asked me, "Okay, well, how am I going to be able to assess where I stack up on ESG relative to other global companies?" That's wishful thinking at this nascent stage since comparable cross-industry data and rankings aren’t available yet. It is a work in progress at the moment.
My recommendation is to rapidly develop a path towards making sure that they are in the best position to assess their data sources and information systems to support ESG reporting expectations for their industry and global region. So if your operations are based within the European Union, your company is prioritizing regulations and standards aligned with European Union environmental, labor, corporate governance, and other reporting and regulatory requirements. If your company’s operations are based in the U.S., you’ll need to align with different expectations.
Where do you begin?
Eric: The starting point is metrics. How do we measure these companies and the positive or negative impact that they provide to society and their stakeholders? Stakeholders are more than shareholders; they include employees, suppliers, partners, customers, and others who are a part of the company's ecosystem. An evaluation of existing metrics that are identified and managed, as well as a prioritized set of ESG-related metrics, helps formalize, reevaluate, and focus on what corporate leaders should focus on to improve upon their impact on social good.
Tell us about some of the specific expectations. Let’s start with the environmental concerns.
Eric: I think a great way to look at it is how quickly companies can reduce the adverse effects of energy or environmental impact from their operations and supply chain management. The biggest way that a lot of companies have been messaging this is through their commitment to creating a net-zero future. There are many metrics tied to that, and that's a normative approach. It's an approach that companies should be doing. And now there’s pressure from public opinion, less so from regulators. Regulators are primarily concerned with operational issues such as chemical usage, raw material selection, and companies’ disposal processes.
Also, there are greenhouse gas emissions metrics that are heavily tracked. It's not good enough just to say that your operations are green. You need to be aligned with suppliers that also run green operations and practice ways for improving their sustainability efforts. As a company, you also have to have the ability to see if a supplier does not operate with sustainable operational practices. Companies must have the courage to part ways with suppliers and to tell them, "Well, you don't meet the standards of our supplier ecosystem for sustainable operations. You will have to improve your practice and demonstrate that you have rapidly made changes. Otherwise, we will have to look to partner with firms that demonstrate the same values and practices of sustainability that we have committed to." That's the expectation in a greener, sustainable supply chain.
What are some of the measurable social criteria?
Eric: These include protections for stakeholders—such as employees—including diversity, hiring, and a solid commitment to safety for a company’s workforce. When it comes to outsourcing labor, companies are asking, “Are we involving suppliers that are free and clear of modern-day slavery practices within their labor pool?” Also, while physical protections against occupational hazards impacting employees are important and obvious, a great concern and interest to us is monitoring mental health issues and supporting improved well-being of client employees through solutions that enable reporting related to depression, anxiety, and related worker productivity.
So, some of the protections are more obvious than others?
Eric: Absolutely. For example, it's clearly important to monitor and address incidents of accidents and casualties when you're in mining operations, heavy machinery, or construction—but that's a very, very low bar. Reporting and monitoring employee mental health—depression, anxiety, substance abuse, drug addiction—is increasingly being viewed as a grave concern during the COVID-19 pandemic.
To track this, you should consider integrating HR systems, which may include healthcare plan data. To a great degree, there has to be active collaboration between employees and the companies to provide some insight into the state of their well-being, as well as the company gathering relevant healthcare- and HR-related data, while having a strong adherence to data privacy considerations. After establishing a foundation and assessing data integration readiness, follow-on evaluations on worker productivity impact, operational costs, and contribution to the company can be clearly reviewed.
I'm currently speaking with teams to evaluate levels of depression and anxiety through a multitude of sensor-based technologies and surveys, and we are also defining employee happiness within our evaluation models. Many indicators address employee burnout, and there are applications that can be considered for measurement and integration within these solutions.
What about issues of diversity, equity, and inclusion? Do these fall under the social umbrella?
Eric: Yes. This first starts with rethinking what employee diversity means to the company. I think, at least in the United States, we think of diverse workforces being tied to common definitions of race, ethnicity, and gender. In technology companies, what I’ve seen is a strong interest to hire on sexual orientation, gender identification, religion, and other areas of non-traditional definitions of diversity through values and beliefs. Leading technology and innovative companies take an expanded definition of employee diversity very seriously, and I’ve seen first-hand how this positively impacts our teams in problem-solving and creative approaches to solution development for our clients. It’s core to why companies hire for employee diversity—to have resulting diverse perspectives. Companies should strive to have diverse modes of thought and diversity in thinking within their organization at all levels.
A second consideration is finding new channels of sourcing diverse hires. There's something that hasn't been deeply discussed within the movement towards ESG monitoring and reporting, which is how our existing systems are unfortunately biased against diversity hiring enablement. Most companies bypass qualified candidates due to the automation rules already established in our resume filtering software systems. Our recommendation systems and recruitment tools overlook potential diverse hires that could add tremendous value to our teams that are not included in our hiring processes.
Do any of these social considerations overlap with governance?
Eric: Some do, but the basis for corporate governance is tied heavily to guidance from the Security and Exchange Commission (SEC), the Sarbanes-Oxley Act (Section 404) established by the Public Corporation Accounting Oversight Board (PCAOB), Committee of Sponsoring Organizations (COSO), and International Financial Reporting Standards (IFRS) governing bodies. An example of one area that requires further expansion is greater transparency on executive compensation.
It doesn’t look good if, at the worst of times, we're seeing the income wealth gap increase dramatically across the United States and other countries while press releases from companies frequently make statements that they believe and invest heavily in their employees and that their people matter the most in the success and growth of their organization. At the same time, we’re seeing profound increases in the difference between executive compensation and average employee compensation. Put simply, that data doesn't support the message.
What else are companies addressing besides pay transparency?
Eric: The complexity surrounding ownership of holdings by executives is crucial. You may have executives on multiple corporate boards, on direct parent companies or subsidiaries, and there might be conflicts of interest that are not transparent or going unchecked. You have to review, through in-depth research, multiple filings to find out how relationships of executive management and board members within a corporate governance structure actually work and what it means for biased decision-making. Once you untangle most of it, you may find issues where decisions are driven by incentives that aren’t optimal for the broader set of organizational stakeholders.
Finally, what are companies most wanting help with?
Eric: First, they often ask, “Are we measuring the correct metrics according to ESG standards and policies?” and “Are we measuring what matters most for our company?” If companies are not measuring what they should be, then they can't manage improvements in their sustainable operations and investment practices.
And the follow-on questions usually include, “Are we doing well on ESG as a company in comparison to other companies in our industry and other leading global firms?” The first priority is to ensure that data access and measurement is either already established, underway, or planned for. Companies contact us at varying degrees of strategic and implementation readiness. The degree to which a company is further along on the ESG reporting and monitoring maturity curve often requires our team to assess what data are already collected, accessed, and aggregated. We also explore the means by which data can be integrated to generate robust sustainability and impact reports that are ready for scrutiny by ESG audit practitioners.
Clients tell us they’ve been speaking to strategy consulting firms, professional services firms, and even to lawyers with expertise in environmental and governance law—all with the aim of understanding what they should tactically implement in preparation for formal ESG reporting audits. Many haven't received actionable plans around metrics frameworks nor technology strategies for implementation.
There may not be solid regulations other than specific pieces of industry-specific information, but it seems like that's the direction where ESG is heading. So, everybody needs to prepare to have those systems in place for when that happens, rather than scrambling once there's some new regulation or metric system put in place. Is that where we are now?
Eric: That's right. The World Economic Forum has established a starting point, but it's not prescriptive to the degree to formulate a strategy that is right-sized for the custom needs of most firms. Upon defining a custom metrics framework, firms can start integrating systems and making sure that all of the data are pulled into a unified location for processing and presentation. ESG strategy and technology teams must constantly stay abreast of the dynamic landscape related to the expectations, compliance, standards, policies, and requirements that impact your company’s industrial, operational, and regional context. You would need to build agility into your systems at any given year upon finding out that there's a new regulation or policy guideline. Your systems and teams have to be ready to adjust reporting requirements to generate ESG and impact reports to stakeholders more frequently than on an annual reporting cadence.
What do you offer clients right now?
Eric: TheoremOne offers digital product and technology strategy, data integration advisory, and solution implementation services that complement the ESG and sustainability reporting plans of our clients. We share our perspectives beyond ESG strategy services offered by large professional services and consulting firms. We focus heavily on ensuring that our clients have readily evaluated the data sources, systems, and architecture. We also advise these clients on developing a metrics framework that is aligned with their ESG reporting needs at a variety of levels in their organization. Our approach to metrics framework design is customized to the context of the business, regulatory and compliance requirements, and relevant standards and policies driving ESG reporting over the coming years. Additionally, our solution delivery teams focus on building integrated solutions that are both flexible to changes in ESG reporting policies and durable through the use of modern platform tools and services. We provide these services across all industries and our clients often begin with a consultation session with one of our ESG technology advisors.
Key Takeaway
ESG strategy formulation and solution development have become primary objectives for global organizations in recent years. With it comes a demand to effectively communicate the sustainable impact on operations, supply chains, and financing. ESG measures contribute directly to an organization’s risk management profile, sustainable operations, strategic planning, and impact goals.
Companies need to accelerate their efforts in preparing for ESG audits and reporting requirements by assessing their technology strategies, disparate systems, and the ways in which they collect and act on non-financial data. This allows an organization to clearly present and govern its sustainable impact efforts against sustainable development goals and expectations.
