Exploring the Social Pillar of ESG  

Over the past two decades, the scope of ESG’s Social pillar has broadened considerably, reflecting technological advances and businesses becoming more interconnected. While all three facets of ESG are intertwined, Social remains important for investors who prefer to avoid businesses with poor human rights records, violations or questionable political ties. Therefore, organisations with a strong social performance underpinning their overall ESG score will offer investors much greater confidence that goodwill is involved, that risks will be avoided and that mutual values are aligned.

The environmental and governance pillars of ESG are primarily focused on an organisation’s impact on the planet and its internal or political functionality. Social, however, is more concerned with relations between a company and people as well as the institutions around it. Understandably, the Environmental aspect has been at the forefront of the ESG movement for years due to the challenges facing the planet and the urgent need for action.

Social has lagged behind, particularly as the pillar has proven difficult to define while the reporting process has been a laborious undertaking for some organisations. Nevertheless, it remains critically important and it can make a major difference to the level of trust placed in an organisation, especially when it comes to attracting socially conscientious investment. Just take people as a core argument.

People are central to business success and the way they are treated by organisations is coming under increasingly heavily scrutiny. One employee, customer or supplier who has been badly treated can create a major backlash against a company that results in a tarnished reputation or serious financial losses. Given those risks, these are some of the key aspects of ESG’s social pillar that should be kept in mind: 

Company relationships matter, whether that involves employees, customers or suppliers. For example, a company failing to pay its staff at the same level as competitors will struggle to attract the best talent with prospective applicants likely to apply elsewhere. Likewise, a high level of employee turnover will indicate a lower level of employee satisfaction. A content workforce typically performs better while continuous new hiring can have high financial costs. Poor customer service can also prove detrimental and lead to loyal clients taking their business elsewhere, resulting in lower revenue. The same goes for suppliers who may become less inclined to support a business if they are treated or paid poorly, leading to difficulties sourcing material, higher costs and extra work to rebuild trust.

Community relations refers to how a company benefits or harms the surrounding community. For example, there is a crossover with diversity and inclusion when a company proactively recruits its employees locally. Additional instances include organisations partaking in community philanthropy efforts or investing in local infrastructure projects. Sourcing local products also represents a measurable attempt to improve a company’s community relations.

Some of the most successful organisations have placed gender equality, diversity and inclusion at the heart of their operations and they have been shown to boost innovation and empathy while empowering employees from marginalised backgrounds. Companies embracing these values and striving to implement an inclusive culture are more likely to engage in ethical sourcing, champion equal opportunities, implement fair wages and introduce flexible working arrangements. This in turn attracts the best talent.

Gender-diverse boards and greater female leadership in general have been shown to improve investment efficiency, result in better engagement between board members and lead to greater discussions on both social issues and climate change.

It is also important to mention that strong gender, diversity and inclusion strengthens all three facets of a company’s ESG operations. Diversity among employees leads to greater awareness of environmental issues and the strategies required to solve them. Organisations actively recruiting from a range of ethnic and social backgrounds experience higher levels of employee inclusion, satisfaction, and ultimately, loyalty. This usually leads to a higher score in the S component of ESG. Finally, gender diversity, a healthy speak-up culture and a corporate style embracing equal pay and opportunities results in a greater performance in the Governance pillar.

Human rights form a critical aspect of the social pillar, and it is important for companies to prioritise and address this issue. A series of UN conventions and agreements define human rights and the term remains very broad in scope for businesses. There are some helpful resources for companies when it comes to respecting human rights, however, such as the UN Guiding Principles on Business and Human Rights. They contain ten principles obliging states to protect human rights and fourteen dealing with the corporate social responsibility to respect them.

The repercussions for companies failing to observe and respect human rights are very real. Once again, a poor record in this area can destroy long-built reputations and prove financially catastrophic. Compliance can be challenging with regards to human rights given that a company cannot always thoroughly vet a partner organisation that is later exposed for violations. Building an ethical culture and sustainable business model with solid anti-corruption measures in place goes a long way towards upholding human rights. Investors also find such an approach appealing and it can also help increase a company’s value.

Investors are giving increasing attention to corporate political affiliation and contributions. This is one of the most publicly identifiable aspects of the social pillar and it has a long history. More and more investors are demanding that companies align their political activities with preferred causes and this has led to greater pressure for organisations to undertake some form of political disclosure.

The consequences of misalignment on political issues can be severe. Reputational damage would occur if a seemingly sustainable company made financial contributions to a politician who denies climate change exists. The same goes for an organisation working with a government guilty of serious human rights abuses.

Real-word examples of this could be seen when companies suspended donations to political candidates in the US in response to the events at the Capitol in January 2021. A long list of Western companies such as McDonald’s and Ikea ceased operating in Russia in response to the invasion of Ukraine in February 2022 while organisations failing to take that step were called out.

All companies have supply chains though they vary in scale and complexity depending on the size of the organisation. The issue has become increasingly relevant and the subject of greater scrutiny given that an estimated 80% of global trade passes through supply chains. In some parts of the world, obligatory reporting requirements are being introduced and it is becoming more important than ever for business leaders to understand supply chain risks.

While outsourcing production to a country with cheaper labour may result in a cost saving, it also creates a far more complicated supply chain that is exposed to far greater risk without effective management. The risks are numerous and can include the following:

• Bribery and corruption
• Shortages of raw materials and natural resources
• Labour and working conditions
• Environmental pollution 
• Increased regulatory requirements 
• Technical quality and reliability  
• Speed of delivery  

If such risks are not managed correctly, the entire supply chain can be disrupted, leading to negative media coverage and reputational damage as well as a loss of trust among both investors and customers. Ultimately, that can result in reduced sales, a loss of access to capital and a failure to attract the best talent.  

It can prove challenging to influence the supply chain but best practice involves mapping risks thoroughly, understanding them and then making the decision about how to best address the problems. It is also helpful to implement key performance indicators to ensure suppliers also fully understand the risks, while obtaining the skills to mitigate them. Further mitigation strategies include a code of conduct in supplier contracts and collaboration with both the regulatory authorities and industry peers.  

Effective supply chain management is becoming more important as new laws are being introduced that can hold companies liable for violations. Under EU law, large companies operating in the bloc are set to be held responsible for environmental violations or human rights abuses committed in their supply chains through new corporate social responsibility (CSR) standards. As a result, CSR management will become increasingly important and businesses will have to introduce regulations to detect, prevent and mitigate any violations with financial penalties defined by legislation such as the Corporate Sustainability Reporting Directive and by respective national governments.