Chances are, if you work in corporate America, you’ve heard of ESG. But let’s be honest – ESG is like Crypto and just because you’ve heard of it, doesn’t mean you really understand it. Let’s shine some light on this timely topic and break it down to better understand what ESG is, and what it’s designed to do.
ESG stands for Environmental, Social and Governance. As an acronym and movement, it’s been around for the last 10 years or so. It’s more visible in Europe, however, over the last few years it’s started to gain traction on this side of the Atlantic. ESG provides a framework for companies to conduct business in a sustainable, responsible, and ethical way. It’s designed to do many different things but at its heart, the goal of ESG is to help governments, businesses and investors move towards a “zero-carbon economy” by defining the disastrous economic impact that climate change will have on our global community. It’s also meant to address the social harm done when companies adopt exploitive business practices, refuse to offer livable wages or put profits before their workforce’s physical and mental health. But one of the most important parts of ESG is the emphasis on starting the process right now to ensure that this century ends with a financial boom rather than a climate-ravaged bust.
Three Core Components
The environmental component of ESG refers to policies, regulations and business practices that help off-set carbon emissions, reduce the negative impact of climate change, and protect our natural environment and resources. It requires businesses to reduce their energy usage and footprint, to curb the waste and associated pollution it produces, take a proactive stance on preservation, conservation and if applicable, its treatment of animals. For investors, the environmental component represents a yardstick to measure how sustainable an organization’s business practices are, and to evaluate how effectively that company is helping to reduce global warming and the negative impact of climate change. ESG investing is rapidly gaining popularity as shareholders become more interested in putting their money into ventures that help preserve, rather than harm, the planet.
The social aspect of ESG primarily looks at business relationships. Do companies put profitability over the welfare of their workforce? Do they offer livable wages and equal opportunity? Do they give back to local or regional causes? Does a company do business with partners that share the same social values? This aspect is particularly critical in the US because there are regions that are reliant on things like coal and oil to keep their local economy afloat. The challenge we collectively face is how to convert these regions into carbon-neutral hubs without exposing the inhabitants to financial ruin. For businesses, the social aspect is a highly visible and growing part of its overall ESG strategy. Action and transparency are what’s needed moving forward and that’s where the last part of the ESG equation comes into play.
The governance element of ESG is primarily focused on creating consistent action, results and transparency. For governments, this means being very clear about key milestones and targets that businesses must meet on the way to a carbon-neutral future. And how they plan to offset the short-term losses to regions that are not ready for the transition to a greener economy. For businesses, it’s about ensuring continuity of action and top-down buy-in and commitment to an ESG plan. ESG investors look for this kind of commitment in actions, not just words.
ESG Emphasizes Profitability
Another focal point of ESG – and this might sound counter-intuitive – is the emphasis on money and profitability. Did you know that in 2021 alone, the US experienced 20 distinct weather and climate-related disasters that each totaled over $1 billion? That’s $20 billion worth of climate-related damage in a single year. Who pays for all of that damage to be repaired? You and me, that’s who. Looking forward fifty years to 2070, if we do nothing about climate change and sustainability, the US economy is projected to lose $14.5 trillion due to climate-related issues and reduce our nation’s GDP by 4%. Translating that into more personal terms, over the next fifty years, each American will lose the equivalent of $70K of lifetime income. For the median American working family, that’s like losing an entire year of earnings.
On the other side of the coin, the economic benefits that are created by acting now to address climate change are overwhelmingly positive. Instead of seeing a shrinking economy, positive action now could add $3 trillion to the economy over the next 50 years. By 2070, ESG-driven change could increase the US GDP by 2.5%. In fact, in the year 2070 alone, the US economy could gain $885 billion in ESG-related revenue. ESG takes a realistic view of what it will take to motivate governments, businesses and investors to think and act differently by using the classic stick and carrot approach. The negative financial aspects of climate change represent the stick, while the amazing, undeniable financial gains created by acting now represent the carrot. If you’re a business interested in remaining profitable over the long-term, it’s a no-brainer.
Moving ESG Forward
You might wonder who is leading the ESG charge. To date, it’s largely been driven by government, through legislation and policy changes. While our government has delivered all the right messages, it’s naïve to think it will solve this problem for us. ESG requires collaborators who can partner with rivals for mutual success. But that’s not our current political environment, which is highly divisive and partisan. Instead, government is best suited to play the role of enabler. Look at the development and distribution of the COVID vaccines for how effective it can be in this role. The U.S. government accelerated research by providing funding and committing to purchase vaccines once developed, and then let business lead the charge.
Nearly every business has a tremendous amount to gain by getting their ESG action plan right. If the US could partner with the G7 to create a coalition tasked with bringing ESG change to life, it would be a game-changer. In fact, a coalition like this might serve to satisfy both sides of the political aisle by delivering a focus on environmental and social issues to satisfy the left, while empowering business over government to satisfy the right.
But success will require more than just a coalition that unites disparate political views. It will require businesses to embrace behavioral change. This change starts at the top with boards and CEOs leading the charge in a highly vocal and visible way. It will require restructuring and realignment. The good news is that behavioral change is possible and the effects it can produce are powerful.
While this all sounds great, let’s be realistic – is this type of radical transformation truly possible? Yes, it is. Take a look at Ford Motor Company if you need an example. They’ve done a great job reorganizing vertically, innovating their supply chain and factories to make EVs the foundation of their success and setting themselves up to become a battery producer for electric vehicles. Was it easy? No. Will there be bumps along the road? Yes. Will it radically improve the company’s financial future? Absolutely.
How You Can Help
What’s the best way for businesses to get involved in ESG? Focusing on actionable, short-term change is a great place to start and an effective approach is to begin with an organizational inventory. Ask some fundamental questions about your organization:
- You can’t manage what you don’t measure – what ESG-related data do we have available and how can we leverage that data to help us define what our ESG exposure and risk is over the next 10 years? How can we use the next 10 years to develop more focused and actionable ESG-related data that will help us fine tune our approach over time? Understanding how you will measure and make incremental progress is a critical component of any effective ESG approach.
- Actions speak louder than words – what is our ESG action plan? What steps are we taking to put this plan into action? And how is our performance relative to our stated milestones and goals? Defining what steps you are going to take to build a sustainable, carbon-neutral business model is the foundational element of an effective ESG plan.
- Just do it (right now) – how can we get started on our ESG journey today? How will we guide and govern this ESG action plan over time? How will we ensure that our organization remains committed to achieving its goals and objectives? How will we create transparency with partners, shareholders and customers and report on our progress over time? Success in this area will involve defining how your organization approaches and practices ESG and mapping out the participants involved every step of the way.
ESG is poised to rapidly become a touchstone of success in corporate America and Wall Street. It represents a rallying cry for businesses who want to remain profitable yet take a proactive stance on climate change and the inevitable financial ruin it will produce if left unabated. It provides investors with a framework to gauge how committed an organization is to creating a world free of fossil fuels and other toxins that harm our environment. And it provides our government and political leaders with a platform that can be used to unify and focus the efforts necessary to combat climate change. The only question left to ask yourself is how you and your organization can become a part of the solution and get started right now.