More Personalized ESG Standards Can Pay Off for Companies

By design, environmental, social and governance (ESG) standards should correlate with long-term performance and financial health by limiting operational risk. They are intended to encourage companies to act responsibly, preserving the planet and promoting a future-forward focus with social and environmental oversight.

However, ESG reporting lacks a clearly defined process providing guidance for improvement leaving companies confused on how to better their scores. As a result, ESG can become just a reporting exercise.

Often, ESG is distilled into a single number, which shifts an organization’s focus on moving the dial rather than understanding the components. Filling the gaps to reach the necessary number is like striving to get a perfect 10 in gymnastics without mastering the basic routines.

To be effective, ESG could become an integrated strategy that produces results, but instead it feels disjointed and disconnected from business priorities.

Multiple Masters

Instead of aspiring to reach a score, companies should develop long-term ESG strategies that will improve their performance and benefit society. Simply put, not all companies can or should have the same targets. ESG should be personalized, with meaningful achievable results. However, investors have distilled ESG into a predictive model based on performance and profitability, with the values of sustainability/environment and inclusion/social impact factored in for good measure.

Because environmental and social factors are not universally applicable, they can seem extraneous. In fact, these factors influence performance negatively when they are mishandled. The value of setting correct environmental and social milestones and measures has been poorly articulated.

It makes sense to large manufacturing companies, but leaves smaller companies, especially those who trade in intellectual capital, stumped as to how to demonstrate their environmental and social focus.

Use as Intended

ESG should not be a one-size-fits-all metric combining environmental and social impact with governance. Governance is and should be a universal standard, requiring that companies (1) act ethically with integrity, eliminating discrimination from their hiring and sourcing practices, and (2) provide transparency.

This ESG factor seems to get the least attention, especially when environmental and social concerns grab headlines. Many people just assume all companies already have proper governance and policies in place. Yet, many smaller companies operate on a handshake and across-the-board business principles, operating manuals may not always be maintained, and employees may not receive appropriate training.

ESG governance should encourage businesses to develop a structure that eliminates bias and requires maintenance of standard operating procedures. All too often, lack of governance is discovered after there has been a security breach or fiscal impropriety — when it is too late. 

The underlying problem is that ESG scores are calculation-based submissions, requiring companies to self-report by submitting documentation. But having written documentation and required training does not guarantee they are being adhered to.  

ESG standards should require companies to demonstrate that practices are in place, and they are being followed — compliance is key. ESG measures should be based on results of testing, validating that companies have the appropriate safeguards in place and that their governance works, showing how threats are being monitored and processes updated.

Lastly, ESG should drive continuous improvement. These validations can be conducted by artificial intelligence (AI), with remediation required. This will elevate governance to become more than a number, evolving it into a business practice.

The Value of ESG

The underlying issue with ESG is that it is seen as a collection of metrics that are difficult to gather, self-reported and unaudited. Companies are encouraged to develop the information requested, but the documentation may not be appropriate to their business. Instead, ESG inputs should be specific for each organization, focused on quantifying improvement and maximizing potential.

Requiring companies to have ESG scores has become an imperative, and yet, the scores may not drive the inferred behaviors to improve society. ESG might be more impactful when deconstructed, looking at each component separately by industry, against a maturity model focused on actions and realistic targets. 

Instead of generating a score, an ESG assessment should produce a series of appropriate next steps, which are task oriented, personal and results based, externally verified and easily understood for each organization to evolve.

Company-specific ESG standards offer a roadmap needed for society to thrive, by creating a healthy economy and a sustainable environmental. Don’t minimize the power of ESG — let it deliver the impact it was designed for.

(Image credit: Getty Images/Kalawin)