ESG: The new mantra for corporate behaviour

on 16 Oct, 2019

ESG — environment, social and governance — is likely to be the most important three-letter acronym that will influence corporate behaviour in the years to come. The largest investors in the world are embracing ESG frameworks to promote better corporate behaviour.

Globally, more than $80 trillion of funds — managed by over 2,300 managers — have already subscribed to the United Nations principles for ‘responsible’ investment, with a commitment to integrate ESG issues into their investment analysis and decision-making processes.

Research by a leading academic in the ESG investing space, Professor George Serafeim of the Harvard Business School, demonstrates a clear correlation between material ESG actions and firm outcomes across markets. A focus on ESG typically yields over time lower cost of operations, reduced risk, lower cost of borrowing, increased analyst coverage & investor interest, and greater prospects for valuation re-rating.

This investment strategy is taking roots in India too, with stakeholder pressure for better ESG performance. There is growing activism, for instance, among shareholders who are keen that the compensation of promoters and senior executives correlate with performance. Customers (including millennials) want companies to demonstrate purpose beyond profit. Brands that can clarify the higher purpose they serve, like The Body Shop, are rewarded with both mind-share and share of wallet.

Government and quasi-judicial bodies like the National Green Tribunal are also pressing the regulatory accelerator on environmental issues and, consequently, many businesses — like tanneries that operate on the banks of the Ganges or carmakers who are yet to make the switch to electric vehicles—will face existential crises in the future.

The HR connection to ESG

Employees are demanding safer, fairer and more sustainable workplace practices. Research indicates that firms with high employee satisfaction outperform their peers by 2.3-3.8% per year in long-run equity returns.

Responding to these varied stakeholder demands, the human resources (HR) function has an important role to play in organisational design for ESG improvement. It has the responsibility of identifying the right location for ESG oversight, and ensuring functional integration across the organisation.

Vital tools in this endeavour include the organisation’s code of conduct and the systems & processes put in place to cascade the values and ethics agenda across the organisation. These include whistle-blower and other grievance-redressal mechanisms, which have become critical in the wake of multiple corporate governance failures in India and the rise of the #MeToo movement.

The code of conduct must critically address diversity and inclusion in the workplace, and the treatment of all employees with dignity and respect. With women representing only 22% of the organised workforce in India and a significant pay gap reported between men and women, HR has its task particularly cut out to improve gender diversity.

Given the growing concerns around inequality, HR must also carefully navigate to secure stakeholder endorsement of senior executive compensation. Studies suggest that the median salary of top Indian executives is on average 243 times higher than the average salary for employees, and there are growing calls for restraint in salary increases.

In building the employer brand, HR can usefully leverage CSR spending. This can be oriented in favour of increasing the connect of the workforce with the local community by supporting social causes that matter to the employees and linking these to corporate volunteering possibilities. Besides enhancing employee engagement, this makes the company a neighbour of choice for the local community.

In the more evolved enterprises, HR is influencing the corporate culture in the direction of greater openness, transparency and inclusion, and nurturing leadership that understands the importance of integrating ESG in corporate strategy. Ultimately, HR will play the pivotal role in preparing Indian companies to embrace the changes that the growing focus on ESG demands.

The writer is chairman, ECube Investment Advisors

This post originally published on The Times of India