Policy Corner | April 25, 2022

Expanding the ‘S’ in ESG to account for the full scope of corporate impact on workers and communities

Fran Seegull
Guest Author

Fran Seegull

ImpactAlpha, April 25 – From the Great Resignation to the historic worker-organized unionization of an Amazon warehouse in Staten Island, N.Y., worker empowerment represents an increasingly important lever for corporate accountability.

The bottom-up grassroots energy, combined with top-down government action, creates a unique opportunity to advance the conversation around the role of corporations in society and the ‘S’ in ESG. 

The Biden-Harris Administration has advanced inter-agency initiatives around quality jobs data at the Commerce and Labor Departments. Next up: an anticipated rule from the S.E.C. that would require corporate disclosures on human capital management factors, or HCM, such as workforce composition, compensation and diversity data.

Engagement in the SEC’s upcoming rulemaking around human capital management is an important first step. We expect the SEC’s proposed rules to cover direct employees and hope they address contingent labor. The next logical step is to consider what implications a company’s practices have on the lives of the people living in the communities where they do business. 

To advance greater transparency and action around the issues workers and communities care about, the impact investing community can leverage the deep thinking that has already been done around climate disclosure. 

How can we apply to human capital management, for instance, the emerging environmental framework for managing direct and indirect greenhouse gas emissions through the disclosure of Scope 1, 2 and 3 greenhouse gas emissions?

To deepen the conversation, we asked colleagues across the field to weigh in on the full scope of the ‘S’ of ESG, especially as it pertains to workers and human-capital management.

Scope 3 for Social

A holistic framework for the tracking and disclosure of direct and indirect HCM issues should capture:

  • A company’s impacts on and policies around its direct employees (e.g., diversity and inclusion, wages, benefits, protections, etc.)
  • The same for a company’s contingent labor, such as contract workers
  • Impacts across a company’s entire value chain, including the workers of suppliers
  • Impacts on a company’s consumers and communities where they operate.

Companies already are grappling with these questions, as evidenced by the more than $50 billion they have committed to racial equity and place-based economic development since 2020. Asking them to report on community impacts as part of the “Scope 3” of human capital management would help put these commitments in perspective and reveal their true impact.

With respect to the racial justice element of the S in ESG, diversity, equity and inclusion or DEI, efforts, can be considered Scope 1, says Transform Finance’s Andrea Armeni. “Scope 2 addresses companies with clearly racialized products/services, such as private prisons.”

“Scope 3 looks at all downstream effects, even those not racialized on their face, yet disparately impacting communities of color, such as municipal bonds placing risk or fiscal burden on taxpayers in communities of color, water privatization that increases cost in communities of color, or retail scheduling practices affecting women of color,” Armeni says.

Social “Scope 1” considers the well-being of employees and the resources firms contribute to society (such as taxes and R&D), according to an OECD conceptual framework laid out in a recent paper. Product impacts and the well-being of consumers are part of Scope 2. The well-being outcomes of workers and communities in the supply chain constitute Scope 3. 

For both direct and indirect effects, “It is critical to measure the range of dimensions of well-being that are affected, and to measure the outcomes that matter to stakeholders, rather than only measuring business activities or inputs,” says Vincent Siegerink, who is with OECD’s Centre for Well-being, Inclusion, Sustainability and Equal Opportunity in Paris and co-authored the paper. 

Beyond disclosure

There is a clear need to boldly rethink corporate dynamics to ensure businesses are accountable to underrepresented stakeholders. The SEC’s upcoming rulemaking on human capital management is one vehicle for that conversation, but disclosure is just the beginning.

“What does an equitable future look like for all people and communities? What decisions do we have to make today to achieve it?” asks Mahlet Getachew of PolicyLink.

“Prioritizing the well-being of all people, focusing on root causes of inequity, and assessing corporate performance against bold equity targets are key steps in the right direction,” says Getachew. “Enhancements to disclosure obligations untethered from any performance obligations won’t get us where we need to be.”

Investors and policymakers must hold companies accountable to their impacts on workers, customers, and communities, she continues. “This is not a time for small steps or small bets,” she said. “It’s time to lay everything on the line for workers, customers, and communities; it’s time to redesign business as usual.”

Systemic risks

Like climate, widening inequities in society create systemic risks that threaten long-term returns by polarizing society, fraying democracy and hindering economic growth. Investors have an opportunity to ask investee companies to make three value-creating changes, according to Federated Hermes’ Diana Glassman

First, she says, build more inclusive boards, workforces and cultures that enable all individuals to maximize contributions to their companies. Second, reduce harmful company practices that may perpetuate supplier, customer and community inequities. Third, create innovative products and services that meet unmet needs of wide swaths of society. 

“As with climate, emerging ‘S’ standards and metrics will enhance visibility and help investors hold boards accountable for a more expansive set of direct and indirect societal impacts that affect long term returns,” says Glassman.   

As we consider the multiple dimensions of private sector activity with social impacts, it is important to not only look at companies, but also account for investor-level influences, which can often disincentivize or inhibit companies from acting responsibly, says The Predistribution Initiative’s Delilah Rothenberg.  

Take certain forms of venture financing as an example, which can pressure companies to “blitzcale,” thereby incentivizing early-stage businesses to cut corners on social responsibility while also potentially boxing out opportunities for other small and mid-sized businesses in the market who are poised to grow at a more stable pace, she continues. 

“In private equity and even in public equities, excess leverage put upon portfolio companies can drain them of the resources necessary to offer quality jobs to workers and affordable goods and services to customers,” says Rothenberg. 

The structure of executive and fund manager compensation can also widen the wealth gap, she adds. “It is important for both businesses and investors to be aware of these systemic issues and take a more holistic approach to managing and mitigating negative consequences.”

Double materiality

As with climate, investors must identify the most useful indicators to them, which will vary depending on their asset allocation, and portfolio holdings, including sector and geographical exposure, says Elena Espinoza with Principles for Responsible Investment.

“Investors have a responsibility to respect human rights and should consider financially material social factors in their investment processes,” says Espinoza. “As investor demand for company data and data that goes beyond controversial information grows, “the better and more sophisticated social data will become.”

Beyond direct metrics, there are a number of other factors investors should consider. Rachel Korberg of the Families and Workers Fund advises centering equity and empathy. “It’s no coincidence that sectors with the highest resignation rates in 2021 also had the highest reported rates of sexual harassment and discrimination,” she says.

“Companies where staff feel safe and have equal advancement opportunities are able to attract and retain talent, improve operational resilience, and deliver innovation.”

Companies and investors must be cognizant of the “S” factors that communities and underrepresented groups care about most. For example, a corporation may score highly on ESG for board diversity, while simultaneously dumping pollutants into rural communities where many of their employees of color live, notes Rachel J. Robasciotti of Adasina Social Capital

“These companies and policymakers need to look intersectionally at the overall racial, gender, economic, and climate impact they are making on their stakeholders’ communities – all of their stakeholders, not just those who hold the most power,” says Robasciotti.

“It is impossible to separate the ‘S’ from ‘E’ and ‘G’ because communities require a balance to survive and thrive.”