ImpactAlpha, July 23 – The goal seems straightforward enough: assess and compare how companies use natural, human and financial capital to provide their products and services, and how their “externalities,” positive and negative, affect society.
In practice, producing reliable and comparable data about corporate environmental, social and governance, or ESG, performance has been anything but simple.
Even consultants that advise companies on ESG strategies are skeptical that current data accurately capture a firm’s performance. That makes the mounting evidence of positive correlations with better management (and, arguably, long-term returns), all the more surprising. Imagine what meaningful and reliable data might show!
Harvard Business School’s George Serafeim teamed up with Sakis Kotsantonis of the consultancy KKS Advisors (Serafeim is a co-founder) to reveal “The Four Things No One Will Tell You About ESG Data.” Improving the quality of information is essential both for companies to be able to integrate environmental and social performance into their operations, strategies and executive compensation, and for investors to be able to reward the leaders and punish the laggards (see “Q&A with Harvard’s George Serafeim: The link between corporate governance and environmental and social impact”).
Their key recommendation: set absolute, not relative benchmarks for progress. “Companies around the world have made hundreds of commitments on deforestation and their environmental ‘performance’ may well have increased as a result of their initiatives; but that hasn’t stopped forests from disappearing,” the authors write.
Relative rankings admit poor performances into many “sustainable” ETFs and mutual funds, as long as their peers perform worse. “Setting pre-defined ranges of performance for ESG metrics provides a way to assess the real impact of a company to the external world” (listen in to ImpactAlpha’s podcast, “If ESG is so great, why is the world going to hell?).
- Core priorities. Serafeim and Kotsantonis advocate the adoption of a baseline indicators and metrics on the most important ESG issues, such as climate change, labor conditions, and diversity. For climate, data providers could calculate requirements to meet the Paris climate agreement’s goal of keeping global temperature increases below 2-degrees Celsius, “and calculate for each industry what the absolute level of good performance means.” Such clear goals would give companies “a clearly defined pathway to future-proof growth by specifying how much and how quickly they need to reduce their greenhouse gas-emissions.”
- Standardize data. The authors’ sample of 50 Fortune 500 companies found at least 20 different ways of reporting employee health and safety data, with different terminology and different units of measure. That even though employee health and safety is a “material ESG issue” for nine out of 11 sectors included in the Sustainable Accounting Standards Board’s industry-specific framework.
- Self-organization. Industry leaders have an incentive to drive meaningful reporting. The Edison Electric Institute assembled U.S. investor-owned electric companies to develop investor-driven ESG reporting templates and spreadsheets. KKS, backed by the Rockefeller Foundation, is convening industry groups “to promote pre-competitive collaboration among companies to solve common sustainability issues” and agree on ESG metrics.