ESG
How DEI fits into ESG strategies.

Accounting for DEI in Your ESG Reporting: Your Guide to Meeting Expectations

It’s not just the general public who expect a business to have its affairs in order on the diversity, equity and inclusion front. Potential investors want to know about the social stability of any organization, just as they want to know how its books are managed and what a company has in the pipeline for future business.

Environmental, social and governance (ESG) factors are a key component to any company’s public image and business potential. Consumers use them to decide which businesses they want to patronize and which products they want to buy and support. Socially conscious investors use them as criteria for gauging the viability of a potential investment; many are reluctant to go into business with a company that will end up in the news as a violator of one of these three key areas of social responsibility.

 

What is ESG?

An evaluation of a firm’s collective conscientiousness over varying social and environmental factors, a company’s ESG score derives from a number of different data points involving specific metrics related to intangible assets within the enterprise. The three primary components of ESG make up what many people view as the vital ingredients to viable and successful strategies for corporate social responsibility. For investors, ESG is a tool akin to what supply chain professionals might know as a STEEP analysis, an acronym for Social, Technological, Environmental, Economic and Political.

That analysis is used to measure the factors that influence a supply chain in the same way ESG is used to measure factors influencing the level of risk attached to an investment over time. How each of these factors can dramatically impact the success of a business is outlined below:

 

Environmental

One of the most important, overall aspects of ESG, the environmental factor is a measurement of the contribution to climate change that a company’s business has over time. It can include factors ranging from greenhouse gas emissions to energy usage to overall waste disposal. As the climate crisis worsens and new generations of consumers hold higher standards for corporate carbon footprints, these factors require careful consideration and regular review for improvements.

Example of how it can impact business: A company manufacturing a new lawn care product finds that investors are wary of doing business with them after discovering that the raw materials sourced for the product contained phosphate mined in Florida. Over the last 50 years, phosphate mines in Florida have contributed to some of the state’s most devastating ecological disasters, and recent incidents making national headlines have increased awareness of this issue. This increases the risk attached to the company’s reputation and requires the company to contribute to research around new methods of manufacturing such a product — or at the very least, ensure the environmental responsibility of its suppliers.

 

Social

The social aspect can include several different potential pitfalls, from a controversial political stance to labor standards further down the supply chain. But it also offers many areas for celebration and success. Companies that are integrated and reflective of their broader community while upholding values of diversity, respect, belonging, inclusion and equity generally garner a better ESG rating and tend to be most well-positioned from a social standpoint.

Example of how it can impact business: Investors and the public alike have grown weary of clothing manufacturers that use forced labor in developing nations to create budget-friendly clothing. Following factory collapses and media exposés on the conditions of the factories and compensation of the workers, the risk of partnering or investing in clothing brands that use such facilities is higher.

 

Governance

Governance is the primary measurement of leadership and corporate visions and attitudes, examining how an organization operates and behaves in the world overall. These factors look at the responsibility and compensation of various shareholders, the company’s accounting methods and involvement of stockholders, as well as numerous aspects of leadership and organizational structure.

Example of how it can impact business: An executive from a high-profile automaker is arrested on accusations of falsely reporting his pay. Further investigation reveals that other executives at the company underreported their pay and supported the company’s use of false product claims, calling into question the integrity of the governance structure within the organization. Such revelations can derail any potential investments or partnerships the company could be pursuing.

 

The Perception of ESG

ESG, for many, may sound like an ethics discussion — something that often fails to translate or inspire at the board level. But the concept and its measurement are continuing to grow in importance and significance. When weighing the “right” thing to do versus something that benefits shareholders’ dividends, the ethical option has become somewhat of a rarity, but this is changing.

Following a number of high-profile cases of poor ESG practices — all of which negatively impacted stock prices — many investors and shareholders have begun to see the value in upholding ESG standards and criteria.

For investors, a good ESG analysis can steer them clear of companies that could pose a hazard to their overall portfolio. For shareholders, adherence to good ESG policy will attract increased investment and protect the company’s reputation and brand from damage.

In the wake of recent social justice campaigns and the growing concerns over climate change, focused ESG policies and awareness within an organization isn’t some feel-good initiative; it’s a business strategy and imperative, the difference between diversifying portfolios and declining stock prices coupled with instability.

 

Where Does DEI Fit into ESG?

It’s true that diversity, equity and inclusion only make up one component of the social aspect of ESG, but it’s also one area that has received a lot of attention in the past year following the events of 2020 that ignited protests around the world.

PwC (a DiversityInc Hall of Fame company) notes that it has seen investors, business partners and consumers placing an increased focus on DEI programs and demanding transparency around metrics, key performance indicators and effectiveness.

The issue many companies encounter is how they measure the performance of DEI initiatives and report that data both internally and externally. For many companies, these programs fall under the purview of Human Resources, a function still coming to grips with its place in the data-driven future of many organizations.

Issues within the environmental and governance pillars are often easier to track because the data is easier to recognize. Social issues, on the other hand, are a bit trickier. They aren’t measured over one specific period, and their metrics can vary widely on a case-by-case basis. They also aren’t always discussed in tangible terms, such as how much someone makes or the carbon footprint of production. Instead, their measurement is less tangible, with fluctuating indicators such as sentiment or perception.

As a result, many managers struggle to understand the impact of these initiatives on the business and DEI’s place in their day-to-day work.

In some cases, companies are afraid of what the metrics may reveal, but allowing this to stand in the way of transparency is a mistake. Rather than backing away from transparency, companies should see communicating data around D&I efforts as meeting the transparency demand head-on, taking the opportunity to create a new narrative around what the company has learned about their DEI efforts.

There is no better time to set new goals around how the company will reimagine these efforts and support real change within its own ranks and broader society.

As part of DEI being less predictable in measuring its effectiveness and keeping up with current issues, executives and shareholders must come to understand that progress on this front is not a straight line and will never involve a quick fix.

Finally, for DEI to tie into the broader ESG efforts of the company, the right leaders must be in full support of those efforts and help teams in HR, IT and accounting understand what data will funnel into ESG reporting. Additionally, it’s the responsibility of the same leaders to help the company define what success looks like and continually shape the narrative around their journey to attain it.

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