Social Impact, the forgotten child in ESG considerations
The social aspect or “S” in ESG (Environmental, Social and Governance) has not always received the same level of attention as its counterparts, particularly of late. The emphasis has, predominantly, been placed on the environment, to ensure sustainability for future generations and was recently brought to the fore by the COP27 meeting.
Governance has also been placed under a microscope given the issues surrounding State Capture and recent corporate failures in the private sector.
But it’s time we give “society, social issues and social impact” the focus it deserves – across investment decision-making and capital allocation processes, in our corporate reporting and in our strategic planning on our corporate and State-Owned Enterprise (“SOE”) boards.
The social pillar encompasses the way companies interact with their employees and the communities in which they operate. Social issues can include employee diversity and inclusion, workplace safety, company policies on the gender pay gap, fair remuneration or child labour, to name a few. Investors and stakeholders increasingly recognise that companies have a responsibility to create value not just for shareholders, but for all stakeholders, including society as a whole. The COVID-19 pandemic amplified this awareness by shining a spotlight on social issues as companies came under scrutiny for employee wellbeing and social inequality.
Social issues can be addressed in our investment decision making and capital allocations by ensuring that potential investee companies are deliberately integrating social issues across all investment and corporate activities. As investors, it is important to assess whether companies are part of the movement and playing their role in bringing about socio-economic change in the areas in which they operate.
Admittedly, social factors are more difficult to assess than environmental or governance issues, which is perhaps why it is often overlooked, but we believe they are measurable. Social risks can be assessed qualitatively or quantitatively, and the degree of importance of these risks can vary across industries. For example, employee health and safety may be considered a more important factor in a mining company than in a bank and customer data protection may pose a higher risk for a bank than a mining company.
At Prescient, we use our proprietary ESG Scorecard, which assesses companies based on their overall ESG characteristics. The scorecard looks at over 60 different environmental, social and governance metrics, which are used to determine a final ESG score, allowing us to evaluate the ESG risks and opportunities associated with the counterparties in which we invest.
For the social component of the ESG score, we look at three main subfactors – Employees, Safety and Social Policies – and these, in turn, comprise more than 20 underlying metrics. This information can be obtained from the public integrated financial reports and is supplemented by the experience and insights of our investment team. Many of these metrics are binary, as in, we view having a policy in place addressing equal opportunities, for example, as positive. Conversely, not having a policy in place would negatively affect the company’s ESG score.
Non-binary metrics are also tracked over time, such as the percentage of women in the workforce or percentage of minorities in management. Having access to this information allows us to ensure that companies are giving appropriate consideration to social issues. If the company is sufficiently addressing social issues, they should score highly on their “S” factor, which, depending on their environmental and governance scores, means we would be more willing to invest in that counterparty. On the other hand, if they scored poorly, we would require a higher return to compensate us for the embedded ESG risk before considering whether to invest with them. This is crucial as a lack of focus on social issues can directly affect a company’s financial performance in the short and long term.
Capital can also be deployed in a socially conscious way by investing directly in projects that facilitate infrastructural, environmental, socio-economic and developmental impact. These projects make a positive contribution towards economic growth and development by improving infrastructure in the country, giving communities access to basic services and creating jobs for the community.
Addressing social issues is also imperative when it comes to corporate reporting and disclosures. Corporates need to identify and define the social issues that are most relevant to their business, industry and stakeholders and prioritise any applicable initiatives. This can be shared in annual financial statements and an annual sustainability report, which detail the company’s approach to addressing social issues, progress made, challenges faced, and future plans in these areas.
Transparency is crucial here, as disclosing and reporting social issues and metrics informs stakeholder engagements. Stakeholders can monitor a company’s progress over time and ensure there’s accountability associated with any stated targets or promises made. This allows stakeholders to address instances where the company falls short and ensures their future actions and plans are aligned with good social values and priorities.
Of course, addressing social issues needs to start at, and come from, the top. The King Code of Governance for South Africa is a set of guidelines and principles for corporate governance in South Africa and it outlines the fiduciary responsibilities of a board of directors. One of which includes the duty to act in the best interests of all stakeholders, including shareholders, employees, customers, suppliers, and the community.
Good corporate governance at board level dictates good social practices. The board is responsible for the strategic direction of the company and their values and decisions filter down to management who are responsible for implementing these strategies. In noting the above, it is important to express our view that E, S, G factors work in tandem – while traditional “S” factors are noted above, these go hand in hand with “G” factors, where we consider and assess the performance of those charged with ensuring the strategic direction of companies we invest in is actioned. It is thus our view that, for ESG to work, we need to prioritise diversity at the board level to cater for various viewpoints and consider the interests of all stakeholders appropriately.
Our research shows that, on average, only slightly more than 20% of the board members in JSE-listed companies were female. However, many independent studies have shown that having gender-diverse boards and management is positively correlated with better financial and non-financial performance – and contributes to overall company growth and improves their ESG performance. Board members with diverse backgrounds and experiences bring different perspectives to the table, which ultimately enhances creativity and innovation when looking for solutions. It also means biases and assumptions will be challenged more frequently, which contributes to a more thorough analysis of issues and thus better decision making. A diverse board can better reflect the needs and interests of all stakeholders and the broader community and can ensure company goals are aligned to meet these needs.
To ensure social issues are addressed at a strategic level, the board needs to focus on putting the necessary structures in place and ensuring they are enforced. The board can establish and implement policies that address internal and external social issues. These policies could include business ethics policies, health and safety policies and equal opportunities policies.
These policies need to guide company behaviour to ensure they are behaving in a socially responsible manner. Specific goals and targets can also be set that focus on areas such as the percentage of women in management or employee turnover percentage. It’s crucial that boards set targets to enable them to monitor their progress towards achieving these goals. Through disclosure and transparency of their current issues and plans to address them, as well as targets, engagements with stakeholders will allow the board to incorporate external feedback and use it to improve or better themselves.
The strategy can also be driven through corporate social initiatives, such as partnering with external organisations to participate in community development. Lastly, the board needs to ensure that they have buy-in from management and that they are implementing the strategies accordingly. The best way to align social strategy and corporate goals is to ensure all employees, from the top down, are living the values of corporate social responsibility. DM/BM
Author: Natalie Anderson, Investment Specialist at Prescient Investment Management
- Prescient Investment Management (Pty) Ltd is an authorised financial services provider (FSP 612).
- The value of investments may go up as well as down, and past performance is not necessarily a guide to future performance.
- There are risks involved in buying or selling a financial product.
- This document is for information purposes only and does not constitute or form part of any offer to issue or sell or any solicitation of any offer to subscribe for or purchase any particular investments. Opinions expressed in this document may be changed without notice at any time after publication. We therefore disclaim any liability for any loss, liability, damage (whether direct or consequential) or expense of any nature whatsoever which may be suffered as a result of or which may be attributable directly or indirectly to the use of or reliance upon the information.