Businesses can no longer overlook the ‘S’ in ESG

BY Infosys’ Aruna Newton, Global Head - Diversity & Inclusion, Infosys.

  • 1 month ago Posted in

The combining of environmental, social, and governance issues into the holistic label of ESG was formalized 17 years ago at the United Nations. Since then, the world’s concern about the impact of climate change has left many business leaders stuck on the E, relegating the S and G to second-tier status.

The climate’s ticking clock has justified this focus on the environment — emissions in particular. However, a broader embrace of ESG offers benefits that company leaders might not expect. Infosys research found that some social and governance initiatives boost the bottom line, in addition to making businesses better corporate citizens.

Our global ESG Radar survey of more than 2,500 business executives and managers — 17% from companies based in the UK — found several initiatives or focus areas that correlate with increased revenue or profit growth. These initiatives are not standardized training programs or off-the-shelf solutions designed to satisfy the demands of UK regulators, or investors chasing market trends. Instead, the changes are structural ones that alter a company’s mindset and approach — starting with the leadership ranks.

Governance: Low priority, big impact

Governance was rated as a lower priority than either environmental or social components among the companies we surveyed. One telecommunications industry executive pointed to the paradox here: “Governance is an area that if you do it well, no one notices. But if it goes wrong, it poses the biggest reputational risk.”

Despite this lack of urgency, UK executives were the most confident in their governance initiatives (75%) having long-term impact. This was more than 20% higher than their confidence in the impact of social initiatives (54%).

Governance also shows great untapped financial benefits. Companies perform better financially when they have all the following: a chief diversity officer (CDO), chief sustainability officer (CSO), ESG committee on the board, and also when the CSO clears capital expenditures. Analysis of survey data found that those four elements correlate with about a 2 percentage point increase in profit growth and revenue growth. Anything short of that does not help the bottom line.

This was one of the strongest correlations in our study and the most significant financial impact. However, only about 22% of leaders at UK-based firms say their company has all four elements in place. That’s five percentage points lower than the average of all the companies we surveyed.

Social: People and profits

Business leaders are already well aware of the need to create a more diverse workforce — one that reflects their communities and customers. These initiatives are necessary but not enough. Our research found that this commitment needs to extend to the board. An increase in the number of women on a company’s board was linked to better financial outcomes. This is good news for UK companies since they excel in this area. The Gender Diversity Index ranks the UK as the third highest scoring country in Europe, with women making up 38% of the board seats (tied for third on the continent).

Analysis of our survey data, which included respondents’ reported financial performance, found that a 10 percentage point increase in women on the board strongly correlates with a 1 percentage point increase in profit growth. This effect is likely a proxy for board diversity, which is assumed to offer broader perspectives that lead to greater innovation. Our findings add another data point to what is already a mixed picture on this subject. A large number of academic and business studies have examined how the percentage of women on corporate boards affect various financial metrics and have reached conflicting conclusions.

Our analysis also indicates that company profits increase more when their ESG efforts are motivated by how their employees view them, as compared to their reputation among customers. This correlates with about a three-quarters percentage point increase in profit growth. In the UK, companies prioritize reputation with customers (29%) barely ahead of reputation with employees (28%).

These benefits could be a result of better engagement among employees and greater success in recruitment and retention — all of which have financial consequences. This also reflects a stronger focus on employees as a resource, perhaps fueled by companies’ ongoing efforts to close their skills gaps. This is particularly critical as UK companies struggle to find the right employees and navigate what has been described as a talent “tug-of-war.”

ESG strategy accelerating in the UK

Companies are moving past the lowest hanging fruit in the world of ESG. Businesses have reduced energy consumption, trained employees on ESG initiatives, and moved away from the all-male boards of the past. A stronger focus on employees and greater board diversity seems not just possible but likely. Even so, respondents are slowing their adoption of changes that are most closely correlated with profit growth, and as a result, could limit the financial benefits of ESG.

Overall, firms that do not have these leadership positions or structures that were mentioned previously are not likely to add them in the future. However, UK companies are embracing these leadership changes to a greater extent than our sample as a whole, despite uncertainty about how post-Brexit regulations will mirror or diverge from EU regulations. More than half of UK companies we surveyed have ESG roles in the C-suite: CSO (54%), CDO (70%), and ESG committee on the board (67%).

Not only are these companies well ahead of the global average, but they are also more likely to add these ESG roles in the future and pull further ahead of their international competitors. More than half of UK companies surveyed say they have a CSO. Among those that don’t, nearly half (49%) plan to add that position in the future. Although not mandatory, the large UK companies without a ESG board committee is shrinking rapidly. More than two-thirds have such a committee, and 62% of the rest say they plan to follow.

The boldest changes will likely come from the companies that already have a CSO. About one-quarter of UK firms (27%) require their CSO to clear capital expenditures. That’s slightly lower than the global average (32%). However, half of UK companies plan to give their CSO that authority in the future — a larger increase than the one-third cited by companies overall.

This points to an approach that seeks to bring more ESG authority into the C-suite. Thirty percent of the respondents from UK companies say their firms tie executive compensation to ESG metrics. This performance was higher than any other country or region, with Germany being the closest at 25%.

It seems obvious that a strong ESG commitment in company leadership will result in greater real-world impact — a worthy goal. However, our analysis points to that commitment also being the key to ESG initiatives contributing to the bottom line, rather than just being an element of corporate compliance with minimal investment.

An unwillingness to add more ESG roles and responsibility to the leadership structure could have serious consequences if companies don’t change their approach to ESG. The gap between the ESG haves and have-nots could expand — leaving some companies uncompetitive in a fast-changing, volatile market.

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