What Is ESG? pt.1

A New Social Contract for Business

ESG” is stands for a recognized system of environmental, social and governance criteria by which investors and stakeholders evaluate a company’s performance and its impacts.

“E” (environmental) encompasses how a company manages the natural resources it draws from the planet and what it pumps back in. “S” (social) covers how a company treats its internal and external stakeholders, as well as how it responds and contributes to larger social trends. And “G” (governance) covers the rules and policies a company sets for itself, its level of transparency and how it functions within the policies, regulations and laws of the jurisdictions in which it operates.

The figure below shows how ESG impacts a company internally and how it interacts externally with the larger community and environments in which a company operates. There’s an inflow and an outflow, a back and forth. When well integrated into a company, ESG is a robust way to create long-term value.

The chart below shows examples of various ESG initiatives, like individual trees within a bigger ESG forest.

ESG isn’t new, and it evolved from programs like CSR (corporate social responsibility), eco-efficiency and sustainability over the second half of the 20th and early 21st centuries. In 1953, Howard Bowen coined the term corporate social responsibility in his book Social Responsibilities of the Businessman. The book was the first to discuss the obligations businesses have to their employees and stakeholders, and the idea of CSR grew in the 1950s and 1960s with the rise of multinational corporations. 

In a riposte to what he deemed “pure and unadulterated socialism,” economist heavyweight Milton Friedman wrote in 1970 “The Social Responsibility of Business is to Increase Its Profits.” Friedman said that business must foremost “… make as much money as possible while adhering to laws and ethical customs.” He also said that the responsibility of corporate executives and workers is to conduct the business in accordance with the desires of owners (i.e., shareholders).

In Friedman’s view, people, not businesses, can have a social conscience and act on that. But business has no place in what he termed social or environmental initiatives.

Meet The New Boss

So how has this perspective seemingly flipped so fast, with corporations onboarding entire ESG and sustainability teams, ranking and rating all sorts of metrics and pumping out rafts of ESG communiques? Is this virtue signaling or a fundamental shift in business?

A 2021 United Nations’ climate report declared a “code red” because carbon dioxide emissions are higher than they have been in 2 million years, and the global surface temperature has risen faster since 1970 than in the last 2,000 years. The United Nations has said repeatedly that business must make a hard turn to stem carbon emissions, climate change, biodiversity loss and mass human migrations and suffering. The global pandemic and social upheavals of 2019 and 2020 reinforced the necessity of change largely driven by consumerist societies in the Global North.

Millennials and Gen Z agree, and they are on track to be the largest bloc of consumers, workers and investors in the United States and abroad. Over the next few decades, $30 trillion (USD) will transfer from Boomers to Millennials in the United States, and more than $40T will transfer globally. So far, investors have committed to divesting $39.2T from fossil fuels and, in Q1 2021, they set an all-time quarterly record by pouring $21.5 billion into sustainable funds.

In the United States, there are 80 million Millennials. They comprise the largest part of the workforce, and 79 percent of them are loyal to companies that care about their societal impact. Eighty-six percent of this group is interested in sustainable investing, and 90 percent want it for their 401(K)s. The Millennial cohort works for, buys the products and services of and invests in companies with robust, embedded ESG values and performance.

The social contract business has with society has changed. Simply put, the Millennial and Gen Z cohorts are voting with their dollars and labor, and ESG companies and investments are winning. Companies that hew to Mr. Friedman’s strict views about profits über Alles will vanish as their markets die off.