In recent years, environmental, social and governance considerations have become increasingly important for businesses. While issues such as employee well-being and business ethics have been longstanding concerns, sustainability, environmental impact and broader social factors have now also come into focus as key elements of ESG initiatives.
With this increased attention, business leaders must be able to measure their organization's ESG performance, especially to help manage risk. For example, companies in industries with high environmental risks, such as oil and gas, need to be aware of their carbon footprint and potential liability for pollution. Similarly, companies that have poor labor practices may face reputational damage and legal action if they don't use ESG metrics to identify the problems.
What are ESG metrics?
ESG metrics are a set of various performance indicators, primarily nonfinancial in nature, that help to assess companies in relation to sustainable and responsible practices. These metrics provide valuable insights into things like environmental impact, corporate social responsibility (CSR) and the internal governance structure. By tracking and analyzing them, companies can monitor their progress toward improved business sustainability and ethical business practices -- and, ultimately, their contributions to long-term value creation and societal well-being.
Why are ESG metrics important for businesses?
In addition to managing risk, ESG metrics can help businesses in a positive way to build and maintain their standing in the market. Consumers are increasingly concerned about the social and environmental impact of the products and services they buy, and many are more likely to support companies that are transparent about their ESG performance. Investors also often use ESG metrics to evaluate companies, and organizations that score poorly might find it harder to raise capital or attract new investments.
Finally, ESG metrics can help businesses identify opportunities for growth and innovation. For example, companies that invest in renewable energy, green computing and other sustainable measures could better position themselves to take advantage of changes in customer preferences and the impact of new government regulations on industries.
Quantitative vs. qualitative ESG metrics
ESG metrics can be divided into two main categories: quantitative and qualitative. Quantitative metrics are based on numerical data that often can be directly measured and compared. Examples of quantitative ESG metrics include greenhouse gas emissions, energy usage, employee turnover rates and reported HR violations. These metrics are useful for benchmarking and tracking performance over time.
Qualitative metrics, on the other hand, are based on non-numerical data and are harder to measure and compare. Examples of qualitative ESG metrics include a company's commitment to diversity, equity and inclusion (DEI), its labor practices and its impact on local communities. These metrics are more subjective and require more interpretation, but they can provide valuable insights into a company's culture and values.
Both quantitative and qualitative metrics are important for measuring a company's ESG performance. By using a combination of them, businesses can gain a more comprehensive understanding of ESG issues and work to improve in the areas in which they fall short.
Examples of the different types of ESG metrics
What kind of metrics would be most meaningful in an organization? Let's look at some useful examples in the different aspects of ESG.
These metrics are used to evaluate a company's impact on the environment and its efforts to lessen that. They often are quantitative and lend themselves to direct comparison across different organizations. The following are some examples:
- Greenhouse gas emissions. This measures the amount of greenhouse gases, such as carbon dioxide, that a company emits into the atmosphere. Greenhouse gas emissions are a significant contributor to climate change, and companies that emit large amounts face potential regulatory, reputational and financial risks.
- Energy usage. The amount of energy a company uses to produce goods and services, power its data centers and run other operations is another common ESG metric. Companies that use renewable energy sources, such as solar or wind, might have a lower environmental impact than those that rely on fossil fuels. Analyzing data on energy consumption can also highlight opportunities to increase energy efficiency.
- Water usage. Similarly, a company should be able to accurately measure the amount of water used in its operations. Water is an increasingly limited natural resource in many areas, and companies that use large amounts of it can face reputational and financial risks if they don't take steps to reduce their usage levels.
How can we measure a company's performance on the social factors of ESG? Social metrics are often qualitative and can be subjective. Examples include the following:
- Labor practices. ESG metrics can be used to evaluate how a company treats its employees, as well as workers in its supply chains. The labor practices that are tracked can include issues such as fair wages and safe working conditions, which have a certain quantitative component. Other considerations, such as nondiscrimination policies, are more subjective.
- DEI. How diverse is your workforce, and how inclusive is the workplace? These metrics are not only about reputation and regulations. Studies have shown that companies with a diverse workforce may be better positioned to understand and meet the needs of a diverse customer base.
- Community engagement. This measures how a company engages with the communities in which it operates. Community engagement can include things such as philanthropy, volunteerism and CSR programs.
These metrics measure how well a company is managed, as well as its internal controls and corporate policies. Governance metrics can be quantitative and compared across different organizations. These are some examples:
- Board diversity. How diverse is a company's board of directors? Board diversity can include issues such as gender, race, ethnicity and age.
- Executive compensation. This measures how much a company's top executives are paid. Executive compensation can be an indication of how well a company is managed and whether its financial incentives for senior execs are aligned with the interests of its various stakeholders.
- Ethics and compliance. This area is very broad and can include issues such as anti-corruption policies, data privacy protections and support for business integrity and transparency.
How can companies use ESG metrics?
Knowing what you want to measure is only the first step on the journey. You also need to know how to measure ESG performance and what to do to improve where needed. Here are some options:
Commercial ESG scores and ratings. Several vendors offer ESG scoring and ratings services that rank a company's performance based on various criteria. For example, these services assess its adherence to ethical and compliance standards, as well as other metrics, typically using ESG reports prepared by the company. The vendors then assign a numerical ESG score or a letter rating that can be compared to other companies in the same industry or sector.
Certifications. ESG metrics can be used to seek certifications that demonstrate a company's commitment to specific practices. Some of these are familiar, such as the Fairtrade certification for ethical labor practices and certification of compliance with the ISO 14001 standards for environmental management.
Internal or third-party audits. Companies can also conduct internal audits and assessments or hire third-party auditors to evaluate their ESG performance. Among other things, this involves reviewing company policies and procedures, evaluating internal monitoring and reporting systems, and conducting interviews with executives and other employees to identify potential areas of improvement.
Engagement with external stakeholders. Another approach is to engage with outside stakeholders, such as customers, investors, suppliers and community members, to understand their expectations and concerns regarding ESG issues. This can involve conducting surveys, focus groups or town hall meetings and using the feedback to improve your company's ESG performance and compliance.
Challenges with ESG metrics and how to overcome them
Inevitably, there will be areas in which companies need to do better on ESG-related practices. However, to make improvements, an organization must ensure that its metrics are actionable and targeted. This often is a challenge itself, but the following steps can help:
1. Set clear goals and targets
Aim for clarity on ESG goals to help focus efforts and ensure that progress can be measured. For example, a company might set a goal to reduce its greenhouse gas emissions by 20% over the next five years. That can create a sense of accountability and ensure that the efforts are aligned with strategic priorities. Because ESG issues are complex and multifaceted, though, it can be difficult to determine which goals are achievable. To address this challenge, a wide range of stakeholders should be involved in the goal-setting process, including employees, customers, investors and community members. Doing so will help ensure that goals align with stakeholder priorities and are realistic.
2. Measure and report on progress
Organizations should regularly measure and report on their progress toward the goals they've set. Regular reporting can also help to build trust and credibility with various stakeholders. This is often easier said than done, because the required data can be incomplete, inconsistent or difficult to obtain. In addition, there's often a lack of standardization in how ESG metrics are measured and reported. You may need to invest in systems or processes that can capture and report ESG data effectively. For example, this might involve steps such as working with third-party data providers or developing better data governance capabilities. It can also be helpful to use standardized ESG reporting frameworks, such as the Global Reporting Initiative's GRI Standards, the SASB Standards or the upcoming IFRS Sustainability Disclosure Standards being developed by the IFRS Foundation.
3. Integrate ESG factors into business decision-making
This is important. Committing to assess ESG issues in decision-making processes will help to ensure that they're considered alongside other factors, such as financial performance and risk management. For example, a company might consider the environmental impact of a new product line before deciding whether or not to invest in it. This approach also may require changes to existing processes and systems. In addition, there could be a lack of understanding or buy-in from key business stakeholders. If so, you'll need to build support for integrating ESG considerations. This could involve providing training and education on ESG to executives as well as other employees.
4. Get all stakeholders involved in the process
Having said earlier that you can reach out to external stakeholders for input on ESG issues, I must admit that it isn't always easy to do so. The aim is to build trust, identify areas for improvement and ensure that ESG efforts and the metrics used to track them are aligned with stakeholder priorities. However, various stakeholders might have different perspectives and priorities. In addition, stakeholder engagement can be time-consuming and resource-intensive. It can take many forms, including surveys, focus groups and public consultations. To get a full range of input, it's helpful to use multiple channels of engagement, such as social media, public events and one-on-one meetings.
As the world continues to face complex and interconnected challenges, such as climate change, social inequality and concerns about business ethics, companies that factor ESG considerations into their business strategies aim to be better positioned to thrive in the future. Prioritizing ESG issues can create long-term value for businesses and their different stakeholders, while also contributing to a more sustainable and equitable society.
As you can see from the variety of approaches and the challenges described above, measuring and improving ESG performance requires a comprehensive and collaborative approach. ESG metrics play a critical role in this process, both strategically and tactically.