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November 15, 2023

The Three Pillars of ESG (Part 2): S for Social

by Team Rowling

As we discussed in Part 1 of this series (The Three Pillars of ESG: E for Environmental), ESG investing, with its focus on issues that are important for society, consists of three major pillars: Environmental, Social, and Governance.

After an in-depth look into the environmental pillar and the factors related to nature that impact ESG analysis, next up, of course, is “S,” which stands for social. Social factors are not as commonly linked to ESG investing as environmental factors, but still play a major role in how companies are assessed with regards to issues within this second pillar.

ESG Social Factors

ESG Standards & Regulations

Before we get to it, remember: ESG is a tool that combines social-good metrics and traditional, economic investment analysis with an overarching aim: to better identify risks, opportunities, and expected financial performance in companies.

Another key point: Because there is no requirement for ESG disclosure in the United States, there is no regulated standard for the details of ESG reporting. This means organizations choose what to report, sometimes based on what is demanded of them by investment firms.

Just as it goes with environmental issues, this means not every ESG analysis is based on the same factors in the social sphere. Still, there are a lot of factors consistently at play that are used to evaluate how well a company is addressing social issues.

 

What ‘Social’ Means

Unlike the environmental pillar of ESG, which is somewhat self-explanatory, the social pillar is perhaps a bit harder to comprehend as it relates to investment decisions. Issues within the social pillar consist of a wide array of factors, ranging from those that affect customers directly, to ones that affect employees, the community, and society as a whole.

 

What Makes Up The ‘S’ Pillar?

Factors relating to the social pillar of ESG analysis include:

Human Rights

This is a broad topic that can consist of a great number of subjects. The Global Reporting Initiative (GRI) says a company’s human rights impacts can extend to anything outlined by the International Bill of Rights. Other human rights highlighted by the GRI include children’s rights with regard to abusive labor and rights of indigenous peoples.

Labor Standards

This is another large umbrella that can include a number of issues. For example, things such as labor-management relations (how an organization communicates “significant operational changes”) and freedom of association and collective bargaining (giving workers’ organizations the right to negotiate terms of employment, working conditions and more) factor into calculations.

Employee Engagement

As defined by Forbes, this means the “emotional commitment [an] employee has to the organization and its goals.”

Gender and Diversity

This one is fairly self-explanatory; does a company feature a wide array of people across all types of demographics? And, as the GRI emphasizes [PDF download], do they have equal opportunity to succeed?

Customer Satisfaction

Are customers pleased with an organization’s products, services and capabilities?

Data and Privacy Protection

Between keeping people’s data secure and not misusing it, data and privacy protection play a key role in an organization’s social compliance, and A Company’s Cybersecurity Practices Impact ESG Ratings.

Community Relations

Does a company engage with, and have a positive impact on, the community?

 

How the ‘S’ Could Affect the Bottom Line

As it is with environmental factors, it’s not hard to see the effect the social aspects of ESG have on society. But many of them can affect a company’s finances as well.

For example, promoting diversity and equality in a company means said company gets access to a broader selection of employees, thus potentially bringing more skilled workers into the fold. Greater equality in society, meanwhile, “promotes social stability” and “supports further economic development,” according to the GRI.

Companies can also attract better talent, per McKinsey & Company, through their behavior and reputation in the social sphere, while having a “social stigma” can have the opposite effect; such positive or negative views can be formed based on a company’s stance and performance on human rights, labor standards, and much more. McKinsey also points out how better-engaged employees are more productive employees, directly affecting a company’s finances.

Scandals in any of the areas can have a drastically negative effect on brand reputation and company value. On the subject of data privacy, for instance, data breaches have been shown to do long-term damage to a company’s stock price.

 

How the ‘S’ is Calculated

In ESG analysis, ESG scores are, naturally, determined based on a company’s performance in all three of the pillars.

Just as there is no set, single standard for ESG reporting, there is no single method for how ESG analysis is conducted. The weighting of the above “S” factors, along with all the factors in ESG, can vary based on who is doing the analysis.

In its May 2022 methodology explainer, Refinitiv put the “S” factors into four buckets: workforce, human rights, community, and product responsibility. They then divided two of the buckets into themes: workforce (diversity and inclusion, career development and training, working conditions, and health and safety); product responsibility (responsible marketing, product quality, and data privacy), while leaving the human rights and community buckets as all-encompassing. Refinitiv then weighted these categories—13% for workforce, 9% for community, 5% for human rights and 4% for product responsibility—and applied them to the final overall score.

Of course, there are other ways social pillar issues are woven into an ESG score. In its December 2022 methodology, MSCI, considered one of the top sources of ESG ratings, included several social categories, including gender pay gap, social violations, tobacco involvement and more. (Their specific percentage weights were not disclosed in this methodology breakdown.)

 

The Evolution of ‘S’

Social factors assessed in ESG analysis change and evolve over time, often reflecting society. For example, according to Bloomberg in 2020, the treatment of employees during the early months of the COVID-19 pandemic played a role in how companies were analyzed within the social pillar. This is a concern that obviously did not exist the previous year.

No matter what exactly the issues are, ESG analysis for investing retains a consistent focus: to determine how well a company is addressing risks and opportunities relevant to its business and therefore, potential projected profits or losses.

 


At Rowling & Associates, we are dedicated to acting in your best interests and firmly committed to your financial well-being. Please don’t hesitate to contact us directly if you have any questions about how we integrate ESG analysis to manage your investments. We’ll be happy to walk you through our investment selection process and discuss any concerns you might have regarding your own personal portfolio.


 

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