by MARCIA NARINE WELDON
PHOTO BY JOSHUA PREZANT
"Environmental, Social, and Governance” has become a buzzword for businesses, investors, regulators, politicians, and consumers in recent years. Law firms now market ESG practice lawyers—a concept that did not exist two years ago. Under an ESG framework, investors make investing and purchasing decisions based on non-financial environmental, social, and governance factors. Companies that touted corporate social responsibility programs in the past to highlight their internal commitment to sustainability and society are now focusing on ESG based on the elements and criteria investors use to determine what to invest in and when to disinvest. Governments worldwide have enacted mandatory non-financial disclosure regimes that also focus on ESG factors.
Today, one in $3 invested in the United States has at least some focus on social responsibility. Under a negative screening approach, investors exclude companies that produce products that can harm society, including alcohol, tobacco, weapons, and gambling. Investors using an integration approach assume that companies with a strong ESG program tend to have more engaged workforces, lower turnover, and stronger relationships with their stakeholders, ultimately leading to higher profitability. In an impact investing approach, individuals or funds invest in microenterprises and other vehicles intended to solve problems that governments and charities cannot do while also making a profit for investors.
Under the “E” prong, investors focus on the financial impact of climate change, greenhouse gas emissions, resource depletion, water use, deforestation, decarbonation, and other environmental issues throughout a company. In the U.S., the Securities and Exchange Commission is implementing a disclosure regime for public companies related to climate change. The recent rise in severe weather and the resulting loss of life and property has made this issue even more urgent to consumers who may have been skeptical about global warming. To assess these commitments, investors, nongovernmental organizations, and consumer watchdogs use a variety of objective metrics, and increasingly, regulators are cracking down on “greenwashing,” where companies claim that their products, services, or investment vehicles are more environmentally beneficial than they are. This is particularly important because consumers increasingly claim that they want to purchase from companies that demonstrate a commitment to the environment, even if the companies are not legally required to do so.
The social factor has increased in prominence in the public eye, particularly in an era of prolonged social and political unrest. The “S” factor includes working conditions, child labor, health and safety, human rights, employee relations, and diversity. The drive toward diversity, equity, and inclusion stems in part from the “Me Too” movement combating sexual assault and harassment in the workplace; the murder of George Floyd and other Black and brown people at the hands of the police; the rise in hate crimes against Asians; and the increase in antisemitism.
However, well-meaning companies that issue statements of support for racial justice often face immediate and public backlash from their employees who point out inequities in the workforce, poor retention, or underrepresentation of diversity in management. Others have faced shareholder derivative lawsuits based on public statements that didn’t match the reality that employees see day-to-day. Many have faced a backlash from doing what some perceive to be too much in the diversity, equity, and inclusion space, with some states passing laws limiting the types of diversity training.
The other most prominent area in the “S” arena is human rights, which encompasses forced labor, safety, child labor, and the treatment of Indigenous peoples. When people hear the term “human rights,” they often think about authoritarian regimes torturing citizens. Businesses, however, play a significant role in human rights, and even some of the largest, most reputable companies are often responsible or complicit in substantial human rights abuses.
The U. S., the E.U. nations, and other powerful countries will not likely vote to ratify a binding treaty on business and human rights. Instead, most large multinationals pledge to adhere to the voluntary principles of the U.N. Guiding Principles on Business and Human Rights, which require states to protect human rights; companies to respect human rights by doing no harm and conducting due diligence; and both the state and companies to provide judicial and nonjudicial access to remedy to aggrieved persons. The U. S. government is currently drafting its second National Action Plan designed to incentivize companies to mitigate human rights impacts.
The U.S. government has also passed Dodd-Frank section 1502, the conflict minerals regulation, which requires companies to disclose whether they have sourced certain minerals from the Democratic Republic of Congo and surrounding nations due to the high rate of child labor, forced labor, and rape as a weapon of war. California, the E.U. and some nations have also passed mandatory and voluntary non-financial disclosure regimes.
The governance factor includes executive pay, say on pay, bribery and corruption, political lobbying and donations, tax strategy, and board diversity. Although consumers focus on the “G” factor the least, investors, employees, and NGOs pay attention. For example, watchdogs named and shamed companies that made political contributions to politicians who refused to accept the validity of the 2020 U.S. election and who chose to incorporate in tax havens while employees and average citizens paid high tax bills.
Notwithstanding the noble purposes behind the increased focus on ESG, many prominent commentators and government leaders oppose ESG investing strategies noting that negative screening could harm pension funds and others that would benefit from having some of the “sin stocks” in the portfolio. Others say that investment funds should focus solely on profits and not the social good. Nonetheless, an ESG focus is here to stay.
Marcia Narine Weldon is director of the Transactional Skills Program, Faculty Coordinator of the Business Compliance & Sustainability Concentration, Transactional Law Concentration, and a Lecturer in Law. Her teaching and research interests include corporate governance, employment law, regulatory compliance, corporate social responsibility, and the intersection of business and human rights.
