The Johnson Papers || Company CSR and ESG: Their Meaning and Substance
Both CSR and ESG have become part of the mainstream of company and investor policy which is now demanding the attention of our boards and most talented executives.
What is the Difference Between CSR and ESG?
Both CSR and ESG have become part of the mainstream of company and investor policy. Once they were at the margins of company interests but now they are firmly part of company profiles and often embedded in company purpose (see The Johnson Papers || The Purpose of the Corporation).
The concepts of Corporate Social Responsibility (CSR) and Environmental and Social Governance (ESG) are often used interchangeably – and there is a good deal of overlap between the two.
But the terms have different origins and implications. CSR has a longer history and was employed initially by companies who wanted to highlight aspects of their social responsibility (which over time was widened to include environmental responsibility). At first these were often leading international companies employing CSR policies to highlight their responsible and mature approach to business. Over time CSR performance indices became almost universally applied for all large corporations.
ESG came later, and was developed by the large international institutional investors who determined to set their own criteria of corporate environmental and social performance. The emphasis upon measuring the impact of corporate activity on the environment was much more upfront and explicit. The concern for social responsibility equally was more closely defined and exacting (no longer to be confused with more general acts of philanthropy).
But the crucial distinction between CSR and ESG is the introduction by the investors of the “G” for governance. The large institutional investors saw governance as the crucial corporate capability to be measured in order to ensure the delivery of not only environmental and social responsibility – but most importantly – the assurance of sustainable value creation.
Here is the crux of the distinction between CSR and ESG:
- CSR was developed largely by companies, in conjunction with consultancies and rating agencies, interested in projecting and measuring the extent of corporate social and environmental responsibility as part of their profile with investors, customers, employees, government and community.
- ESG was developed by institutional investors, as they wanted an independent and rigorous set of measures they could apply across the companies in their investment portfolios, and a responsibility ruler they could run across any intended corporate investment.
The reason that investors wanted to see their own measures applied, was of course a lingering view that company driven CSR policies and measures might be influenced too greatly by company executives view of the interests of the company, and possibly descend into cosmetic presentation or even illusory achievements.
“It is now realised...there are considerable market opportunities in transforming towards environmentally sounder and socially acceptable products, processes and services.”
What Do CSR and ESG Measures Actually Mean?
Despite the evident growth of interest in and commitment towards corporate social and environmental responsibility, in some quarters the concept and practice of CSR still provokes a degree of understandable scepticism, partly due to CSR’s occasional record of lapsing into apologetics for unacceptable corporate behaviour. Particularly in the resources sector, but in other industry sectors too, some companies were seen to express support for CSR ideals, while clearly pursuing profit maximisation strategies often neglecting the ultimate environmental and social consequences.
David Vogel in a review conducted for the Brookings Institute, The Market for Virtue: The Potential and Limits of Corporate Social Responsibility (2005), was the first to clearly set out this dilemma. He contends there are many reasons why companies may choose to behave more responsibly in the absence of legal requirements to do so, including strategic, defensive, altruistic or public-spirited motivations. However, despite pressure from consumers for responsibly made products, the influence of socially responsible investors, and the insistent call for companies to be accountable to a broader community of stakeholders there are in Vogel’s view important limits to the market for virtue: “CSR is voluntary and market driven, companies will engage in CSR only to the extent that it makes business sense for them to do. Civil regulation has proven capable of forcing some companies to internalize some of the negative externalities associated with some of their economic activities. But CSR can reduce only some market failures.”
A number of important things have happened since Vogel conducted his survey of CSR in the United States. Firstly, international and national regulators have become more engaged in the protection of the environment and human rights, placing firmer legal requirements upon companies to act responsibly. Secondly, large international investors with a view to developing long term sustainable value creation have become much more insistent on environmental and social responsibility.
It is now realised by many large corporations that there are considerable market opportunities in transforming towards environmentally sounder and socially acceptable products, processes and services. Finally, markets in many sectors have powerfully reinforced the drive towards sustainability. For example, the meteoric rise of the market capitalisation of Tesla once it was recognised by the Nasdaq as the best bet in the international electric car market. (That convinced all the mainstream car manufacturers to suddenly introduce whole ranges of electric vehicles).
Cumulatively over time these changes in regulation, investment criteria, consumer sentiment and the direction of market forces has resulted in more robust, meaningful and impactful CSR and ESG standards being applied.
“Though there is more widespread adherence to CSR commitments now, there do remain some problems with the development and application of CSR.”
How Do CSR and ESG Contribute to Value Creation?
Enlightened CSR and ESG policies offer opportunities to create value through all-round improvements in business relationships and performance:
- Reduced regulatory intervention
- Enhanced reputation and stronger brands
- Better relationships with business partners
- More loyal customers
- More engaged staff and greater ability to attract them
- Cost savings
- New products
- Minimising risks
- Lower cost of capital
- Valuation premium
CSR has now evolved from referring to any philanthropic or social initiatives on the part of companies to encompassing a more robust and comprehensive approach to corporate financial responsibility, social responsibility and environmental responsibility.
The balance of emphasis often remains with the company concerned, however many major international corporations have signed up with one or more of the international ratings agencies such as the Global Reporting Initiative and/or the UN Social Compact. The GRI has over 10,000 companies reporting across the world, who are asked in detail to “report on their impacts on the economy, environment and people in a comparable and credible way” (GRI 2022). The UN Global Compact with more than 15,000 corporate signatories, sets out principles for meeting “fundamental responsibilities in the areas of human rights, labour, environment and anti-corruption.”
Though there is more widespread adherence to CSR commitments now, there do remain some problems with the development and application of CSR including:
- an over-proliferation of CSR initiatives at the international level and lack of clarity about how these initiatives relate to each other in a coherent way;
- an excessive focus on getting businesses to make commitments to CSR and not enough focus on enabling them to implement them effectively;
- an absence of credible monitoring and verification processes of CSR initiatives.
Similar forces that are impressing corporations towards taking a greater regard of CSR issues are guiding investment institutions towards addressing environmental, social and governance issues more directly in their investment policies and practices. A growing number of institutional investors in approaches to asset management explicitly include environmental, social and governance (ESG) criteria and metrics, either for ethical reasons or as relevant to investment performance.
Disclosure of the performance measures of ESG represents the next iteration of the relationship between companies and their investors. The International Corporate Governance Network (ICGN) and the Principles of Responsible Investment (PRI) have set out the Investor Agenda for Corporate ESG Reporting. These two influential bodies in the investment community suggest:
- There is a clear business case for ESG reporting for investors and companies.
- There is no single solution – one set of metrics or a single framework – that will satisfy all users of ESG data.
- At the same time, it would be beneficial for companies to disclose standardised ESG information at a basic level to complement more customised ESG reporting (ICGN/PRI 2018).
ESG performance reviews can address the really big issues that companies face. “As companies continue to grapple with finite natural resources, material sourcing from conflict zones and working to address economic inequality around the world, ESG is a means for organizations to address these concerns” (Navex 2022:2).
The Relevance of CSR and ESG
The relevance of the increasing rigour in both CSR and ESG performance measures is that they may provide more consistent, comparable, and credible assessments of the social and environmental impact the performance of companies. In turn this helps build better relationships based on integrity with investors, customers, employees and communities.
Thomas Clarke is a Fellow of the Royal Society of Arts, and editor of the Cambridge University Press Elements in Corporate Governance book series. Formerly he was Professor and Director at the UTS Centre for Corporate Governance.
GRI (2022) Global Reporting Initiative, https://www.globalreporting.org/
ICGN/PRI (2018) International Corporate Governance Network/Principles of Responsible Investment, Investor Agenda for Corporate ESG Reporting, https://www.icgn.org/sites/default/files/202106/ESG%20Reporting%20Discussion%20Paper.pdf
Navex (2022) A Definitive Guide to ESG, NAVEX.COMhttps://www.navex.com/en-us/resources/definitive-guides/definitive-guide-to-esg/
David Vogel, Brookings Institute, The Market for Virtue: The Potential and Limits of Corporate Social Responsibility, Washington: Brookings Institute (2005)
United Nations (2022) The Ten Principles of the UN Global Compact, https://www.unglobalcompact.org/what-is-gc/mission/principles
If you would like to explore the market for leading ESG and CSR executives, please reach out to Jason Johnson, Founder & CEO at Johnson Partners for a conversation on how we can support your search for top talent – [email protected] or +61 414 793 980.