Consideration of environmental, social, and governance (ESG) issues is becoming increasingly important for companies when conducting business and in dealings with investors and employees. The increased emphasis on ESG poses unique and difficult challenges for companies that can have a direct impact on their financial performance and broader perception as responsible corporate citizens.
With Earth Day, a global annual event to promote environmental protection occurring on April 22, 2023, companies’ efforts to promote sustainability will be in the spotlight. Employers may want to take the opportunity to consider the risks and opportunities with ESG initiatives and policies.
What is ESG?
ESG, which stands for “environmental, social, and governance,” is a widely recognized framework by which investors and stakeholders, including employees, customers, and suppliers, evaluate businesses and their efforts to prioritize sustainability and ethical business practices. The concept has existed for decades, but its modern understanding can be traced back to the 2004 report by the United Nations produced in conjunction with financial institutions titled “Who Cares Wins.” That report suggested, among other things, that companies implement ESG principles into their policies, that investment analysts gain a better understanding of ESG and long-term value creation, and that regulatory frameworks require more ESG disclosures and accountability.
In general, the ESG components can be defined as follows:
The environmental component broadly refers to the consideration of an organization’s efforts with regard to addressing environmental challenges, including pollution, climate change and related risks, and conservation, as well as a company’s overall environmental impact. In some circumstances, inadequate attention to environmental issues may create regulatory compliance concerns for companies. With regard to employment issues, the environmental component could include issues such as policies to encourage employees to implement environmentally responsible behaviors at work.
The social component centers on relationships and addresses how companies manage relations with employees, financial stakeholders, and the communities in which they operate, how they maintain workplace health and safety, and how they address the broader sociopolitical environment. From an employment perspective, the social component of ESG encompasses issues such as diversity, equity, and inclusion (DEI) initiatives, practices impacting pay equity and pay transparency, and relationships with labor unions. The manner in which companies treat their human capital is increasingly important for investors as well as employees, including recent entrants to the workforce who increasingly expect employers to be transparent and responsive to workplace concerns and broader social issues affecting the communities in which companies operate.
The governance or “corporate governance” component focuses on the structures and processes that control organizations and how they can be more transparent and accountable. This can include the composition of boards of directors, conflict-of-interest issues, executive compensation, accounting and disclosure practices, and anticorruption efforts.
Impact on Employers
Consideration of ESG may now be considered critical for employers as employees, job candidates, and investors increasingly evaluate companies with respect to ESG-related factors. Some studies suggest that beyond traditional compensation and benefits issues, employees, particularly those in the younger generations, want to see diversity in their workplaces and employers that are socially conscious.
Environmental and sustainability initiatives are also part of that equation and are an integral part of an organization’s broader ESG goals. Beyond adjusting products and services to reduce their environmental impact, some employers have enacted policies to encourage environmentally friendly behaviors by employees. These policies can include providing incentives for clean commuting, such as carpooling or using public transit, leveraging technology to reduce the use of paper for employee-facing and other internal processes, and practicing recycling in the workplaces.
Moreover, ESG factors are now important factors considered by investors and sought by employees in their retirement investments. In 2022, the U.S. Department of Labor issued a rule that explicitly allowed fiduciaries of employee retirement plans regulated by the Employee Retirement Income Security Act of 1974 (ERISA) to consider ESG factors when making investment decisions or exercising shareholder rights. In March 2023, President Biden vetoed a bill that would have reversed that rule, which some lawmakers have criticized as politicizing retirement investments.
ESG considerations are becoming increasingly important for employers. With shareholders and other investors, clients, customers, and workers demanding greater accountability from companies and organizations, prioritization of ESG may better position companies for recruitment and retention of talent, investment, and overall long-term stability. At the same time, employers may have to tread carefully to ensure that ESG initiatives align with their business goals. Employers may want to review their current ESG initiatives, policies, and strategies and consider how they communicate them with their workforces and other stakeholders. In some instances, proactive and privileged audits of human capital issues may position employers to identify and address potential vulnerabilities and avoid more serious reputational challenges.
Ogletree Deakins’ Environmental, Social, and Governance (ESG) Practice Group will continue to monitor developments with respect to ESG issues and will provide updates on the Employment Law blog as additional information becomes available. Important information for employers is also available via the firm’s webinar and podcast programs.