Multinational entities and governments are pushing for more action regarding Environmental, Social and Governance (ESG) issues. As a result, enterprises increasingly integrate the ever-changing social and environmental factors into their business strategies. The concept of business success has changed and so must the actions they take. But what exactly is ESG? ESG is a set of standards to guide corporate policies to ensure sustainable development in the fields of environment, social and corporate governance.
Only twenty years ago, if one would ask a group of individuals with a business background about the main objective of any business – its key purpose – the crowd would chorus: ”shareholders’ wealth maximization”. This mantra reflected the residuals of an influential school of economic thought across several decades, based on the understanding that financial results are the only measure of a business’s success. According to these economists, other objectives, such as social causes, create an unnecessary cost for businesses and do not fit with its main goals. They argued that if enterprises were successful at developing and achieving their financial objectives, this would be the best contribution to resolving other concerns. Growth and profit would lead to increased employment, higher wages, individual growth. Anything besides that is not the concern of a business, but something others should take care of – government, the non-profit sector, charitable organizations, etc. This makes sense, right?
However, this line of reasoning was facing significant challenges despite the benefits of industrialization in the form of new jobs and economic growth. In the pursuit of profit, there was an increasing number and frequency of instances where businesses, most notably expansive multinationals, had a negative impact through questionable labor practices and actions damaging to communities and the environment. Moreover, the concern for the environment and a stronger case for global warming placed an even greater focus on the role of corporations and the need to understand what sustainable development should look like. It was clear that by focusing on profit, businesses were responsible for generating so-called external costs that nobody was paying for. Indeed, the proverbial free lunch does not exist, and things had to change.
It became more evident that businesses affect many and thus have responsibilities toward a wide array of individuals and groups, both internal and external. The stakeholder model was born. A key role of managers became to understand the often-divergent interests of their stakeholders and balance them with the key objectives of the business. Fuelled by campaigns by increasingly powerful pressure groups, irresponsible and unethical conduct by businesses was in the critical eye of the global media like never before, which heightened awareness of the issues and shaped public opinion worldwide. Enterprises saw the multifaceted and long-term consequences of their negative practices through tarnished reputations, which now undeniably had a knock-on effect on financial results and share prices, their main objectives. As a result, businesses realized that their success is multidimensional. They understood that besides the financial aspects of success, they must also look into social and environmental aspects, which require equal attention. The triple bottom line concept was born.
In the same vein, socially responsible investment (SRI) movements encouraged investors to incorporate these considerations in the capital markets through selective investment practices, aiming to direct capital flows into responsible businesses. The social enterprise model, which comprises businesses with primarily social objectives that invest their profits back to benefit society, also became popular.
Another modern expression that became widely used to encapsulate the stakeholder concept is corporate social responsibility (CSR). Proponents of CSR argue that not only will society benefit from their socially responsible actions, but there are opportunities for businesses adopting such policies to boost profit because they are socially responsible. Many prominent businesses began publishing annual CSR reports, emphasizing the importance of non-financial factors for their business. However, critics argue that CSR, as a set of voluntary activities, is just a PR stunt to make profit-driven corporations seem more socially conscious. The controversy persists, though a strong case for the former statement has already been made some time ago.
In 2005, the UN partnered with key financial institutions to investigate the true bottom-line relevance of social responsibility from the investor perspective. The report titled “Who Cares Wins” launched the term ESG investment (Environmental, Social and Corporate Governance) and showed that considering these factors in investment decisions did make hard financial sense. The report also produced recommendations that have shaped the agenda and helped develop a vast ESG market currently valued at EUR 20 trillion. Hence, the US Securities and Exchange Commission (“SEC”) stated that it views ESG reports as highly relevant while global financial markets have seen the creation of sustainable indices and market experts introduced ESG company rankings. All this was a catalyst for legislators and regulators to take an ever more normative approach to the array of underlying issues.
Indeed, pressing matters of sustainability have in recent years pushed the agenda significantly beyond self-regulation and voluntary activities into the territory of law. Numerous governments and institutions across the globe are passing regulations making these considerations mandatory and likely to have a fundamental impact on businesses. For instance, the EU passed a broad range of rules regulating this area, including non-financial reporting requirements and standards, ESG benchmarks, measurements and disclosure requirements for businesses, recommendations on fostering a long-term approach to corporate governance, channeling capital flows into sustainable economic activity, etc. Finally, the rules incorporated in the famous European Green Deal are likely to affect not only enterprises in the EU but many exporters to the EU wherever they may be…
Though the legal environment is not the same everywhere, the focus on ESG is such that businesses in an increasingly globalized world must prepare for what already is a new reality and understand the inherent opportunities and risks. Incorporating ESG considerations into the core of the overall business strategy is gradually becoming a necessity for all businesses and a fundamental part of building sustainable business success in the long term.
So, if we were to today ask what the main purpose of business is, we would likely be met with a set of much longer and more varied answers than before, as the world struggles to cope with some of the most important issues yet.
In the articles to follow, our experts will delve into the details of this critically important legal area and walk us through what we need to know.
