As a violinist, I was interested to learn that Irish violinist Patricia Treacy performed at President Biden’s inaugural mass held at 7:30 AM on Inauguration Day at a Washington cathedral. For the occasion, Ms. Treacy performed on a Stradivari violin worth around $4 million.
This Stradivari wasn’t made by the famous 17th century Cremonese luthier Antonio Stradivari whose instruments have become the gold standard for violin makers ever since. Instead, the violin Ms. Treacy played was made by Antonio’s son, Omobono Stradivari.
Omobono likely was primarily assigned repair work in Antonio’s shop. Compared to Antonio, few surviving violins are attributed to Omobono, and those are considered “clumsy” compared to his father’s work. And there is speculation that Omobono’s business interests primarily laid outside violin making.
Omobono might not have kept up with the productivity or workmanship of his illustrious father. But his instruments still reflect considerable artistry compared to other makers of his day and are not to be overlooked.
The same comparison might be made of large, publicly-traded corporations and their small, privately-held business counterparts. Although the former may generate more news reports and generate more revenue and government regulation, privately-held businesses far outstrip public companies in number. And small business is the backbone of many local communities.
On March 4, 2021, the Securities and Exchange Commission (SEC) announced that it was creating a Climate and ESG Task Force to focus on disclosure and ESG-related misconduct. Although the SEC’s focus likely primarily will be on disclosures by reporting companies and ESG funds, small businesses and privately-held companies also can create a significant impact with ESG programs.
This article provides a basic primer on ESG principles and discusses how small businesses and privately-held companies can positively affect their communities and stakeholders with ESG initiatives.
What is ESG?
Environmental, Social, and Governance (ESG) focuses on a company’s efforts in those three areas. ESG is used by investors when considering where to invest. ESG also should be a factor in developing a company’s policies and products.
ESG requires a holistic evaluation of the business to determine how it serves its stakeholders inside and outside of the company and the environment where it has influence. The relative focus on environment, social, and governance will vary by company.
Focus on environmental should include the company’s use of natural resources, conservation efforts, and recycling and sustainability. Companies also may evaluate their carbon footprint and energy use. If the business involves the use of chemicals, the company might determine if there is a more environmentally friendly option.
Social issues require evaluation of the company’s diversity and inclusion efforts from the boardroom to entry-level employees. Wellness programs and work environment must be evaluated to assure that employees are treated fairly and can work safely and without harassment. Companies also should consider their opportunities for social impact to make the world a better, safer, and more just place where all people can thrive.
Governance focuses on a company’s leadership and how it guides the company to have a positive impact. Governance also will include evaluating the board, executive, and management composition for diversity and inclusion. It also focuses on equity in compensation, transparency with investors and other stakeholders, and integrity.
Why is ESG Important?
Not only is it important that companies use their resources to make the world a better place, but ESG also is good business. For example, conserving energy, using renewable energy, and recycling can reduce costs and help the environment. Creating a diverse workforce where employees are valued and treated fairly will attract top talent, improve morale, and reduce turnover.
Millennial job hunters, consumers, and investors value ESG and may bypass a company that doesn’t. And Gen Z, which are entering adulthood, is the most diverse generation ever, with only 52%. For Gen Z, addressing climate change, equity, and social justice aren’t optional for Gen Z. With Millennials and Gen Z becoming important stakeholders, companies that ignore ESG initiatives aren’t likely to survive.
Eight of the top ten global risks to business identified by the World Economic Form are ESG-related. Further, according to McKinsey & Company, ESG can improve the bottom line. ESG can lead a company to new markets and business opportunities since consumers may seek companies dedicated to ESG.
Conservation efforts can lead to significant cost savings, for instance, in energy costs. And creating an ESG program can help a company futureproof its operations by anticipating changes (e.g., carbon credits, bans on plastic bags, etc.).
Finally, employees who are treated well and enjoy a workplace free of discrimination and harassment are likely to be more productive and less likely to leave their jobs. And employees who are treated fairly are less likely to leave their jobs or file regulatory complaints.
Why Should Small Businesses and Privately-Held Companies Care about ESG?
In March, Acting SEC Chair Allison Herren Lee spoke about the SEC’s enhanced focus on ESG, which she said was driven by a “shift in investor focus.” She noted that “ESG risks and metrics now underpin many traditional investment analyses on investments of all types–a dynamic sometimes referred to as ‘ESG integration.’”
According to Lee, the “perceived barrier between social value and market value is breaking down. This change is driven by investors, lenders, asset managers, and ultimately consumers, making it an essential consideration for every business, whether or not under SEC regulation.
Further, the SEC now has set the expectation that reporting companies accurately disclose ESG information and programs. Investors and other stakeholders naturally will come to expect similar information from private businesses. Indeed, Lee Gardella, head of Investment Risk and Monitoring at private equity asset manager Schroder Adveq believes “private markets are a better place for an investor to apply their sustainable goals than the public markets.”
The Process of Developing an ESG Strategy
The first step in developing an ESG program is self-reflection. Every business needs to ask difficult questions such as:
Is there diverse leadership and employees at every level in the company? What effort is the business making to recruit a diverse workforce?
Is the work environment free from discrimination and harassment? What does the company do to foster employees’ mental and physical health? Do employees receive a fair, living wage?
How does the company use natural resources? Does it use renewable energy sources and conserve water? What is the company’s carbon footprint? Does the company recycle and purchase recycled goods where possible? How do the company’s operations impact the land, water, and plant and animal life?
Do leadership and management deal fairly and transparently with stakeholders, including employees, customers, vendors, and investors?
What governmental regulation is the business subject to? Is the business in compliance with equal opportunity, wage hour, environmental, and ethical requirements?
After a business identifies its ESG successes and areas for improvement, it should develop strategies to address areas needing improvement. That ESG strategy should be integrated into the business’ culture and operations.
Key Elements of an ESG Strategy
Although contents of a business’ ESG strategy will depend upon its industry and the business’ unique circumstances, every ESG strategy should include these considerations:
A successful ESG strategy will involve all of a business’ stakeholders, including the board, executives, staff, investors, and consumers. The board may adopt the ESG strategy, but only after seeking information from other stakeholders. In addition to involving management and employees, a business may also seek customer or investor input through surveys.
Address All Three ESG Components
Balance is essential in business and in ESG strategies. An effective ESG strategy will not emphasize one or two of the areas to the neglect or exclusion of the other(s).
Many businesses may find it easier to have a strategy for one or two of the three ESG components (environmental, social, governance) than the others. Frequently the area where the business finds it most challenging to develop a strategy will be the one where the business needs to place the most focus.
For example, a business whose C-suite and board comprised of white men may find it difficult to attract women, people of color, and LGBTQ persons. Or the company may be in an industry where such individuals are underrepresented. Yet, a strong diversity program might be the best way for the business to demonstrate its commitment to ESG. A diversity initiative also may help futureproof the business by bringing new ideas and opportunities to the table.
Or on the social side, it may be difficult for a business to obtain management or owner approval for initiatives that increase employee or worker safety costs above minimum required levels at the expense of owner profit. Yet, in the long run, a happy and healthy workforce may lead to improved financial results.
Top to Bottom Education and Commitment
360-degree engagement doesn’t end when the ESG strategy is developed. Instead, all business personnel, from the board chair to the entry-level employee who started yesterday, needs to be educated about and engaged in carrying out the business’ ESG strategy.
Board, management, and staff must be educated about and committed to the business’ ESG strategy. And ESG should become a consideration in every business decision.
The book of Matthew in the Christian Bible says, “For where your treasure is, there will your heart be also.” As with a person, a business’ “treasure” might not refer just to money but also time and focus.
The business that adopts a strong ESG strategy but continues to place the lion’s share of its funds or employee time on practices that undermine that strategy isn’t likely to succeed. The business’ allocation of time and money and choices for community involvement should support its ESG strategy.
Disclosure and Marketing
Usually, it is a good idea for a business to promote its ESG strategy, even if it isn’t legally obligated to do so. By publicly committing to its ESG strategy, the business is more likely to follow through. Plus, public discussion shows customers, investors, and competitors of the business’ commitment to ESG and could encourage those stakeholders to make similar commitments.
Continued Self-Reflection and Evaluation
Businesses should develop metrics so they can continuously evaluate the effectiveness of their ESG strategies. If ESG strategy isn’t effective in one or more areas, the business should make changes designed to increase impact
ESG is dynamic. Yesterday’s social and environmental concerns different from today’s concerns, and tomorrow’s concerns will be different yet. The most effective ESG strategies will proactively anticipate and be ready for future industry ESG concerns. And the business should make the investments necessary, so it isn’t left behind when those ESG concerns become reality.
This series draws from Elizabeth Whitman’s background in and passion for classical music to illustrate creative solutions for legal challenges experienced by businesses and real estate investors.