How companies can rethink how they address social issues

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Key points: 

• Poor management of social issues can affect a company’s financial metrics, in our view, but it can be difficult to identify and measure such a diverse set of factors
• We have set out a checklist for how to establish robust data to track progress, and describe some of the challenges around oversight for investors to consider
• We think good management of human capital can help prepare businesses for future crises and help prevent damage from mental health issues in the workforce

The environment has been at the forefront of ESG for years due to the nature of the challenges faced by the planet – the governance pillar, meanwhile, has endured and toughened as those challenges emphasise the need for robust executive oversight.¹ Social has lagged behind. The pillar has proven difficult to define and the reporting process continues to be obscure for issuers. It is, however, central to business success and companies are now coming under increased scrutiny over how they integrate it into their decision-making and strategic thinking. We think the repercussions from poor management of social issues – from worker rights to supply chain management – can tarnish reputations and have real impacts on financial metrics which may directly impact our clients’ investments.

In this paper we will first examine the complexity of analysing the social pillar, seeking the most effective way to measure and document progresses and define responsibilities at senior level. Second, we will discuss what kind of improvements we may expect from companies on the metrics currently in use, to reflect the challenges faced by people and communities.

The complexity of measuring social factors

Measuring ESG factors requires the development of methods that use a robust and repeatable scoring system, forcing companies to demonstrate improvements. On social, the metrics generally used at company level face another challenge: Capturing the complex and changing nature of issues, constantly evolving due to sometimes unpredictable factors. The raw data can mask potential outcomes and repercussions. Improvements in numbers reflecting a situation at a given moment may obscure how a decision may be translated over the longer term.

The need for deep metrics

We believe the measurement of social factors is best articulated around a purpose. Adhering to certain values over the blind pursuit of short-term profit maximisation has been one of the main shifts in society recently. Companies now need to think about how they can contribute to society beyond philanthropic initiatives. For example, increasing accessibility of their products, which ranges from affordability considerations to distribution in areas of greater unmet needs. We think that a corporation that takes such a stance can potentially be highly rewarded in terms of both reputation and, ultimately, capital flows. However, this purpose and the targets set to achieve an objective need ‘deep metrics’ to effectively measure and improve social performance progress over time, and monitor the inputs, outputs and potential risks.

In our view, these metrics should:

• Demonstrate causal logic and define the results chain, which will detail the method through which actions are expected to generate results. The key inputs required to generate the desired outputs and outcomes, as well as the final results, should last over time, and not only satisfy a specific demand from the market or society at a given moment
• Establish the framing for how the company is positioned within a social context. Crises have shown that companies can adapt to deliver social value, whether through philanthropy or revenue-generating means. A new economic crisis will arrive eventually, and we believe that a well-defined purpose can help a company avoid mission drift or the pursuit of short-term responses that may involve compromises on its objectives
• Deliver accountability, especially at board level. A dedicated board member, a committee or the board as a whole should be accountable for the programme and its impact. This should help shape a strategy that can drive long-term value.

Clear responsibilities

A company’s board is responsible for determining who has responsibility for decision-making. However, effective board oversight requires a certain level of understanding of how social issues need to be integrated into business decisions, including strategic decisions and risk assessments.

An EY survey of nearly 400 public company directors in February and March of 2021 examined their perspectives, practices and forecasts for ESG. It concluded: “Most directors are approaching ESG as a compliance matter rather than as a strategic opportunity, and a number of them lack confidence in their understanding of shareholders’ expectations related to environmental and social factors.”

The paper showed that 57% felt “very confident” in their personal understanding of the materiality of social issues faced by their companies, far below the level of understanding reached by governance (83%) and raising questions over how companies might establish what is indeed material for their business.

This lack of confidence in understanding what matters most may be reflected in the overall oversight of these social issues. For example, on oversight of workforce diversity, equity and inclusion, the study shows that this is being take care of by the full board at 43% of respondents, then follows the compensation committee (27%), nomination and governance committee (19%), other board-level committee (5%) and audit committee (1%), while 6% of respondents said that board does not oversee this.

The corporate structure is not at fault here, but the wide spectrum of responses – from compensation to audit committees – raises question about the credibility of board oversight on social and where expertise may lie. Cross-skilling is real, but this division of responsibilities may impact the reporting of how companies deliver against pre-set objectives and who to hold accountable in case of failures, which in turn might create confusion around what actually needs to be done.

In our view, the absence of a consistent approach may negatively impact boards, and their members, directly. The growing expectation among investors, including AXA IM, that there is effective board oversight on ESG, may expose the laggards to ‘vote against’ campaigns and an increasing number of shareholder proposals on ESG issues.

On the social aspect, we believe that the integration of risks and potential issues into the board’s oversight greatly benefits the company. Before mentioning the positive impact of good functioning governance at board level, it may reduce liability and strengthen the response should one of those risks become reality.

Improving social metrics

The pressure on management over social issues has increased the risk of ‘social washing’ – the equivalent of greenwashing, where actions fail to match stated ambitions. This disconnect can sometimes fly under the radar and the risk may actually have been aggravated by datasets designed to respond to the urgent demand for quantifiable social metrics. In other words, data could be tailored to match the rhetoric but may not address the current challenges faced by employees or a portion of the society impacted by companies’ actions.

A case study: Measuring employee satisfaction

One of the most common ways to measure progress on social is the employee satisfaction survey. They can offer valuable information about a company’s workforce and identify possible ways to improve efficiency. They can therefore be used for employee retention in the long term. Well designed, they value workers’ input and give them an opportunity to express grievance when needed. It can make them feel like they are genuinely being heard. In fact, employee surveys work well for companies as they are a vehicle for influencing behaviour. Positive results can create commitment; negative responses invite a time of reflection.

There are flaws with surveys, of course. First, they are subject to recency bias, as they capture sentiment at a certain time if not done regularly – which leads to another issue: Indifference. Surveying your workforce several times a year has limited effect, simply because progress may not be visible over a short period of time.

Answers can also be influenced by apprehension about confidentiality, which may favour more positive feedback. In December 2021, a survey from the Trades Union Congress (TUC) of more than 2,209 workers in the UK showed that 60% believed they had been subject to some form of surveillance and monitoring at their current or most recent job, compared to 53% in 2020.^{2 3}

Surveys are often seen as a good way to drive participation and engagement, but simply getting the numbers up will not necessarily make things better and could see instances where bare data on survey completions are the target, rather finding the real challenges facing the workforce. Targets centred on driving employee engagement, rather than responding to any negative feedback, probably focus on the wrong end of the process. Conclusions can be quite vague, cheering an “exemplary employer” or concluding that staff “generally look forward to going to work.” However, we have seen examples of major corporations citing positive employee survey results while engaging in union-busting strategies, or suffering from very high rates of staff turnover.

Elevating and supporting people

This suggests that defining metrics by gathering data alone cannot work. Improving and delivering on social issues in a way that drives organisational change and performance should go hand-in-hand with a profound change of culture. Initiating focused action is a more pragmatic and potentially complementary approach that can leverage existing skills and talents.

In the 1990s, Nike was accused of using sweatshops in Southeast Asia. The company’s reputation was severely damaged, as the then-CEO Philip Knight said: “The Nike product has become synonymous with slave wages, forced overtime, and arbitrary abuse.”⁴

This sort of issue could be tackled in two possible ways: Enhancing compliance programmes or adding more training hours, which are traditionally well received and are indeed measurable over time. Instead, Nike used another other way to solve the problem: Lean manufacturing, similarly to the method used by Toyota: the “Toyota Way”.⁵

The idea was to teach line workers to accomplish a range of different tasks rather than a single repetitive task, encouraging them to have their say on quality control, make necessary improvements in production, and elevate them with a higher skillset. As certain factories were deemed an unfit work environment, Nike hired managers to transform them, after auditing every single one. A study⁶ found that the adoption of lean manufacturing resulted in a 15% reduction in non-compliance with labour standards such as wages or working hours and generally improved working conditions in their factories in several countries.

Elevating employees so that they can measure the impact their work is having should make their job feel more meaningful and appreciated, either by their employer or customers, which in the end may result in better retention of talent. In our view, investors should push for developed plans and significant assessable results from firms considering going down this road.

Staying ahead of future crises

In some circumstances, especially at a time of crisis, some employers are stepping up to help out workers and communities at a greater scale. As living costs rise, a growing number of workers will find themselves in a stressful situation where their salary is simply not enough.

Companies are facing increasing pressure to deliver solutions which would usually have fallen outside of the workplace. There are several ways to support employees, and the ways firms navigate such difficult times – and the repercussions this has for the business – will be closely scrutinised by investors, similarly to events during and immediately after the COVID-19 pandemic.

Supporting flexible working and planning and reporting what can be done, and what has been done, to manage different working patterns should be top priority in our view. Many employees will struggle to afford rising energy costs and we might see a temporary shift away from the work-from-home trend. Allowing employees to come back to their workplace more often, by offering to cover their travel costs partially or totally, can be an effective way, among many, to positively impact their financial wellbeing. A potential spike in employees seeking salary increases will demand careful management and we will closely monitor these trends across the workforce 2023.

Fundamentally, we believe a sensitive approach and potential investment may bring a return. When employees are struggling financially, it can deeply affect their ability to focus on their work and increase on-the-job mistakes, as well as reducing cognitive capacity.⁷

Supporting mental health

Integrating mental wellbeing, flexibility and fair pay in corporate strategy is now key for employees. One recent report from accountants Deloitte found that the annual cost to UK employers of poor mental health has increased by 25% since the start of the pandemic, considering factors like absenteeism, presenteeism and turnover.⁸ Identifying and addressing what drives these behaviours can be decisive.

There is a growing expectation that companies should take responsibility for supporting their employees’ emotional stability. We think this could be a significant differentiating factor in the context of the so-called ‘great resignation’ which has seen about 48 million people quit their jobs in 2021 in the US,⁹ a quarter of UK employees wanting to change jobs,¹⁰ and pushed a large number to pursue ‘quiet quitting’ – effectively doing the minimum required – in response to what they have found to be harmful corporate cultures and job insecurity.

Companies may not need to reinvent the wheel. A few tweaks to what already exists could bring significant improvements. For example, companies could measure the gap between compensation and the real cost of living in a context of likely recession, a situation that increases stress levels and therefore risks disengagement at work.

They might also re-evaluate promotion opportunities by calculating the average period between the time spent in the same role until dissatisfaction or resignation. That could help identify employees that a business wants to retain with targeted interventions. This calculation can include access to training opportunities with potential individual growth leading to better jobs obtained further up the company.

Finally, companies could make efforts to manage higher-risk groups by understanding how their employees sit in categories such as location or profile to allow a more tailored approach for these groups – a worthwhile acknowledgment, we think, that not all employees are affected by circumstances and pressures in the same way.

In the end, companies need to explore different approaches for addressing social issues. The questions around this are evolving rapidly and in an uncertain environment. Managing this process requires real accountability and adaptability by defining clear responsibilities and appointing people with significant expertise on social matters at board level.

A better understanding of the challenges of our society and a lucid vision from decision-makers will improve the setting for more ambitious and realistic metrics, reflecting both investor demands and the integration of people and communities’ concerns in the overall business strategy. Our belief is that the upfront investment companies make in their human capital should pay off in the long run, as it is the only way for them to retain their competitive advantage.