Nice Guys Finish First: Getting Ahead of the Competition with ESG

In the ruthless world of business, nice guys are supposed to finish last. Until recently, this sentiment reflected the common school of thought in business and economics; influential twentieth century thinkers believed that businesses suffer financially if they mitigate their environmental impacts, or go above and beyond for their employees. But more recent research reveals that being one of the nice guys in business usually carries financial benefits. For example, one landmark study from the US found that, between 1984-2009, companies with outstanding employee satisfaction outperformed their competitors by 2.1%.

The business world has increasingly pursued nice guy aims over the past decade, seeking to safeguard the environment, develop fair relationships with clients and employees, and maintain just and appropriate corporate governance structures. The recent surge in interest in Environmental, Social and Corporate Governance (ESG) is at the heart of this trend.

What is ESG?

ESG is a framework for recognising the social and environmental value companies produce, aside from their direct financial results. ESG includes a business’ sustainability, its social impacts and working conditions, and the capacity of stakeholders to have their say on how the business is run.

The recent interest in ESG is the latest in a longer lineage of concerns about how commercial activity affects the world. For example, in the 1970s and 1980s, many companies across the globe refused to engage in business dealings with South African companies because of the apartheid racial regime. Over subsequent decades, corporate social responsibility principles have inspired businesses to pursue ethical and philanthropic aims. ESG has emerged out of these existing movements, but with far more wide-ranging goals.

ESG essentially assesses how businesses make society – and the economy – function better as a whole. Environmental considerations relate to land, one of the factors of production needed for economic activity. These considerations include managing water, waste and carbon emissions, and using clean technology and renewables. As the environment thrives, it provides a platform for societies (and economies) to flourish.

Social considerations include ethical supply chains and data security, as well as workers’ health, safety and personal development. Corporate governance includes the revenue spent on executives’ salaries, tax transparency and ESG reporting, the diversity of workers and board members, and the protection of human rights through company policy. Although social and corporate governance criteria may seem idealistic, they reflect more than just the moral fibre and long-term viability of a company’s operations. Much like ESG principles more generally, they also frequently correlate with short-term risk management.

For example, prior to high-profile data breaches in 2017 and 2018, Equifax and Facebook scored low on ESG ratings for data security. Clearly, the capacity of large tech firms to protect people’s data is not only an ethical issue – it is a matter of risk. Share prices tanked for both companies after the breaches. Beyond these examples, ESG measures often correlate with how well a company is run and how well the company is insulated against risk, which explains the relationship between nice guy corporations and success.

Government regulation

Nonetheless, the government does not yet comprehensively regulate ESG in Australia at any level. While ESG themes are laced throughout the Australian legal system, many significant gaps remain. Regarding environmental regulations, the precautionary principle and the principle of intergenerational equity have been included in some regional statutes since the 1980s. In the absence of the kind of clear regulation around sustainability reporting and performance that exists in parts of Europe, Australian companies often adhere to various non-standardised ESG frameworks and only report under them voluntarily.

The new Albanese government has pledged to address this issue, bridging these gaps with additional regulations and legislation. While the new government is seeking to address pay equality, they are mainly proposing indirect methods, such as strengthening union bargaining powers. New rules relating to ethical supply chains will also likely pass under the new regime. However, the Modern Slavery Act already forces companies earning over $100 million annually to provide detailed reports on their supply chains, ensuring that they avoid ethical issues relating to labour exploitation around the globe.

The new government has also pledged to institute more robust requirements protecting Indigenous cultural heritage and reducing carbon emissions. This change will affect many sectors, perhaps none more so than mining. Across the mining sector, Australian companies have adopted the Towards Sustainable Mining ESG framework, primarily designed to assess sustainability. After the destruction of several Aboriginal cultural heritage sites in recent years, mining companies have also self-consciously sought to develop better relationships with Aboriginal groups and engage more respectfully with Aboriginal lands. So government intervention would not only follow some highly publicised failures to manage risk, it would also reflect existing trends that seek to address recent shortcomings.

In September 2022, Prime Minister Albanese promised to introduce legislation to reduce carbon emissions in the resources sector. These regulations would affect coal production in the long term, as the Australian economy transitions towards renewables. But ESG is actually quite poorly situated to address the overall environmental and social impacts of industries like coal mining. ESG-related laws and regulations are often porous and haphazard in Australia, which can leave space for some industries to greenwash by applying selective ESG frameworks.

Even beyond government restrictions, ESG contains a key limitation; it assesses the effects of how a company operates, completely ignoring the products it sells. Even so, ESG is an important framework for investors and companies to assess their current success and predict future risks. Paying attention to ESG is becoming more important; it is gathering momentum, both among companies and in the public domain.

IBISWorld’s ESG Tool

IBISWorld has developed an ESG Tool to help companies benchmark themselves against their wider industries, help investors decide which industries to invest in, and inform companies of risks in their procurement supply chains. The ESG Tool provides a score out of 9 for each Australian industry or sector, including a breakdown of 15 different inputs, which draw data from sources including the Australian Bureau of Statistics, the Workplace Gender Equality Agency and government departments. The tool takes the average from these inputs, producing a score for each of the three categories of Environmental, Social and Corporate Governance.

For example, the mining sector scores a 7 for the Environmental inputs of Commitment to Environmental Initiatives, Energy Efficiency and Greenhouse Gas Emissions. This score is relatively high, reflecting mining’s below-average performance in these categories. Nonetheless, for Waste Management and Water Efficiency, the mining sector scores a 3 and a 4, respectively, due to improved water and waste management practices in recent decades. Overall, mining scores a 5.6 under the Environmental aspects of the ESG framework.

Under the Social category, the sector’s strong performance in Indigenous Participation, Pay Equality and Workplace Composition has offset weak ratings in Fair Labour Standards and Leave Benefits, producing an overall Social score of 4, which is better than average. However, under Governance, the sector scores worse than average for Regulatory Complexity, Tax Corruption, Fines, Penalties and Enforceability, and Trade with Risky Geopolitical Regions. Despite a slightly better than average rating for Modern Slavery, the sector scores 6 overall for Corporate Governance, signalling (for example to potential investors) that the sector carries higher than average risk in this category.

The future of ESG

ESG is here to stay. As wealth passes increasingly from the Baby Boomer generation to their children, more people are investing in industries that are perceived to be conducting business ‘the right way’. This recent turn to ESG is investor-led and companies will go where investors take them – or else risk being overlooked and left behind.

For investors and procurement departments too, accessing reliable information on ESG is more important than ever. Although the internet provides vast quantities of data on the environmental and social impacts of investments and supply chains, online information can be notoriously partisan, misleading or otherwise unreliable. In this post-truth internet era, virtually limitless amounts of information produce new decision-making challenges relating to ESG. In this context, sources like IBISWorld objectively assess different industries and sectors, cutting through the information overload – this ESG assessment is essential, whether you want to put your money behind the nice guys or become one of them.