Introduction
Every business has three bottom lines to focus on: Profits, People and Planet. The theory suggests that businesses should not just focus on profits, but other allied factors as well such as the key stakeholders (people) in the organization and the planet from where they derive the resources which contribute to their profit and leads to growth. The pandemic has reminded us of the latter components of the theory, to which most of the corporates remain oblivious as they primarily focus on profits at the cost of the planet.
Several allied approaches to a sustainable business emerge from this basic concept. These include corporate social responsibility (CSR), environmental, social, and governance (ESG) and corporate governance. The terms are often used interchangeably and though they are founded on the same premises, they are different from each other on trivial aspects.
In this article, we study the aforesaid concepts at length and thereafter distinguish them.
The Concept of ESG
Risks faced by the corporates are not limited to financial risks but extend to various other risks. ESG is founded on the basis that adequate risk management strategies should be created for the non-financial risks faced by the companies as well. We may study the components of ESG in the following manner:
Environment:
Environmental component in the ESG theory includes environment conservation measures such as water conservation, reduction of waste, reduction of carbon emissions, conservative use of natural resources, adoption of renewable energy, and protection of flora and fauna. Since reckless use of natural resources may escalate various risks such as scarcity of raw material, non-availability of a suitable environment to carry out the production process, regulatory risks or reputation risks, businesses should be aware of the impact they are causing on the environment and mitigate any risks arising therefrom.
Social:
Business is not limited to the environment, but also made out of the people around it. Not just employees, but the social aspect of the ESG theory also takes into consideration the entire supply chain and the consumers of the business. The social aspect of the ESG theory advocates for fair remuneration, human rights, fair competition, protection of shareholders’ rights and employee welfare. Associated risks include regulatory risks on account of unfair labour practices, opposition from human rights activists, irregular supply chain and high procurement cost of raw materials, low employee satisfaction and high employee turnover. Thus, the company should effectively manage its relationship with the people in its ecosystem.
Governance:
Governance of companies essentially revolves around how the management and the board run the company. It involves the structure of the company, the practices, the ethics and the transparency with which the company operates (Corporate Governance is discussed at length below).
ESG is one of the ingredients to a successful corporate strategy, as investors consider it as an important qualitative parameter before investing in any entity. In recent times, investors are focusing on non-quantitative parameters as well and are increasingly integrating ESG considerations into their investment decisions. This may be attributed to the following reasons:
Having an appropriate ESG strategy indicates the organisation is sustainable in the short and the long term;
It also gives an insight into the risk management techniques that the company can apply to mitigate the risks or threats - primarily non-financial risks that may not have an immediate monetary impact on the organization however, it may be quantified in the coming years;
For investors the concept of “maximisation of wealth” has broadened and is not limited to monetary figures.
Investors include institutional investors such as pension funds and mutual funds who participate in the company in a fiduciary capacity on behalf of their investors. Pursuant to this fiduciary duty, they are keen to analyze all aspects on the viability of the investee business.
ESG around the world
The United Nations through its 2030 agenda for sustainable development has laid down 17 goals that it aims to achieve throughout the world, with the help of “global partnership” of countries across the world. All the 193 member countries of the UN have adopted the goals.
Globally, companies are trying to contribute towards achievement of the specified goals by integrating them into their ESG strategy. The goals are depicted in the following diagram:
Source: The United Nations
ESG in India
The Ministry of Corporate Affairs carved out the National Guidelines on Responsible Business Conduct (‘NGRBC’) in 2019 from the National Voluntary Guidelines on the Social, Environmental and Economic Responsibilities of Business. The principles intend to be the guiding principles for business conduct in India. The NGRBC principles are based on the following codes:
Sustainable Development Goals;
The UN Guiding Principles for Business and Human Rights;
Paris Agreement on Climate Change;
Core Conventions 138 and 182 on Child Labor by the International Labor Organization;
Annual Business Responsibility Reports;
Companies’ Act 2013.
Following are the NGRBC principles and have been aligned with the sustainability goals in the following manner:
The SEBI vide notification dated May 10, 2021 mandated business responsibility and sustainability reporting by the top 1000 companies from the financial year 2022- 2023. The reporting framework seeks to standardize reporting on ESG matters by the top companies.
Corporate Social Responsibility
CSR is founded on the premises that the businesses derive their resources from the Earth, and thus every business has the responsibility to make up for the resources it has taken from the Earth. The responsibility of ensuring this has been reposed in the top management and the Board of Directors of companies, who act on behalf of the shareholders in a fiduciary duty.
In India, section 135 of the Companies Act, 2013 along with the Companies (Corporate Social Responsibility Policy) Rules, 2014 governs the CSR framework to be implemented by a companies meeting the following criteria:
(1) Every company having net worth of rupees five hundred crore or more, or turnover of rupees one thousand crore or more or a net profit of rupees five crore or more during the immediately preceding financial year shall constitute a Corporate Social Responsibility Committee of the Board consisting of three or more Directors, out of which at least one director shall be an independent director.
Every company meeting the specified criteria should spend at least two per cent. of the average net profits of the company made during the three immediately preceding financial years on CSR activities. Activities qualifying as CSR activities are stipulated under Schedule VII of the Companies Act, 2013. Expenditure on activities specified in Schedule VII qualifies for CSR expenditure.
CSR is a mandatory compliance obligation on the aforesaid companies and thus, it is organised and formalized by putting in place a CSR policy that governs all the aspects of the CSR function of the company.
Corporate Governance in India
As per the Institute of Company Secretaries of India, corporate governance means:
Corporate Governance is the application of best management practices, compliance of law in true letter and spirit and adherence to ethical standards for effective management and distribution of wealth and discharge of social responsibility for sustainable development of all stakeholders.
Further, the OECD defines corporate governance as:
Procedures and processes according to which an organisation is directed and controlled. The corporate governance structure specifies the distribution of rights and responsibilities among the different participants in the organisation – such as the board, managers, shareholders and other stakeholders – and lays down the rules and procedures for decision-making.
From the above definitions, we may infer that corporate governance is a way of managing the entire corporate structure. Corporate Governance emanates from the board and management level and goes down till the grassroot level employees. The board of the company lays down (and delegates certain functions) the structures, the principles and the processes on which the organisation functions. The employees at the lower levels carry out the execution the corporate strategy, on the basis of the policy set by the top management in order to achieve organisational goals.
For stakeholders outside the company, corporate governance strategy is decided by the board and management of the company. Herein, the top authorities govern how the company will be engaging with the stakeholder ecosystem around them - by maintaining the balance between transparency and confidentiality. It is important to note that corporate governance not only takes into account the shareholders of the company, but other stakeholders as well.
Corporate Governance is founded on the premises that the shareholders of any company provide the requisite capital for its functioning and thus, they are entitled to timely disclosures about how their money is being utilised and how the company is functioning. The stakeholders too, contribute to the company in many ways - for instance, the supply chain provides the company with raw material, the government provides a regulated ecosystem in which the company may function, the lenders provide capital for their functioning and the customers give them revenue and thus, they all are entitled to adequate disclosures about the functioning of the company as well.
Thus, corporate governance helps the business to utilise the synergies of the people around them to translate its actions into meaningful results. A company with high corporate governance standards also wins consumer confidence, is subject to lower regulatory scrutiny and is appreciated by constituents of its supply chain.
On the basis of above discussion, we may distinguish between the aforesaid concepts in the following manner:
The idea behind corporate social responsibility is somewhat philanthropic i.e the businesses have utilized the resources of the ecosystem around them, and thus have a responsibility to make up for the resource depletion caused by them. However, the idea behind ESG is on the basis of risks faced by the company i.e what are the risks that the company may face in case it does not take into account ESG factors in its decision making. Corporate governance is a subset of ESG.
This brings us to our second difference - i.e CSR approach is from the view of the company i.e how the company contributes to the ecosystem in which it operates. Similarly, corporate governance also determines how the company will operate in the best interests of its stakeholders, whereas ESG approach is the view from the investors i.e it is one of the aspects used by the investors to analyse the investment worthiness of the company.
Further, ESG can be seen to be integrated with the entire strategy of the company, like a component of a strategy. However, CSR is a separate function in itself. For instance, a restaurant chain intends to reduce non-degradable waste on the Earth. Under ESG, the restaurant chain may adopt alternatives to plastic cutlery, whereas in case of CSR, the company may contribute to the Clean Ganga Fund in order to remove litter from the river.
In India, these concepts can also be distinguished on the basis of regulatory prescriptions. Apart from the reporting norms, the concepts may be distinguished as follows - CSR prescriptions are to be followed by any company meeting the qualifying under Section 135(1) (discussed above) whereas ESG criteria is to be fulfilled by only the top 1000 listed companies, qualifying as such on the basis of market capitalization. On the other hand, corporate governance should be followed by every company. Though, the statute puts some mandatory obligations on certain companies, like an ideal board composition, minimum disclosures, shareholder rights to be respected by the company and formation of committees, minimum standards of corporate governance are to be followed by every company.
Closing Thoughts
Though there are certain differences between the concepts, businesses should never forget the main idea: to cater to its surroundings along with earning desired profits. Though the process of adopting these approaches have gained momentum, a lot more needs to be done in the area. As per an ESG risk assessment report by CRISIL, only 1/5th of 586 companies surveyed by it have published their sustainability reports. Such initiatives are limited to a few big companies. The government should encourage more of these initiatives as the ignorance from the industry in the area stems from lack of awareness and knowledge. Consumer activism should also play a vital role, as businesses tend to realign their business strategies around the needs of their consumers.
Comments