ESG Social Risks Overview

This is the second in a series of articles introducing the three components of ESG: Environmental Risk, Social Risk, and Governance Risk. 

In the wake of intensifying conversations about climate change, sustainability, human rights, and social well-being, there is a growing expectation for organizations to embody the values that individuals hold dear. In recent years, the discourse surrounding conscientious consumerism, ethical employment practices, employee engagement, and the support of progressive DEI metrics has amplified the importance of aligning personal values with the products chosen, the workplaces embraced, and the businesses endorsed. As the global community grapples with pressing social issues and their far-reaching impacts, the imperative for organizations to prioritize sustainability, uphold human rights, and contribute to social well-being has become more pronounced than ever, especially in the wake of a global pandemic.

The business world recognizes that it impacts society and social equality through its power and influence as well, and many investors are looking at social policies to evaluate a company’s performance to dictate their investment decisions. The “S” in ESG embodies various social factors that reflect a company’s commitment to ethical practices, social responsibility, and fostering a positive impact on society. Key dimensions encompassed within the “S” of ESG include human rights, human capital, social issues, social responsibility, and initiatives geared toward enhancing social equality and inclusivity. By prioritizing social factors of ESG criteria, businesses can proactively address issues such as diversity and inclusion, fair labor practices and working conditions, community engagement, and ethical sourcing, thereby fostering a corporate culture grounded in integrity and responsible business conduct.

Who Is Impacted by Social Risk?

Generally speaking, the social aspect of ESG factors, especially ESG risks, includes internal and external stakeholders. These groups include employees, customers, vendors and suppliers, the nearby community, and possibly the global community.

Employees

Prioritizing the social well-being of employees necessitates fostering an inclusive and equitable workplace environment, starting with unbiased hiring practices that address and mitigate unconscious biases. Overcoming these ingrained biases can prove challenging, as demonstrated by scenarios where highly qualified applicants, such as individuals with Autism Spectrum Disorder (ASD), may face barriers during traditional interview processes. For instance, the inability to maintain eye contact during an in-person interview may inadvertently lead to the dismissal of an otherwise suitable candidate, highlighting the pervasive nature of unconscious bias within recruitment practices. This emphasis on fostering an inclusive workplace extends to the fair treatment of employees by both managers and peers, transparent protocols for evaluating promotions and salary increments, and the implementation of compassionate and respectful procedures for employee terminations. By prioritizing diversity, equity, and inclusion (DEI) throughout the entire employee lifecycle, companies can cultivate a supportive and nurturing workplace culture that values the unique contributions of every individual, fostering employee satisfaction, retention, and overall well-being. The governance factors of ESG considerations play a role here as well; these actions stem from effective and transparent corporate governance.

Customers

Maintaining equitable treatment of customers is vital for nurturing trust in their providers and upholding a positive brand reputation. Companies must prioritize transparent and ethical marketing practices, avoiding any discriminatory targeting or predatory tactics that exploit vulnerable customer segments. For instance, deceptive advertising or manipulative messaging aimed at military personnel and their families with predatory lending offers can jeopardize financial well-being and undermine the company’s integrity, financial performance, and therefore ESG considerations by socially-conscious investors. By prioritizing honesty, transparency, and consumer welfare, businesses can foster lasting customer relationships built on mutual respect and ethical business conduct, ultimately establishing themselves as responsible market players committed to upholding the highest standards of customer service and satisfaction.

Vendors and Suppliers

The selection of vendors and suppliers introduces a range of potential social risks as companies may inadvertently engage with unethical suppliers, leading to reputational damage. Notably, historical cases like Nike’s utilization of sweatshops from the 1970s through the 1990s, which garnered public scrutiny following an exposé in 1992, exemplify the detrimental consequences of unethical supply chain partnerships. However, proactive measures can be taken to rectify such situations, as demonstrated by Apple’s initiative to restructure its supply chain, absorbing the associated costs to counteract supplier malpractice. By implementing stringent vetting processes, ethical guidelines, ESG performance, and ongoing monitoring mechanisms, companies can mitigate the risks posed by problematic suppliers, safeguard their reputations, and uphold ethical functionality in their supply chain operations.

Local Community and Beyond

As companies expand their operations into the global market, the significance of engaging with the local community transcends geographical boundaries, encompassing a broader, more inclusive perspective. While the traditional emphasis has been on supporting and contributing to the immediate local community through volunteerism and financial services, the evolving global landscape necessitates a comprehensive approach that integrates a global outlook into community engagement initiatives. This shift entails strategic investment, advocacy, and support for both local and international policy changes that align with the organization’s overarching goals and values. For instance, Starbucks exemplifies this approach by offering grants to local nonprofits and communities involved in coffee production, thus fostering sustainable partnerships and contributing to the well-being of communities on a global scale. By recognizing the interconnected nature of communities and aligning corporate initiatives with global sustainability objectives, companies can establish meaningful and enduring relationships with diverse communities worldwide, fostering a culture of responsible corporate citizenship and sustainable development.

Recognizing the interdependence of these stakeholders and their impact on the company’s social standing is vital in effectively managing social risk within the framework of ESG. Prioritizing the well-being and equitable treatment of employees, fostering positive relationships with customers and suppliers, and contributing positively to the community at large are essential in mitigating social risk and upholding the principles of responsible corporate citizenship. By proactively addressing social risk and embracing a holistic approach to stakeholder engagement, companies can establish themselves as ethical leaders within their industries, fostering a culture of trust, accountability, and sustainable growth.

How Is Reputational Risk Tied to Social Risk?

The correlation between reputational risk and social risk is substantial, particularly in the context of the contemporary digital landscape and the influential role of social media. Given the rapid dissemination of information and opinions across various online platforms, the impact of reputational risks can be potentially devastating for companies and their stakeholders. Salesforce’s proactive commitment to fostering pay equity as a corporate standard exemplifies how addressing social risks can significantly mitigate reputational risks. By conducting comprehensive pay equity audits and implementing retroactive adjustments to ensure fairness, Salesforce not only solidified its reputation as an employer that values its workforce but also minimized the likelihood of reputational damage stemming from allegations of unfair labor practices.

In contrast, companies that neglect to address social equity concerns heighten their vulnerability to reputational damage, potentially leading to disgruntled employees and disillusioned customers. In the absence of proactive measures to address social risks, companies risk tarnishing their brand image, losing consumer trust, and facing public scrutiny, all of which can have far-reaching implications for their long-term market viability and sustainability. Therefore, the effective management of social risks serves as a critical component of preserving and enhancing a company’s reputation, reinforcing the importance of prioritizing ethical and socially responsible business practices in the modern corporate landscape.

What is Corporate Social Responsibility (CSR) and How Does it Play into Social Risk? Corporate social responsibility (CSR) refers to the ethical and philanthropic initiatives undertaken by a company to contribute positively to society and the environment. CSR embodies a company’s commitment to operating ethically and sustainably, encompassing actions that go beyond mere profit generation. By actively engaging in CSR practices, companies demonstrate their dedication to social well-being, environmental issues, and ethical business conduct. This commitment to CSR is intricately linked to the management of social risk, as it underscores the importance of identifying and mitigating potential risks that could impact stakeholders, communities, and the broader societal fabric. Incorporating CSR principles into business operations not only fosters a positive corporate image but also minimizes the potential for reputational damage and stakeholder disengagement arising from social risk factors. 

How Can I Start Assessing Social Risks? 

Assessing social risks requires a comprehensive approach, including the implementation of strong controls and accurate sustainability reporting, integrated into the broader risk assessment framework. Many companies adopt an effective strategy of conducting a thorough pay equality audit, revealing concerns such as job offer discrepancies, salary disparities, or biased promotion practices, as illustrated in instances like Google’s case of gender or race-based pay disparities within specific job categories. To facilitate this process, organizations can utilize a set of curated sample questions, addressing various areas including employee demographics, hiring practices, marketing evaluation, vendor monitoring, and community participation.

Examples of Social Risk Assessment Questions:

• How does the company address diversity and inclusion in its hiring practices and workforce composition? Are there initiatives in place to ensure equal opportunities for all individuals, regardless of gender, race, or background?
• What measures are implemented to promote a safe and inclusive work environment, and how are issues such as harassment and discrimination addressed within the organization?
• How does the company engage with the local community and other stakeholders to understand and address their specific needs and concerns?
• What steps does the company take to ensure responsible sourcing and ethical supply chain practices, particularly in terms of labor standards and environmental impact?
• How transparent is the company in its reporting of social impact and initiatives, and how are the results of these initiatives communicated to stakeholders?
• Are there mechanisms in place to monitor and assess the effectiveness of social programs and initiatives, and how does the company measure the tangible outcomes and impacts of its efforts?
• How does the company promote social responsibility and sustainability in its products, services, and overall business practices, and what steps are taken to ensure alignment with ethical standards and industry best practices?
• How does the company demonstrate its commitment to human rights, both within its operations and across its broader supply chain, and what measures are in place to address any potential violations or discrepancies?

Social Risk and ESG Ratings

Social risk is intricately intertwined with a company’s environmental, social, and governance (ESG) performance through ratings and ESG scores. It serves as a crucial indicator of the company’s dedication to fostering a sustainable business model that prioritizes employee well-being, community engagement, and ethical business practices. Companies with robust social risk management strategies often receive higher ESG ratings, reflecting their commitment to responsible corporate conduct and proactive social stewardship. Proactive management of social risks not only enhances a company’s sustainability profile but also fosters stakeholder trust and attracts socially conscious investors seeking to align their responsible investing priorities with ethical business practices.

By mitigating social risks and emphasizing social responsibility, companies can bolster their ESG ratings and scores, positioning themselves as industry leaders in sustainable and ethical business operations. This approach not only enhances the company’s brand reputation and market competitiveness but also fosters long-term value creation and resilience. Consequently, integrating comprehensive social risk management strategies into ESG initiatives contributes to the establishment of a more equitable and sustainable global business landscape, reinforcing the company’s commitment to responsible business practices and social impact.

Overcoming Top ESG Program Challenges

Internal audit has brought immense value to organizations by focusing efforts on important emerging risks. Unfortunately, we seem to be slow in responding to ESG, and social-specific risks. Internal audit’s efforts devoted to ESG are significantly less than the assessed magnitude of the risk, creating a gap that is not sustainable. This needs to be addressed in modernized ESG programs. Additional challenges of top ESG programs often revolve around the need for a cohesive system of record to monitor all ESG initiatives and claims, the collection of robust evidence to substantiate the organization’s progress, the selection of appropriate frameworks for comprehensive mapping, and the consolidation of results for streamlined ESG reporting. Whether integrating stand-alone ESG reports or incorporating them into broader annual reporting, the implementation of connected ESG software can provide a solid foundation for organizations to embark on or enhance their ESG journey, ensuring preparedness for potential future requirements.