Human capital is the key to a successful ESG strategy

The geopolitical challenges amplified by the COVID-19 pandemic have made environmental, social and governance (ESG) issues even higher priorities for policymakers, boards and executives. Having a robust set of ESG metrics and a model to organize and govern them not only guides organizations as they strive to achieve a positive impact on society and the environment; it also enhances long-term business performance, mitigates risk and creates value.

The three parts of ESG are interconnected by human capital. Leading companies have realized that their people are the strongest advocates and enablers of ESG strategy, and thus a key force for change.

Numerous stakeholders, including investors, policymakers, consumers and employees, are demanding change. More than eight out of 10 global consumers expect CEOs to lead on societal issues, and the top 500 global asset managers place a premium on the sustainability nexus that links purpose, diversity, equity and inclusion (DEI) and ESG principles, according to Pensions & Investments and The Thinking Ahead Institute’s World’s Largest Asset Managers 2020 report. Meanwhile, 58% of employees consider a company’s social and environmental commitments when deciding where to work, and employees are three times more likely to stay and 1.4 times more engaged at what they consider to be purpose-driven organizations.

These stakeholders are also demanding accountability and transparency on financial exposure to risks, opportunities, governance and fiduciary duty related to human capital. For example, 51% of S&P 500 companies utilized ESG metrics to reward executives in their annual incentives as they entered 2021. Among companies that use ESG metrics in executive incentives, the most prevalent category for North America and Europe is people and HR, which includes metrics such as succession planning, talent development, DEI, employee engagement and culture, according to Willis Towers Watson research.

Efforts to introduce robust standards, principles and metrics to value human capital as part of ESG efforts are accelerating. For example, the Sustainability Accounting Standards Board (SASB) and the International Integrated Reporting council (IIRC) announced a merger to consolidate their ESG initiatives by forming the Value Reporting Foundation.

As we wrote in the World Economic Forum white paper, in collaboration with Willis Towers Watson, Human Capital as an Asset: An Accounting Framework to Reset the Value of Talent in the New World of Work, we must treat human capital as an asset, with associated metrics. A holistic model to oversee human capital across ESG factors yields benefits for a variety of stakeholders, including boards, investors, chief risk officers, and HR and finance leaders.

Human capital can be evaluated across areas including wellbeing, DEI, employee experience and operational excellence. Human capital metrics include workforce profile, pay, benefits, careers, hiring, retention, productivity, wellbeing and culture. Governance and ethical metrics related to human capital include whistle-blower policies, unethical behavior tied to monetary losses, dismissal and incentives against excessive risk-taking.

There are also several human capital management-related ESG metrics, including employee productivity, pay gaps, high-performance employee experience, and equitable access to reskilling and upskilling programs. There are quantitative metrics, including pay-equity ratios, diversity and representation targets, the retention rate of top talent, investment in employee upskilling, return on work, and the total cost of work. And there are metrics that cut across categories, such as benefit claims ratio and total workforce value.

When defining, developing and implementing metrics, organizations must align them with their overall business strategy, company purpose and culture, incorporating ESG principles in all three. They choose metrics carefully and abide by principles that already are in use for measuring physical and financial capital, including materiality, relevance and meaning, measurability, reliability, comparability, timeliness, auditability and cost versus benefit.

Forward-looking companies must integrate meaningful ESG metrics into performance expectations and executive incentive plans to make substantive change.

For example, Mastercard’s initiatives to advance purpose-driven total rewards demonstrates how environmental and social goals can be progressed through human capital. In March 2021, the company announced that compensation for its executives will be tied to ESG goals and specifically to improvements in achieving carbon neutrality, financial inclusion and gender pay parity. The company also continuously adapts its total rewards models to address different areas of human capital value and risk, for example, DEI, supporting new ways of working and employee wellbeing.

In an increasingly socially and ethically conscious world, organizations must put ESG principles at the center of their human capital management strategies. The added emphasis on organizational and financial sustainability provides opportunities to outperform the market, manage risk and drive shareholder value.