Redefining profit: How ESG reporting signals a shift towards a revised ‘social contract’

The influential economist Milton Friedman famously said, “There is one and only one responsibility of business: to use its resources and engage in activities designed to increase its profits.”

But in a world recovering from COVID-19, grappling with war, climate change, ecological destruction and human rights, profit alone cannot be the sole objective of companies.

Having just emerged from the damaging effects of the global recession, the pandemic exacerbated already deep inequalities and pushed millions into poverty. Vulnerable groups like women, the poor, elderly, disabled, indigenous people and migrants were hit hardest, with growing insecurity over access to food, health care and housing.

At the same time, the rich have become richer, with the world’s eight wealthiest individuals now worth as much as the entire poorer half – which is equal to some 3.6 billion people.

Faced with an immediate crisis of health, poverty and isolation during the pandemic, many governments stepped up to play a bigger role, either as regulators to curb excessive market behaviour (like irresponsible lending that precipitated the 2008 recession), or as providers of financial assistance to those in dire financial need during lockdown.

Indeed, the response to COVID-19 has been a playbook for business purpose and private-public collaboration, from companies helping out in the community, to state participation in vaccine development and roll-out.

But there’s a growing feeling amongst consumers, investors and employees that this cannot be a temporary response and that private business must continue to play a bigger role in building a fairer society – one that looks beyond just making money.

And, in the digital age, companies cannot hide from their responsibilities, as they come under 24/7 scrutiny. For example, within minutes of the Russian invasion of Ukraine, details on corporate links with Russia were being released on social media. As the war progressed, one Yale University professor even released a list of major companies continuing to operate in Russia, putting pressure on them to withdraw.

Across the entire environmental, social and governance (ESG) spectrum, corporations are being exposed for carbon footprint, pollution, waste, lack of diversity and modern human slavery.

Determining what businesses are here for is not a new debate, but the question of purpose has assumed greater importance in recent years.

Three centuries ago, the philosopher Jean-Jacques Rousseau described the notion of a ‘social contract’ – an agreement by the people on the rules and laws by which they are governed, for the good of all society.

And more recently, in response to the digital revolution, and the uncertain working conditions of the ‘gig economy’, academic Minouche Shafik has suggested a new social contract between business, government and workers.

She believes there is an urgent need to provide greater job security, to help adapt to economic shocks and automation, and to tax capital and people more equitably.

This follows acclaimed works on inequality by the likes of Thomas Piketty, eschewing economic liberalism and urging greater collaboration between companies and nations, using tools such as trade unions and progressive taxation, setting ‘higher goals’ of sustainable and equitable development, governed by strong regulation.

These ideas are not an argument against profit, but about how profit is earned, in order to better address inequalities and insecurities, share economic growth more evenly and protect the planet for future generations.

ESG reporting is an idea that’s gathering pace, as companies start to disclose the non-financial impact of their activities and demonstrate that they are earning profit in a more purposeful way.

Firstly, it provides evidence of the commitment to ESG targets and values, by documenting carbon footprint, energy efficiency, pollution, human rights, and diversity and inclusion, within the organization and across the supply chain.

ESG reporting requirements are quickly shifting from voluntary to mandatory, with companies under pressure to show how they’re improving people’s lives, tackling inequality, paying a living wage and contributing to the environment – as well as documenting how they’re mitigating negative outcomes.

Secondly, it assures stakeholders that management understands the risks of exposure to climate change, poor corporate behaviour and inefficient use of scarce resources, and is working to make the business more resilient. Asset managers in particular are increasingly demanding evidence of a sustainable business strategy and are homing in on ESG metrics when making investment decisions.

Thirdly, it recognizes the true cost of inputs and outputs such as carbon emissions, pollution, water usage, deforestation, biodiversity damage, poor treatment of workers and disruption to communities – and builds these into a ‘triple bottom line’ of profit, people and the planet.

By combining these ‘externalities’ with traditional metrics like raw materials, labour, work in progress and sales revenue, companies can arrive at a more realistic calculation of the value they bring.

Being sustainable doesn’t just mean factoring in additional costs; it can also unlock hidden value. Adopting a circular business model that preserves natural resources (including water), produces less waste, achieves greater re-usability and recycling, and contributes to biodiversity.

Other ways to create value for society include creating jobs, improving citizens’ lives, generating tax, and contributing to infrastructure, health and education – all of which can be expressed in financial terms.

Unlike the private sector, governments have typically measured their effectiveness in terms of wider population outcomes like health, education, housing, employment and poverty. As companies look beyond financial profits, and take a societal view of their purpose, the goals of government and business should align more closely.

Of course, companies continue to be driven by an entrepreneurial spirit and fuelled by private capital. However, the growing focus on purpose – along with increased state regulation over working conditions, sustainability and societal impact – could bring governments and enterprises together with a shared goal to produce a better, more equal, greener society.

The sheer size and reach of the world’s largest companies gives them immense power to be a force for positive change.

Given the enormity of the climate change challenge, and the need to reduce inequality and hold back the rising tide of social unrest, such a ‘social contract’ – enabled by ESG reporting – may ultimately herald a new era of capitalism that is kinder to people and the planet, while still generating prosperity.