Michele Leung, Green Finance Advisor of Friends of the Earth (HK)

Social pillar within ESG world, depending on the materiality and relevancy to the industry, would cover a wide variety of factors, including but not limited to labour management, supply chain labour standards, health and safety, product safety and privacy and data security. These social factors have often been downplayed or ignored, due to its nature of hard to quantify and the perception of social pillar is less financially relevant. 

While the measurement of social factors is still open for discussion, there is improving transparency of corporate ESG disclosure, hence more robust assessment can be done nowadays. For example, under labour management, the evaluation can be based on the number of employees (including part time and contract workers), turnovers and layoffs, percentage of workforce covered by trade unions, available benefits to employees, any events of strikes, and external recognition such as employer of choice etc. These indicators are being compared to the industry’s best practices, while taken into consideration of any controversies (defined as incidents negatively impact its stakeholders), then one would deduce whether the company outperforms or underperforms its peers within same industry group.

Regarding the financial relevancy, among many industry research papers, one found governance pillar scores proved to be far more significant than environmental and social pillars over a relatively short period in terms of their impact of profitability and systematic risk, yet the environmental and social factors were more significant over longer periods^. It explained the social factors are more related to event risks, such as health and safety or data privacy issues, witnessed in the stock plunges resulting from data breaches at Facebook and Equifax.  It also confirmed social pillar was the most significant in the consumer discretionary sector. In fact, when time got much stressful and tough, especially in the recent year, it is observed that social pillar has become an increasingly important consideration when analyzing the company’s financial performance.

The U.S. Bureau of Labor Statistics reported that over 47 million Americans quitted their jobs in 2021, which was also known as the Great Resignation. The pandemic caused the workers to rethink about their pay, job satisfaction, health and safety, as well as career choices. It is a global issue and reflects the structural risk of the industry that depends on large work force. From cost perspective, these high turnovers and low retention would lead to higher operational cost and lower margin. It is also true that employees are more willing to help their employers when time is tough if they have been valued and treated well.

In fact, according to CFA Institute’s Financial Analysts Journal, from the period of 1984-2020, an equal-weighted portfolio of companies that treat their employees the best earns an excess return of 2% to 2.7% per year. The result seemed to suggest the stock market undervalues employees’ satisfaction.*

Closer to home, we are seeing some tech giants are being scrutinized by the regulatory on the privacy and cyber security issues. For example, with the China Personal Information Protection Law (PIPL) that targeted at personal information protection, these tech companies are now required to have a robust data privacy framework. Coupled with the earlier anticompetitive crackdown and the order to remove the gaming and digital content that’s harmful to the minors, these clampdowns and social concerns have weighed on the stocks’ performances. There are also some textiles and apparel companies that being alleged of forced labour in Xinjiang region and North Korea. In addition to supply chain disruptions, they are facing reputational damage.  Investors that have strong opposition on modern slavery have also divested away from those companies as a result.

These impacts are real and does come with a cost from financial perspective. Social pillar within ESG world should not be ignored. On the positive side, we are seeing more corporates are now taking more social responsibility, from establishing better labour standards in regard to employee protections and benefits and supply chain management.

^ Deconstructing ESG Ratings Performance: Risk and Return for E, S And G by Time Horizon, Sector and Weighting – MSCI

*Employee Satisfaction and Long-Run Stock Returns, 1984–2020 (cfainstitute.org)