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Why was an E missed out from the ESG?
Articles- Aug 16,23
The Triple Bottom Line (TBL) accounting mentions three profits – economic profit, environmental profit and societal profit. In ESG, the economic profit has been ignored, and that’s taking the focus away from PE, says R Jayaraman.
After many decades of introducing the ‘Performance Excellence’ (or PE) models, like the Malcolm Baldrige, EFQM (almost every country in the world has adopted either of these two or a hybrid of these or their own design, but based on the same fundamentals), it has now been in the air that banks and financial institutions will insist on an ‘ESG’ report, as a part of the loan application portfolio. Consultants and other experts are getting ready to participate in this much awaited exercise. Indeed, good news. Loans should be given to companies which demonstrate their capability to perform well rather than on their ability to repay. If a company can perform well, its ability to repay is a matter of time.
For many years, several studies have been done to show that those companies that adopt the PE models outperform others, in the stock market. Many Fortune 500 companies, as well as companies in India, have adopted these models and reaped huge benefits. Along the way, there have been suggestions made that banks should give weightage to the adoption of these models in their lending. Since PE companies have strong financials, and have imbibed the ‘PE’ way to run their companies, the cash flow tends to be high positive, and used for repayments, sometimes sooner than what has been agreed upon.
The unique point about the PE companies is that they cannot adopt the PE models in full if they don’t address the environmental, societal and governance (ESG) requirements. All PE models take a holistic view of running an organisation (there are separate PE models available for educational institutions, healthcare, small and medium companies and non-profits, apart from regular profit-oriented companies), and, which have, over the years, included several clauses to enable companies understand and address the requirements. For example, the EFQM model contains a separate chapter on society and environment, and uses the RADAR logic to evaluate the status of addressal by the company. The Baldrige model uses a ‘rubric’ based band descriptor system to do the same.
In spite of the holistic approach, which led to demonstrated, consistently high performance, these companies were not recognised as such by lending institutions. Banks did not factor this into their loan sanctioning mechanism. The need for a holistic approach was foreseen by the PE models in 1987, the same year that sustainable development was defined by the Brundtland Commission of the United Nations. ‘The ‘Triple Bottom Line’ (TBL) accounting expands the traditional reporting framework to take into account social and environmental performance in addition to financial performance’, and, the UN declared the same in 2007. An ISO standard, SA 9000 was also introduced, in addition to OHSAS, ISO 18000 etc., all to make companies do ‘sustainable’ business.
All these approaches were trying to drive companies to adopt ‘sustainability’ measures, to make the long term safe from serious, deleterious climate effects. However, the banking industry took no notice. It never credited any company with a positive, if the company got accredited to any of these or other standards. For example, when information security was in its infancy, Tata Communications became the first telecom company to obtain the ISO 27001 Information Security certification, which led to its establishing ‘replicated’ ‘Disaster Recovery’ data centres to take care of Force Majeure driven calamities. But the company never got any formal recognition from banks.
For any company, finance from a bank is needed for working capital as well as capital asset creation. Naturally, they look to banks for funds, from time to time, for which they provide a justification, which essentially assures the banks that they are capable of repaying. Since all banks insist on ‘ability to repay’ as a critical criterion, this policy often resulted in the ‘money going to where the money already is’ syndrome. More importantly, companies felt that banks were not supporting the sustainability, and the PE movement, which is a pre-requisite to sustainability.
Enter ESG. After a lot of debate and discussions, banks finally came up with the ESG. Environmental, Societal and Governance. I suspect that the banks really wanted to improve the ‘Governance’ of companies, and tagged along the other two, so that it will ‘pacify’ companies. Most companies already feel that they are overburdened by a weighty compliance system, which wants them to report on many things, for which they have to collect data systematically. And, there have been many instances where companies have been found wanting in their governance. After Enron, this reached alarming levels. So, banks had to act. They did. So, ESG. But this is incomplete. The TBL mentions three profits – economic profit, environmental profit and societal profit. In ESG, the economic profit has been ignored, and that’s taking the focus away from PE.
By taking the economic profit away, banks have, once again, chosen to ignore PE practicing companies, chosen to ignore their superior systems which give a higher possibility of ‘repayability’. I suggest that the ESG be replaced with ‘ESEG’. Only then, the PE companies will be duly rewarded. In India, only the EXIM bank has dared to come out openly in support of PE, through their ‘CII EXIM Bank’ award for business excellence. This award recognises companies which practice PE, reach great heights of performance in the TBL, and are able to provide high quality products and services to discerning customers, while addressing the E & S requirements. In fact, the PE models posit that only a holistic approach can lead to a sustained TBL.
It is time that other banks in India followed the lead of the EXIM Bank. For lending, banks should insist on a ‘PE Report’, a comprehensive document, which shows how the company is faring on the PE scale. It is time that banks in India accept, acknowledge, and insist on Indian companies following the PE models way of working, so that sustainability can be achieved, along with economic profit. The ESG needs to become ESEG.
About the author:
R Jayaraman is the Head, Capstone Projects, at Bhavan's S P Jain Institute of Management & Research (SPJIMR). He has worked in several capacities, including Tata Steel, for over 30 years. He has authored over 60 papers in academic and techno economic journals in India and abroad. Jayaraman is a qualified and trained Malcolm Baldrige and EFQM Business Model Lead Assessor.
ESG
Sustainability Development Goals
Malcolm Baldrige model
Triple Bottom Line
project managers
R Jayaraman
project management
CSR
S P Jain Institute of Management & Research
EXIM Bank
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