In recent years, the importance of the social factor ("S") in ESG has risen significantly, especially in the context of the COVID-19 pandemic, which has brought employees and their needs into focus. The pandemic exposed vulnerabilities in value chains, revealed the depth of corporate values, and promoted coordination and cooperation among companies across industries.

Research by Standard and Poor's shows evidence that investors are increasingly inclined to support companies that have a positive impact on society. Although companies are still awaiting the U.S. Securities and Exchange Commission's (SEC) final rules on climate-related disclosures, many have begun preparing for the impact of these rules on their operations. However, despite the current attention on sustainability reporting, companies also need to adapt to upcoming workforce disclosure regulations, such as California's recently passed Senate Bill 54, which pushes investment firms to make more diversity-related disclosures.

In addition to regulatory pressure, investor demand for ESG ratings is also increasing. According to the sustainability consulting firm Environmental Resources Management, publicly listed companies spend between $220,000 and $480,000 annually to obtain ESG ratings, while private companies spend up to $425,000 and often rely on third-party agencies. Companies depend on multiple rating agencies, such as Sustainalytics, Refinitiv, MSCI, and others, to assess the extent to which they integrate ESG factors into their frameworks.

However, because the social data collected by different companies and industries varies, these results are difficult to standardize and compare. Additionally, differing state data privacy laws in the U.S. pose challenges to data acquisition.

How do different companies define "S"?

Most companies define the "S" in ESG as social responsibility and issues related to business operations, ranging from employee health and safety to diversity and inclusion, or the impact of supply chains and distribution on human rights. S&P research notes that environmental factors focus on a company's impact on the planet, governance factors focus on internal and political functions, while social factors primarily involve "issues arising from the company's relationships with external individuals or institutions."

However, PwC points out that social issues have historically lagged behind environmental and governance factors, attributing this to the clearer definitions of "E" and "G" compared to "S."

Harvard professor Ethan Rouen said: "The million-dollar question is: What should companies talk about when discussing their social impact? What matters to employees and what makes a good employer varies by company, industry, and time." Rouen noted that what social data leaders choose to share is subjective. In his research, he interviewed over a dozen executives involved in disclosure decisions, and most said they "use disclosures to tell the human capital story" and "would never disclose anything that makes them look bad." For example, compensation data and turnover information are often omitted.

As a result, the picture presented by corporate ESG reports is often incomplete, lacking information that points to where real risks lie.

"The million-dollar question is: What should companies talk about when discussing their social impact? What matters to employees and what makes a good employer varies by company, industry, and time."

— Ethan Rouen, Professor at Harvard Business School

Rouen pointed out, however, that for "S," unified social data measurement standards and metrics are not always the solution, because different companies and industries may consider these data in different ways.

In a 2022 study by PwC, the consulting firm advised clients to determine which social elements best align with their business values and purpose before developing a social strategy. The firm noted that these priorities "vary by company and are influenced by its purpose, strategy, sustainability goals, and commitments."

Retail giant Walmart, in its 2023 corporate ESG report, categorized social data into four themes, including "Opportunity," "Ethics and Integrity," "Community," and even "Sustainability," showing how disparate social information can be organized. Walmart reported metrics on a wide range of issues, including human capital, equity and inclusion, human rights issues, philanthropy, contributions to local economies, and the well-being of workers in its product supply chain.

On the other hand, investment bank Morgan Stanley, in its 2022 ESG report, divided social factors into two categories: "People and Culture" (focusing on benefits, well-being, and compensation practices) and "Diversity and Inclusion" (focusing on DEI efforts in the workforce and society).

Rouen said: "I strongly support the metrics currently proposed by the SEC," referring to the regulator's recent update to its workforce disclosure rules, which would require companies to disclose comprehensive workforce data such as pay ranges and employment status. However, he said such rules are "definitely not a panacea" and understands the challenges companies and regulators face on this issue. "If a tech company reports health and safety information, I don't care. I care about their diversity," he said. "But if a mining company doesn't talk about its health and safety, I would be very concerned."

Data collection is inconsistent and difficult to obtain

According to the United Nations Principles for Responsible Investment (UN PRI), the social factor in ESG issues may be the most difficult part for investors to assess. The organization attributes this to the lack of mature market data records and robust regulation regarding "S," making it "less tangible" and with "less mature data on how it affects company performance."

PRI assessed feedback from multiple asset management companies and research firms, including Allianz SE, Morgan Stanley, ClearBridge Investments, and research and ESG rating company MSCI, among others.

Which social factors companies should measure is a complex question, but how to obtain the data is equally daunting, and differing state data privacy and security laws in the U.S. make this task even more difficult.

"Depending on what 'S' content you disclose, you must be mindful of data privacy laws and whether the source of information is third-party data," said Elodie Timmermans, Managing Director at Ernst & Young. Timmermans, who specializes in climate change and sustainability services, noted that differences in state data privacy laws also pose obstacles. While some states (such as New York, California, Colorado, and Washington) have implemented pay transparency laws, most have not, hindering the collection of company-wide recruitment, compensation, and diversity data. She noted this is also why pay equity and compensation information does not appear in most companies' sustainability reports.

Although the U.S. has passed laws protecting children's online information, medical and educational records, there is no overarching law covering all types of data privacy. These varying regulations can make it harder for employers to obtain certain employee demographic information, as it falls under protected data.

"While climate-related data reporting is indeed inconsistent across markets, it is not as protected as diversity-related data," said Alyssa Stankiewicz, Associate Director of Sustainability Research at Morningstar.

Moreover, handling diversity data (even when available) is a delicate matter. According to a report by the Harvard Business Review, companies must ensure that gender- or race-based hiring practices are only implemented when there is "evidence of company-wide or industry-wide hiring discrimination" and as a means to "correct initial imbalances." Otherwise, racial data should not determine or influence hiring decisions, which is governed by laws enforced by the U.S. Equal Employment Opportunity Commission.

The social factor in ESG is also difficult to collect because it is primarily a qualitative indicator that needs to be explained in quantitative terms to generate an overall score. According to ADEC Innovations, a sustainability consulting and data management company, while some social initiatives (such as auditing suppliers and vendors for fair compensation) can be quantified, most components cannot. ADEC noted that many organizations find it difficult to quantify or assign monetary value to services or benefits such as employee mental health support or creating an inclusive environment.

Rouen noted: "It is difficult to define what we mean by treating employees well, and it is difficult to develop a set of rules that applies to every company."

Where is this heading in the future?

Despite obstacles in defining and measuring "S," regulatory momentum on social disclosures in the U.S. is growing. In September, the SEC's Investor Advisory Committee proposed a new rule to the agency requiring public companies to disclose more comprehensive workforce and human capital management data, including pay ranges, employment status, and workforce demographics.

Shortly thereafter, California Governor Gavin Newsom signed SB 54 in October, requiring venture capital firms headquartered in California or with significant operations there to annually report the number of diverse founders they invest in and disclose data on their race, sexual orientation, gender identity, disability, and veteran status, as well as the amount of investment given to them.

Overall, Timmermans believes that companies have made progress in collecting and disclosing environmental and social activity data due to the consolidation of multiple reporting frameworks. Recently, several reporting frameworks have begun consolidating under the International Sustainability Standards Board (ISSB) of the IFRS Foundation, which was established in 2021. To date, the ISSB has consolidated the work of four reporting bodies: the Sustainability Accounting Standards Board (SASB) of the Value Reporting Foundation, the Task Force on Climate-related Financial Disclosures (TCFD), the Climate Disclosure Standards Board (CDSB), and the International Integrated Reporting Framework.

"From an ESG disclosure perspective, we are trying to do a lot in a short period of time. We are trying to accomplish in three years what the financial world took 100 years to do."

— Elodie Timmermans, Managing Director at Ernst & Young

"I do believe the consolidation of reporting frameworks will help, whether it's CSRD or ISSB," she said. "What is important for the 'S' of one company is different from another, so there will be nuances, and not everyone will disclose the same content, but consolidation will help."

In August, a coalition of international investors also urged the ISSB to prioritize human rights and worker rights on its next agenda. However, Timmermans noted that the consolidation of reporting standards takes time, and the streamlining of ESG disclosure practices across different companies and industries—especially regarding "S"—will be gradual and cannot be accelerated.

"From an ESG disclosure perspective, we are trying to do a lot in a short period of time," Timmermans said. "We are trying to accomplish in three years what the financial world took 100 years to do."