ESG Data Explained: A Comprehensive Guide to Metrics, Calculation, and Reporting — Part III

Table of Contents

Introduction to ESG Data
Understanding ESG Classifications
Environmental Data:
— Key Terminology and Classifications
— Overview of Reference Data
— Explanation of the Calculation
— Authorities & Data Providing Mechanism
— Reports

Above covered in Part I — Link: https://mrmanna.medium.com/esg-data-explained-a-comprehensive-guide-to-metrics-calculation-and-reporting-part-i-ba5479e527ce

Part II
Social Data:
— Key Terminology and Classifications
— Overview of Reference Data
— Explanation of the Calculation
— Authorities & Data Providing Mechanism
— Reports

Above covered in Part I I— Link: https://medium.com/@mrmanna/esg-data-explained-a-comprehensive-guide-to-metrics-calculation-and-reporting-part-ii-4ff8b891b764

Part III
Governance Data:
— Key Terminology and Classifications
— Overview of Reference Data
— Explanation of the Calculation
— Authorities & Data Providing Mechanism
— Reports
Conclusion

Governance Data: Key Terminology and Classifications

The “G” in ESG stands for Governance, which refers to the rules, practices, and processes by which a firm is directed and controlled. Governance data provides insights into how a company is managed and the extent to which its management structure and practices uphold the rights and interests of stakeholders, including shareholders, employees, and the community. Here are some of the key terminologies and classifications within governance data:

Board Structure

This refers to the composition and organization of the company’s board of directors. Important aspects include board diversity, the separation of the CEO and chairman roles, and the presence of independent directors.

Executive Compensation

This involves the payment arrangements for the company’s top executives. Good governance entails aligning executive pay with the company’s long-term performance and the interests of shareholders.

Shareholder Rights

These include the rights and privileges of shareholders, such as the right to vote on significant corporate matters. Ensuring these rights is a crucial aspect of good governance.

Accountability and Transparency

This involves a company's openness about its activities, and providing accurate, timely information to stakeholders. This can involve the quality of financial reporting and disclosure practices.

Ethics and Compliance

This involves the company’s commitment to ethical conduct and compliance with laws and regulations. This can involve bribery and corruption, antitrust practices, and adherence to the company’s code of conduct.

Risk Management

This pertains to the strategies and actions taken by the company to identify, manage, and mitigate risks that could adversely affect its performance or reputation.

Understanding these categories and how to measure them is critical for companies to assess their governance performance and for investors to make informed decisions.

Governance Data: Overview of Reference Data

Governance data is largely based on a company’s own disclosures, such as annual reports, proxy statements, and other regulatory filings. Reference data, in this context, would be widely accepted frameworks or standards that provide benchmarks or guidelines for what a company’s governance structure and practices should look like.

Here are a few key sources of reference data for governance:

Organization for Economic Co-operation and Development (OECD) Guidelines ( https://www.oecd.org/corporate/)

The OECD Guidelines for Multinational Enterprises include a section on corporate governance that provides guidance on good governance practices.

The International Corporate Governance Network (ICGN) Global Governance Principles (https://www.icgn.org/)

These principles provide guidelines on topics such as board independence, executive remuneration, and shareholder rights.

Sustainability Accounting Standards Board (SASB — https://sasb.org/)

SASB provides sector-specific standards for sustainability reporting, including governance-related topics like risk management, business ethics, and competitive behavior.

ESG Ratings Agencies

Companies like MSCI, Sustainalytics, and others provide companies with assessments of their governance performance based on a range of metrics. These ratings can serve as a form of reference data for companies to understand how they’re performing relative to peers.

National Corporate Governance Codes

Many countries have developed their own codes of corporate governance, which provide guidelines for companies operating in those countries. These can be a useful source of reference data for companies operating in those jurisdictions.

Financial Reporting Standards

Organizations like the International Financial Reporting Standards Foundation (IFRS) and the Financial Accounting Standards Board (FASB) provide standards for financial reporting, a crucial aspect of corporate governance.

These are some of the sources of reference data for governance. They help companies understand what good governance looks like and how they’re performing relative to these standards.

Governance Data: Explanation of the Calculation

Like social data, governance data is primarily qualitative and often requires judgment to convert into quantifiable metrics. Let’s take a look at how some aspects of governance data can be quantified:

Board Structure

The diversity of a board can be represented as a ratio or percentage. For example,

Gender Diversity Ratio =
 (Number of Female Directors / Total Number of Directors) * 100.

## Similarly, the independence of a board can be represented as 
Independent Director Ratio = 
  (Number of Independent Directors / Total Number of Directors) * 100.

Indicator Report: A report on board structure could involve the following metrics:

• Percentage of independent directors
• Gender diversity ratio
• Ethnic diversity ratio
• The average age of board members
• Number of board meetings held annually

Executive Compensation

Compensation data is typically reported in monetary terms. A useful measure is the CEO Pay Ratio, which compares the CEO’s pay to the median employee’s pay:

CEO Pay Ratio = Total CEO Compensation / Median Employee Compensation.

Indicator Report: This report would cover metrics like:

• Total compensation for each top executive
• The ratio of CEO pay to median employee pay
• Performance-based compensation as a percentage of total compensation
• Vesting schedules for stock options and other incentives

Shareholder Rights

Rights can be represented by governance policies, such as the existence of a one-share, one-vote policy. However, quantifying these policies can be challenging. Some use binary data (e.g., 0 for no policy, 1 for the existence of the policy), while others may use score-based systems.

Indicator Report: To measure shareholder rights, the following indicators could be useful:

• Frequency and quality of shareholder meetings
• Voting rights per share
• History of shareholder resolutions and their outcomes
• Poison pill provisions or other anti-takeover measures

Accountability and Transparency

This could be quantified using the scores from ESG rating agencies on these factors or by binary indicators that show the presence of specific disclosure practices.

Indicator Report: Transparency is key to governance. Metrics could include:

• Frequency and quality of financial disclosures
• Number of external audits performed
• The existence of a whistleblower policy
• Instances of retractions or corrections to previous disclosures

Ethics and Compliance

Like shareholder rights, this might be represented by binary indicators or scores, such as the existence of an ethics hotline or the number of violations of antitrust laws within a reporting period.

Indicator Report: This would involve metrics such as:

• Number of ethics and compliance training programs undertaken
• Number of reported incidents related to ethics and compliance
• Enforcement actions or penalties related to ethics and compliance
• The presence of a dedicated compliance committee or officer

Risk Management

This might involve scores from ESG rating agencies, binary indicators of the existence of risk management policies, or specific metrics like the number of cybersecurity incidents in a reporting period.

Indicator Report: Risk management metrics could include:

• List of identified strategic, operational, financial, and compliance risks
• Risk mitigation strategies in place for each identified risk
• Frequency of risk assessment exercises
• Crisis management protocols and their efficacy in past instances

These calculations rely on company data (e.g., board composition, CEO compensation) and reference data from authorities or industry standards (e.g., OECD guidelines, ICGN principles).

Please note: The calculations mentioned are indicative and may vary based on company-specific definitions or industry norms.

Governance Data: Authorities & Data Providing Mechanism

The authorities for governance data, much like environmental and social data, can be international bodies, national government agencies, industry alliances, or consortiums. They define best practices and standards for corporate governance and drive transparency in the market. Here are a few notable authorities and their data-providing mechanisms:

1. Organization for Economic Co-operation and Development (OECD): The OECD’s Principles of Corporate Governance are one of the key international standards in this area. The OECD regularly updates these principles and makes them publicly accessible online.
2. International Corporate Governance Network (ICGN): ICGN sets global standards for corporate governance through its Global Governance Principles. These standards are accessible to ICGN members and form a benchmark for companies globally.
3. Sustainability Accounting Standards Board (SASB): SASB provides comprehensive guidelines for companies to report their governance data, among other ESG data. The guidelines are publicly available on their website.
4. ESG Rating Agencies (e.g., MSCI, Sustainalytics): These agencies assess companies’ governance performance using a combination of public disclosures, data providers, and stakeholder surveys. While their methodologies are typically proprietary, they are grounded in widely accepted standards.
5. National Corporate Governance Codes: Various countries have their own corporate governance codes that set out standards and best practices for companies operating within their jurisdictions. These codes are generally freely available online.

These authorities provide updates to their data and APIs periodically, based on changes in global or national standards, new research findings, changes in company operations, or stakeholder feedback. They usually provide subscription-based access to their databases and API services, though some information or guidelines may be freely available.

These authorities, by defining what constitutes good corporate governance, provide benchmarks for companies to assess their governance performance and guide improvement efforts.

Governance Data: Reports

Governance data is typically reported in several formats. Here are some of the most common ones:

Annual Reports and Proxy Statements

These reports, required by regulatory bodies in many countries, provide insights into a company’s governance structure, board composition, executive compensation, and risk management policies.

Corporate Governance Reports

These are standalone reports that detail a company’s governance practices, including how it is managing governance-related risks and opportunities. They are usually guided by national corporate governance codes or international standards.

Here is the graph diagram illustrating the organizational structure commonly found in Corporate Governance Reports:

Sustainability Reports

Many companies include governance data in their sustainability reports, detailing how their governance structure supports their sustainability goals. These reports often follow guidelines from the Global Reporting Initiative (GRI) or the Sustainability Accounting Standards Board (SASB).

India Specific Reports:

In India, the Business Responsibility and Sustainability Report (BRSR) is a crucial report mandated by the Securities and Exchange Board of India (SEBI). It’s a comprehensive report covering all ESG aspects, including substantial governance data such as details about a company’s governance structure, board diversity, executive compensation, and risk management.

These reports provide a window into a company’s governance practices and performance, assisting stakeholders in making informed decisions.

Conclusion

ESG data plays an increasingly critical role in business and investment decisions. It provides stakeholders with valuable insights into how companies manage environmental, social, and governance risks and opportunities, which, in turn, can significantly impact their financial performance and long-term sustainability.

We have delved into the specifics of ESG data: its classifications, authorities, key terminologies, how data is calculated, and the important reports for each aspect. Understanding these elements of ESG data is vital for companies and investors alike, allowing them to track progress, benchmark performance, and make informed decisions.

There are a few key ESG indicators that are particularly important in today’s context:

1. Carbon Emissions (Scope 1, 2, and 3): These metrics provide a comprehensive view of a company’s carbon footprint, which is critical in the context of the global goal to achieve net-zero emissions.
2. Workforce Diversity: This metric offers insights into a company’s social responsibility and commitment to promoting an inclusive and diverse work environment.
3. Board Structure: A diverse and independent board is often seen as a sign of good governance, which can be crucial for long-term company performance.
4. Community Impact: This reflects a company’s social responsibility and its positive or negative effects on the communities in which it operates.
5. CEO Pay Ratio: This indicator provides insights into a company’s approach to pay equity, a crucial aspect of social justice and corporate responsibility.

These are just a few examples; different stakeholders may prioritize different ESG metrics based on their values, goals, and risk tolerance.

In conclusion, ESG data, while complex and multifaceted, is an invaluable tool for companies seeking to operate sustainably and responsibly. It’s not just about doing good — it’s about doing well by doing good. By understanding and effectively utilizing ESG data, companies can not only improve their ESG performance but also enhance their reputation, operational efficiency, and long-term financial success.

Disclaimer: The views reflected in this article are the author’s views and do not necessarily reflect the views of any past or present employer of the author.