It has often been argued that the ‘S’ in ESG has been overshadowed in the ESG acronym, having long played third-fiddle to corporate governance and environmental concerns. There are various reasons for this, one being that the social pillar has often proved more difficult to define, and indeed confine, than the other two letters, the concept often seemingly devolving into an ‘everything but the kitchen sink’ approach to navigating the friction between societal norms and the numerous business functions associated with running a company. Indeed, employee rights, working practices, consumer relationships, other stakeholder relationships, a business’ wider relationship to society writ large and even moral questions are just a few aspects that can fall under the tent of the Social. It is precisely this broad remit, and the various guises that social concerns can take, that makes the possible reputational risks that can span from such concerns complex for companies to address.
Exacerbating this is that addressing concerns from the other letters of ESG can sometimes prove detrimental to social concerns, as the letters of ESG do not always sing from the same hymn sheet. For instance, a considerable percentage of the polysilicon components included in solar panels are produced by forced labour based in Xinjiang, China. In this case, does the green energy transition or the prevention of human right violations take precedence in the concept of ESG where both cannot be addressed simultaneously? Is it to be left to companies to balance the trade-offs between the acronym’s letters?
Given the above difficulties, it is perhaps unsurprising that many UK companies have traditionally decided to focus on the more tangible environmental and corporate governance concerns. Moreover, social concerns have recently been pushed further down the agenda by the ongoing debate on executive remuneration in the UK market and the attempt to improve the competitiveness of UK Plc following a spate of delistings from the London Stock Exchange (LSE) (for more information, see: A Mid-season Review of the Ongoing UK Executive Remuneration Debate).
Nonetheless, despite remaining largely under the radar, there have been a couple of recent examples of social concerns causing serious reputational and financial damage to companies.
Boohoo and Shein
It was recently reported that a group of 49 investors, including the California State Teachers’ Retirement System (CalSTRS), brought a claim against the online fashion retailer, Boohoo. The claim, which seeks approximately GBP 100 million in compensation, follows allegations of labour rights violations at the Company’s suppliers, which allegedly paid employees far below the minimum wage. In the aftermath of the allegations, the retailer’s share price declined by c.40 percent over the course of several days. The legal firm, Fox Williams, which is leading the litigation claim against Boohoo, stated the following:
“The claim relates to Boohoo’s failure to disclose serious labour rights violations at its suppliers’ factories, which were exposed by The Sunday Times in July 2020 and November 2022 and by BBC Panorama in November 2023 […] Boohoo has long been aware of these issues, failing to keep to past promises of fair production.”
According to Fox Williams Partner, Andrew Hill, the case:
“[…] will test the legal framework for securities litigation in the UK and the role of environmental, social and governance (ESG) factors in corporate governance and disclosure. Boohoo is a prominent example of a company that failed to live up to its ESG responsibilities and caused significant harm to investors. We believe that our clients have a strong case for compensation.”
The Company has stated that it strongly contests the allegations and will vigorously defend any claim.
It should also be noted that Shein, another online fashion retailer, recently considered a London listing after tensions between the US and China stalled plans for an IPO in New York. Given the recent exit of some companies from the LSE, the retailer’s possible listing was welcomed in many quarters as reinjecting some confidence in London as a competitive listing location. Nonetheless, there have been some questions in relation to the Company’s social practices. For instance, there are concerns that cotton farmed by forced labour in Xinjiang could be used in some of its products, and that other human rights abuses exist in its supply chains.
However, such concerns could be brushed aside by those keen to see UK Plc recover its economic clout on the world stage. Quoted in the Financial Times, Peter Harrison, CEO of Schroders and member of the Capital Markets Industry Taskforce, recently stated the following when asked about the possibility of Shein going public in London: “There is a high bar for companies seeking to be listed in London — if a company can meet that bar, it’s up to investors to decide if they want to invest.”
Nonetheless, the recent general election in the UK, which gave a majority of seats to the Labour Party, may lead to more scrutiny surrounding Shein’s possible listing in London. Speaking to Times Radio, the UK Government’s new Business Secretary, Jonathan Reynold, stated that the online fashion retailer would be required to meet “ethical and moral targets” in all aspects of its business. In addition, he raised questions regarding the possible closing of a so-called tax ‘loophole’, which allows overseas retailers and brands selling cheap products to avoid paying import duties.
Consequently, it is yet to be seen if Shein’s listing will go ahead in the coming months, with the online fashion retailer keeping a Hong Kong IPO as a back-up plan if its London plan falls through
South West Water and Severn Trent
Another recent example of social concerns precipitating substantial damage is at various water utility companies in the UK.
For instance, a recent parasite outbreak in Devon was traced back to a damaged valve casing in the South West Water (SWW) network. Back in April 2023, the Company had been fined more than GBP 2.1 million as a result of sewage pollution incidents. As a result, the parasite outbreak led many to once again question whether SWW was investing enough in local infrastructure.
Following the outbreak, the CEO of Pennon Group, which owns SWW, Susan Davy, forwent her annual bonus, and the Company announced that the bonus for the next financial year would be linked more heavily in line with performance in relation to safety and customer concerns.
Nonetheless, SWW increased its dividend by 3.8% shortly after the incident despite a recent warning to water utility companies from the UK’s water regulator, Ofwat, against paying significant dividends to investors while failing to address consumer safety and environmental concerns.
Similarly, in February 2024, Severn Trent was fined GBP 2 million for pollution of the river Trent between 2019 and February 2020 at the Barlaston treatment works, with raw sewage being discharged in breach of permits.
In response to the fine, the Company reduced its EPA rating performance metric, which was due to pay out in full, to zero for its CEO. Nonetheless, this represented only 5% of the maximum opportunity provided in her FY2023/24 annual bonus. As a result, the bonus still paid out at 60.9% of the maximum and her overall remuneration increased to almost GBP 3.2 million.
As can be imagined, these incidents likely did little to improve the public image of water utility companies in the UK.
ISS benchmark policy and social concerns
As the examples above have illustrated, although social concerns are often not at the top of a company’s agenda, there nonetheless can be serious ramifications for companies that fail to pay heed to the reputational, and in some cases financial, risks associated with them.
Generally, ISS Governance Benchmark research analyses incidents that have had an impact on a company’s reputation on a case-by-case basis, considering the incident’s ramifications for business operations and shareholders. In addition, we consider the Company’s response, including whether the incident should be appropriately reflected in remuneration outcomes for executive directors.
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By: Tom Inchley
