Social Capital and Its Role in ESG Risk Mitigation

Social capital can be one of the most difficult ESG metrics to measure. According to the Harvard Law School Forum on Corporate Governance, the “S” in ESG covers a range of different factors, including “human rights; labour issues; workplace health & safety; and product safety and quality.” 

Because these issues are closely linked to financial capital, they can play a major role in ESG risk mitigation. As Harvard notes,

“Factors which fall within the ‘S’ of ESG are as common as (and for some companies more so than) those within ‘E’ and ‘G’ in contributing to business risk and, in turn, causing lasting damage to a company’s reputation.”

As a result, having a strategy to collect, measure, and analyze social capital data will be essential as ESG reporting requirements expand. 

Taking time to understand the links between social and financial capital – and how harm to social capital harms financial capital – can help investors and institutions make better financial decisions.

This post will take a close look into social capital’s role in ESG risk management, and how new ESG reporting requirements will bring its impacts to light.

What is Social Capital?

In simplest terms, social capital is related to a company’s reputation and goodwill in the communities in which it operates. Investopedia describes it as a set of “shared values.” Just as a business needs financial capital, and in many cases, natural capital, in order to operate, it also needs the support or approval of governments, banks, employees, and other stakeholders in order to generate revenue and get things done.

AQUAOSO defines social capital as:

Social capital is the measurement of the value that people, workspaces, common spaces, diversity, representation, employees, citizens, etc., bring as well as the relationships that tie them together, with the end product being productivity and collective success. It is closely linked with financial capital; value that is diminished from social capital is value that is diminished from financial capital.

In other words, a business with success in social capital can count on consumers, lawmakers, and other stakeholders to support its initiatives, what it does as a business, and enhance a business’s operations. Businesses who don’t take this type of capital into account may be more likely to face controversies and problems.

As Ayana Elizabeth Johnson and Katharine K. Wilkinson say in All We Can Save, “there is a recognition that building community is a requisite foundation for building a better world.”

Examples of Social Capital

Social capital encompasses a spectrum, starting from the small scale (local groups and networks) to the large-scale (entire communities and industries). The relationships between these groups, as well as their inner workings, all contribute social value. This type of value, though, can be abstract and difficult to measure.

Social capital is measured in a variety of ways, but the most important metric is that which is material to the combined sustainability and resilience of local business.

For example, ensuring that a farming community benefits from modern water use efficiency practices through monetary incentives would mean that the cost of operations is less impacted when drought occurs. This is due to the fact that those operations are not as reliant on the diminished supply of water. Crop yields are more likely to remain steady, and farmworkers stay employed.

The local social network of the agricultural community benefits from best practices. The resilience transfers from business operations to the local ag community, creating a resilient ecosystem.

Social Capital’s Relationship with Financial Capital

The relationship between social capital and financial capital is complex but are important to have a functional understanding of because they both contribute to and reinforce each other in the marketplace.

Weakened social health, such as lack of diversity and representation, can diminish a community’s ability to innovate and succeed to its full potential – which in turn damages its ability to generate financial capital.

In a paper titled, “Social Capital, Economic Diversity, and Civic Well-Being in Flint and Grand Rapids,” Michael DeWilde compares the social capital of two Michigan cities:

“The long history and preponderance of privately-held and family-held businesses [in Grand Rapids] meant that employees have some good reason to think of themselves a ‘part of the family,’ and to expect that their employment is more than simply a contractual agreement. Various GM officials are on record over the years suggesting they ‘owe’ Flint nothing, even in the face of a rich history and shared loyalty there.”

Flint was once known as the “happiest city in Michigan,” with wages that were 37% higher than the national average. But soon, “Flint’s entrepreneurs became largely subsumed into GM’s vertical structure as that city became a ‘one-industry’ town, diminishing the prospects that entrepreneurship would continue to flourish.”

Flint’s ongoing water security issues have contributed to bad press and made it harder for the city to rebuild its social capital. In a similar way, rural communities often struggle to have their perspectives heard on water security issues without the networks of social capital found in larger cities. Because water issues affect everyone in all communities, this is ultimately a people risk and a business risk.

To account for these ESG risks, investors and businesses must get better at measuring social capital and incorporating it into their financial decisions.

Social Capital’s Importance in ESG Reporting

The growing awareness of and interest in impact investing has led to a renewed focus on ESG reporting. For years, experts have argued that inconsistent standards and a lack of regulation make it difficult for investors to gather and compare ESG data.

New reporting requirements are on the horizon in both Europe and the U.S., which will mean businesses have an added reason to get their ESG reporting up and running. Although this can be time-consuming and onerous, it will make it easier for stakeholders to see the connections between social capital and financial capital and, therefore, help the bottom line of business and aid the success of ESG reporting initiatives.

Many businesses are already reporting some forms of ESG data, but the “social” part of ESG has been particularly hard to measure. With standardized reporting requirements on the way – and with new tools to measure granular social and environmental data – stakeholders can be confident that ESG reporting will become easier over time.

Now is the time to adopt these tools and develop customized reporting strategies.

As stakeholders at all levels develop better social capital measurement and reporting strategies, it will become easier to identify and mitigate ESG risks.

Read more about ESG reporting and capital risk in the explorable AQUAOSO Guide.

The Bottom Line

Social capital includes all of the networks and relationships – from the professional to the political – that contribute to a company’s success. Along with natural and financial capital, social capital contributes to the long-term viability and profitability of a company – or lack thereof.

In businesses, communities, and economies – just as in natural ecosystems – “diversity fosters social coherence, creating more stable and harmonious relational networks, which in turn lead to more stable and harmonious societies,” – a quote from Sherri Mitchell in All We Can Save.

Although social capital is one of the harder types of capital to measure, new reporting regulations are expected to standardize the process. Through the adoption of tools and technologies, investors and other stakeholders can begin to collect and analyze social data now in order to prepare for ESG reporting requirements. This will also prepare them to better mitigate ESG risks in their financial decisions.

Agriculture professionals, in particular, can benefit from the environmental data found in AQUAOSO’s Water Security Platform, which is designed to identify and monitor water risk. With its geospatial Research and Reporting tool, and the collaborative Portfolio Connect tool, lenders and investors can use the platform to comply with new ESG reporting requirements and build social value with other stakeholders.

Reach out to the team to discuss the water security issues that impact your business, or sign up to the newsletter to stay on top of this and other ESG news.

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