The Growing Complexity of ESG Metrics: Rethinking How Human Capital Development Is Evaluated
In this article, we explain the ESG indicators that have rapidly proliferated alongside the global rise of ESG investing. We focus on how indicators differ in scope and methodology, and on items that could become widely adopted in the near future. In this installment, we highlight “talent development,” one of the major indicators within the “S” (Social) pillar of ESG.
Table of Contents
The Expansion of ESG Investing and the Growing Complexity of Indicators
Interest in ESG investing and green finance has been increasing worldwide. ESG investing refers to investing that considers not only traditional financial information, but also Environmental, Social, and Governance factors.
There are dozens of major ESG indicators used by leading global investment institutions when selecting investee companies. This includes indicators across markets. Each indicator typically contains dozens or more evaluation items.
In addition, ESG rating organizations differ in what data they evaluate and how they evaluate it. Their criteria are also updated every year.
We explain how major ESG frameworks assess talent development, a key indicator within the “S” (Social) pillar of ESG. Specifically, we clarify how evaluation scope and methodology differ across indicators, using perspectives such as how each framework defines “training” and the level of data granularity required. Human capital is one of the intangible assets that generates corporate value. Talent development related to human capital is therefore closely tied to corporate sustainability.
Differences in ESG Evaluation Items Across Major Rating Organizations
Multiple major rating organizations are referenced in the context of ESG investing. Even when they address the same theme, their ESG indicators often use different evaluation items. This is mainly due to differences in scope and methodology.
Definition of Talent Development
“Talent development” is commonly used as an umbrella term for training programs and systems offered for employees.
Under the GRI (*1) Standards published by The Global Reporting Initiative (*2), “training” refers to all types of vocational training and instruction aimed at upgrading employee skills, including internal training courses, paid educational leave provided by the organization, and external training or education that the organization funds in whole or in part. By contrast, on-site coaching by supervisors is not treated as training under the Standard.
Similarly, the ESG survey division of RobecoSAM (*3), which was acquired by S&P Global in 2020, provides the SAM Corporate Sustainability Assessment (CSA) (the “SAM indicator”) (*4). Within the broad category of “talent development,” the SAM indicator uses the term “Employee Development Programs” for initiatives aimed at improving or developing employee capabilities.
Examples include role-based skill development, leadership, coaching, and management. Some programs target specific groups, such as junior employees or sales executives. At the same time, the SAM indicator explicitly states that training required for employees to perform their jobs and meet minimum requirements is not included.
Excluded items include training on compliance, occupational health and safety (OHS), workplace security, and similar topics. It also excludes executive onboarding programs for new officers, new graduate onboarding, intern training, establishing internal study sessions, and purchasing e-learning licenses.
Some rating organizations treat employee initiatives as “talent development” even when they are not tied to industry-specific skills or job tasks in the way described above. The Sustainability Accounting Standards Board (SASB) provides the SASB Standards (the “SASB indicator”) (*5), which aims to promote corporate disclosure and support investor decision-making from an ESG perspective by providing ESG evaluation criteria.
The SASB indicator lists labor-standards-related training as talent development. This includes workplace safety, health management, risk measures, and compliance. It also includes training related to cultural norms, such as bias, discrimination, microaggressions, and harassment (*6).
Other organizations evaluate corporate initiatives that support employees’ careers as talent development. For example, The Nadeshiko Brand program provided by Japan’s Ministry of Economy, Trade and Industry (METI) (*7) recognizes listed companies with strong performance in promoting women’s participation and advancement. From the perspective of women’s advancement, it evaluates internal talent development activities (*8).
As initiatives to increase the number of women managers and directors, the program evaluates whether companies provide training for managers and next-generation leadership candidates, improve workplace environments, and promote appropriate management practices.
In addition, it also evaluates whether companies offer initiatives that are not limited to women. These initiatives aim to drive mindset change among employees and support career development and career advancement. Examples include systems that allow study or overseas study at domestic or international universities and graduate schools, leave or sabbatical arrangements for volunteering, policies that allow side jobs for career advancement, and financial support or paid leave for graduate school attendance.
Training counted here is limited to programs that are mandatory for the target participants. Voluntary training, attending lectures, or joining organizations is not included.
Cost and Time
Many rating organizations evaluate talent development based on how much a company invests in human capital. They focus on time and cost spent on talent development.
The GRI indicator calculates average annual training hours per employee using total employee data. It reports this by category, including gender, position (such as senior management and middle management), and job function (such as technical, administrative, and manufacturing roles).
The SAM indicator evaluates average annual training hours per employee. It also evaluates training cost per employee. In this calculation, operating expenses and salaries of the department responsible for training are excluded.
MSCI (Morgan Stanley Capital International) calculates globally recognized benchmark indices. Within these, the MSCI Japan Equity Human Capital Investment Index (the “MSCI indicator”) (*9) evaluates not only the items above, but also training days per employee (*10).
Labor Management
Appropriate labor management underpins innovation because it supports employee efficiency and productivity. For this reason, many rating organizations position talent development as one aspect of labor management. It is often treated alongside occupational health and safety, diversity, and related topics.
In the ESG Risk Ratings provided by Sustainalytics (*11), “human capital” is included as one of 20 Material ESG Issues. Because human capital requires employee management by HR functions, it includes not only “talent development,” but also “recruitment,” “diversity,” and “labor relations,” among other topics (*12).
Access to opportunities to participate in corporate talent development initiatives serves as a measure of whether a workplace ensures fair and equitable systems. This is especially relevant where employees differ by race, gender, or job category.
Similarly, the three rating organizations discussed earlier, GRI, SAM, and MSCI, all ask about the share of employees who received training.
In addition, some organizations establish talent development as an evaluation item from a worker-rights perspective. This can be seen as reflecting a global trend in which companies are increasingly expected to monitor the entire supply chain.
The S-Ray rating provided by Arabesque (the “S-Ray indicator”) (*13) evaluates training time and training cost spent on full-time employees and workers across the entire supply chain (*14). Examples of talent development under S-Ray include skill-up training for full-time employees and ESG-related training for suppliers.
FTSE Russell’s ESG Ratings (the “FTSE indicator”) (*15) evaluate training implementation across four categories within the social pillar: “Health and Safety,” “Labor Standards,” “Human Rights and Community,” and “Supply Chain.” This refers to training that addresses the content covered by each category (*16).
These items were revised and added in 2019 with the aim of reflecting international trends in debates on labor-related human rights (*17).
Advanced ESG Evaluation Items That May Become Mainstream in the Near Future
Some ESG indicators related to talent development are currently adopted only by specific rating organizations. These can be seen as advanced indicators. Companies should consider the possibility that they will become more widely adopted in the near future.
Outcomes of Talent Development
Many rating organizations focus not only on inputs, such as funding and personnel, and not only on outputs, such as program content and work products. They also focus on outcomes. This includes the extent to which talent development contributes to corporate performance and employee careers.
The SAM indicator questionnaire includes a section where companies list their talent development programs. It also asks companies to describe program objectives and the benefits they bring to the company.
In addition, the SAM approach looks at employee engagement, turnover rate, efficiency, productivity, revenue, internal promotion, and retention. It states that it aims to evaluate the overall picture.
In this section, companies are assessed on whether they can capture the effects of talent development both qualitatively and quantitatively. They are also assessed on whether they have the capability to manage talent proactively.
This item also checks the fundamental purpose of talent development. That purpose is to contribute to corporate performance and support the achievement of strategic goals.
Within the “human capital” items of the GRI indicator, there is an item asking about the percentage of employees who receive regular reviews related to workplace performance and career development.
This item examines how much employees’ individual capabilities improve through talent development initiatives. It also examines how that improvement contributes to company-wide human capital.
Companies are expected to monitor how investments in talent development translate into employee skill sets and performance. They are also expected to design more effective talent development content and systems.
In the Nadeshiko Brand questionnaire provided by Japan’s Ministry of Economy, there is a section on training and support systems aimed at increasing women managers and directors and supporting each employee’s career development. In addition, it asks about the gender ratio and number of promotions by fiscal year.
This evaluates talent development by looking at how much it contributes to the objective it targets, namely the advancement of women.
Talent Development Related to Employee Health Management
Awareness of the importance of employee health has increased further, in part due to the global spread of COVID-19. This theme includes mental health as well as physical health.
Some rating organizations evaluate whether companies implement training aimed at improving knowledge related to employee health. One background factor is the idea that developing talent with strong health management capabilities can contribute to securing healthy and capable employees, reducing turnover, and enabling sustainable corporate growth.
When the SASB indicator evaluates a company’s ability to create and maintain a safe and healthy workplace, it includes efforts to promote norms and corporate culture through talent development as an evaluation target (*18).
Japan’s Health and Productivity Stock Selection program provided by METI (*19) selects companies that excel in “health and productivity management,” based on the view that corporate health initiatives are important for increasing long-term corporate value.
Its questionnaire evaluates whether managers receive education on employee health maintenance and promotion measures, and how frequently. It also evaluates whether education is provided to employees on health maintenance and promotion topics such as mental health and cancer prevention.
Training and education in this context may include e-learning, support for taking and obtaining certifications related to health knowledge improvement, and trips planned to promote physical and mental health (health tourism). Simply distributing awareness documents is not included.
Other ESG Evaluation Items Under Discussion or Review
Below, we introduce themes where discussion is advancing in the context of talent development. These are not currently adopted by ESG rating organizations, but they may be included in evaluation items in the future.
Responding to Changes in Labor Demand
Technological innovation, including digitalization and automation, is said to increase shortages of talent with specific skills across industries. It also increases the need for employee upskilling and reskilling.
Upskilling refers to acquiring additional skills to become more effective in one’s current role. Reskilling refers to acquiring new skills either to move into a new job or to adapt to major changes in the skills required in one’s current job (*20).
The World Economic Forum (WEF) predicts that more than one billion people will acquire new skills by 2030. This is driven by further technology adoption and growing demand for interpersonal skills such as communication and empathy (*21).
A SASB report predicts that demand for certain skill sets will increase. This includes talent with STEM education. It also predicts labor shortages and increased competition (*22).
In addition, research has shown that focusing on talent development aimed at appropriate capability development contributes to corporate competitiveness and strategic strength.
Given these trends, investment in human capital to retrain employees and improve skills is becoming increasingly important for innovation, productivity, and efficiency.
Talent Development for Diverse Workers
In recent years, growing attention to human rights and the global pandemic have helped accelerate discussions on corporate purposes, ESG initiatives, and talent. Corporate focus has expanded beyond short-term profit.
It now includes long-term ESG perspectives such as ensuring the safety and health of employees and customers, securing flexibility in working environments, and supporting and maintaining supply chains.
At the same time, many investors are increasingly focused on how companies recognize and manage talent when evaluating risk factors embedded within companies.
In addition to quantitative and qualitative shifts in labor demand, work styles and environments are diversifying. As a result, these multi-dimensional ways of working may be reflected in major indicators in the future.
For example, alternative workers who cross industry and job boundaries, such as outsourced workers, contract employees, freelancers, gig workers, and crowd workers, have become essential for many companies’ operations (*23).
McKinsey Global Institute estimates that by 2030, 400 million workers could lose their jobs due to automation. It also estimates that if automation adoption accelerates, up to 800 million workers could be at risk of job displacement (*24).
As many companies come to employ various forms of human capital, momentum is increasing to reassess traditional approaches to talent management.
Investment in talent development increases employee engagement and satisfaction. As a result, it improves overall work quality. Across industries, talent development is increasingly emphasized to become an employer of choice.
How to Efficiently Link ESG Information to Higher Corporate Value
As discussed in this article, it is important to understand both the differences across existing ESG indicators and the advanced ESG indicators that are emerging.
Many companies likely want to increase opportunities to raise corporate value through ESG management and investment. Many also want to reduce risks that could damage corporate value. The question is how to reduce those risks and capture those opportunities.
First, it is critically important to accurately understand those risks and opportunities. However, doing so requires long-term perspective. It also requires comparative analysis of a wide range of ESG data, not only for one’s own company, but also across other companies and industries.
At the same time, there are dozens of major ESG indicators across markets. Each indicator contains dozens or more evaluation items. Their standards are also updated every year
Therefore, it is not easy for many companies to continuously and systematically understand ESG trends across markets across Japan and overseas in a broad way. It is also difficult to keep tracking the business risks and opportunities that follow from those trends.
In addition, deeper analysis is needed. This means quantitatively linking identified trends and ESG indicators with a company’s own business data, and translating insights into business strategy. This requires substantial data processing and operational effort.
Even if you focus only on the “G” in ESG, there are many different indicators and calculation methods. The analytical structure becomes highly complex.
To execute both broad and deep analysis efficiently, it can be far more effective to rely on a specialized expert team with consolidated know-how. Compared with each company researching and responding on its own, a specialist team can reduce unnecessary steps and complete the same work faster. This can make the approach both highly efficient and effective.
This article introduced one ESG trend example. At “cuoncrop”, we provide services such as “ESG/SDGs Management Capability 360° Assessment and Improvement Support.” We do this by leveraging a specialist team in ESG management data analysis, centered on professionals with experience at foreign-affiliated strategy consulting firms. We also use proprietary analytical know-how that includes AI.
Our services support companies in understanding and improving the level of ESG activity that is necessary and sufficient to become an employer and business partner of choice.
This service can be used not only by companies that already have an internal ESG management analysis team and are working to improve analytical efficiency. It can also be used by relatively smaller companies that do not yet have such a team but feel a growing need to pivot toward ESG management.
If your company is interested in a scientific and efficient analytical approach to accelerating ESG management, please feel free to contact “cuoncrop”.
cuoncrop ESG Global Trend Research Division
*1 globalreporting.org/publications/documents/english/gri-404-training-and-education-2016/
*2 https://www.globalreporting.org/
*3 https://www.jpx.co.jp/corporate/sustainability/esgknowledgehub/esg-rating/04.html
*4 https://www.spglobal.com/sustainable1/en/csa
*5 https://www.jpx.co.jp/corporate/sustainability/esgknowledgehub/disclosure-framework/03.html
*7 https://www.meti.go.jp/policy/economy/jinzai/diversity/nadeshiko.html
*8 https://www.meti.go.jp/policy/economy/jinzai/diversity/r3chousahyou.pdf
*10 https://www.msci.com/eqb/methodology/meth_docs/JP_Human_Physical_Investment.pdf
*11 https://www.sustainalytics.com/esg-data
*13 https://www.jpx.co.jp/corporate/sustainability/esgknowledgehub/esg-rating/07.html
*14 http://arabesque.com/docs/sray/S-Ray%20Methodology%20v260.pdf
*15 https://www.jpx.co.jp/corporate/sustainability/esgknowledgehub/esg-rating/02.html
*16 https://research.ftserussell.com/products/downloads/FTSE-ESG-Methodology-and-Usage-Summary-Full.pdf
*18 https://www.sasb.org/wp-content/uploads/2020/05/HC-Briefing-Document_FINAL-for-web.pdf
*19 https://www.meti.go.jp/policy/mono_info_service/healthcare/kenkoukeiei_yuryouhouzin.html
*20 https://www.meti.go.jp/shingikai/mono_info_service/digital_jinzai/pdf/002_02_02.pdf
*21 https://www.weforum.org/agenda/2020/01/reskilling-revolution-jobs-future-skills/
*22 https://www.sasb.org/wp-content/uploads/2020/12/HumanCapitalBulletin-112320.pdf