Social Criteria: Definition, Example, and FAQs

What Is Social Criteria?

Social criteria refer to a set of standards used to evaluate an entity's performance and impact on society, encompassing its relationships with employees, customers, suppliers, and the communities in which it operates. These criteria are a fundamental component of sustainable investing and help investors assess the non-financial risk management and opportunities associated with a company's operations. The overarching category to which social criteria belong is sustainable investing, which considers environmental, social, and governance (ESG) factors alongside traditional financial performance.

Social criteria examine aspects such as labor practices, diversity, human rights, product safety, data privacy, and community involvement. Investors and stakeholders use these criteria to understand a company's commitment to ethical behavior and its broader societal contribution beyond profit generation. Companies that demonstrate strong performance in social criteria often foster greater trust, enhance their reputation, and may experience improved long-term resilience.

History and Origin

The consideration of social criteria in investment decisions has roots extending back centuries, with early forms emerging from religious groups like the Quakers and Methodists in the 18th century, who avoided investments in industries like alcohol, tobacco, and slavery.¹⁵ However, the modern emphasis on social criteria gained significant traction in the latter half of the 20th century. The civil rights movement and anti-apartheid efforts in the 1960s and 1970s spurred greater awareness of corporate social responsibility.¹⁴

A pivotal development in formalizing social criteria within the financial world came with the launch of the UN Principles for Responsible Investment (PRI) in 2006. This initiative provided a framework for integrating environmental, social, and governance (ESG) considerations into investment analysis and ownership practices, encouraging institutional investors worldwide to incorporate these factors into their decision-making.¹³ The PRI's establishment marked a significant step towards mainstreaming social criteria, moving them from niche ethical considerations to a broader, more systematic approach in investment.¹²

Key Takeaways

• Social criteria assess a company's impact on and relationship with its employees, customers, suppliers, and communities.
• They form a critical part of sustainable investing frameworks, specifically the "S" in ESG (Environmental, Social, and Governance).
• Key areas include labor practices, human rights, product safety, data privacy, and community engagement.
• Strong social performance can enhance a company's reputation, reduce risks, and potentially contribute to long-term value.
• The evaluation of social criteria involves qualitative and quantitative assessments, often relying on disclosed data and third-party ratings.

Interpreting the Social Criteria

Interpreting social criteria involves analyzing a company's policies, practices, and outcomes related to its social impact. This analysis goes beyond simple compliance with laws and regulations, seeking to understand the spirit and effectiveness of a company's social commitments. For instance, a company's approach to stakeholder engagement might be assessed by examining its communication channels with employees, suppliers, and local communities, as well as its responsiveness to their concerns.

When evaluating social criteria, investors often look for evidence of robust human capital management, including fair labor practices, employee training and development, and efforts to promote diversity and inclusion. In terms of product responsibility, the focus might be on product safety records, responsible marketing, and customer data protection. Companies demonstrating a proactive approach to addressing potential social issues, such as those related to their supply chain management or community relations, are generally viewed favorably. The goal is to gauge how well a company manages its social relationships and contributes positively to society, which can reflect on its overall stability and future prospects.

Hypothetical Example

Consider "EcoBuild Inc.," a construction company. An investor analyzing EcoBuild's social criteria would look beyond its financial statements.

1. Labor Practices: The investor examines EcoBuild's employee turnover rates, workplace safety records, and training programs. They note that EcoBuild has a low accident rate and invests in continuous skill development for its workers, leading to higher employee retention than industry averages.
2. Community Relations: The investor investigates EcoBuild's engagement with local communities affected by its projects. They find that EcoBuild holds public consultations before commencing large builds, supports local charities, and prioritizes hiring from nearby areas, creating positive social impact.
3. Diversity and Inclusion: The investor reviews EcoBuild's workforce demographics and policies. They discover that EcoBuild has initiatives to promote gender diversity in leadership roles and offers mentorship programs for minority groups, reflecting a commitment to equitable opportunities.
4. Customer and Supplier Relations: The investor checks how EcoBuild handles customer complaints and its policies for fair dealings with subcontractors. They learn that EcoBuild has a transparent dispute resolution process and ensures timely payments to its smaller suppliers, demonstrating ethical business conduct.

By assessing these aspects, the investor can form a comprehensive view of EcoBuild's commitment to social criteria, which informs their overall assessment of the company's long-term sustainability and potential for steady returns within their investment portfolio.

Practical Applications

Social criteria are applied across various facets of the financial world, particularly within the realm of responsible investing. Investors utilize these criteria for:

• Fund Screening: Investment funds, particularly those focused on ESG or ethical investing, use social criteria to screen potential investments. This might involve excluding companies involved in controversial activities (e.g., child labor, human rights abuses) or actively seeking out those with strong positive social records.
• Company Engagement: Institutional investors often engage with companies to encourage improvements in social performance. This can involve dialogue with management or shareholder activism to influence policies on issues like worker rights or community development.
• Risk Assessment: Companies with poor social criteria performance may face significant risks, including reputational damage, regulatory fines, legal liabilities, or consumer boycotts. Investors use social criteria in their due diligence to identify and mitigate such risks.
• Impact Measurement: For impact investing strategies, social criteria are central to measuring the positive societal outcomes generated by an investment, alongside financial returns. Organizations like the Sustainability Accounting Standards Board (SASB), now part of the IFRS Foundation, provide frameworks for companies to disclose financially material information related to social capital, human capital, and other sustainability dimensions.⁹, ¹⁰, ¹¹ These frameworks help standardize how companies report on issues like employee health and safety, data security, and community relations, making it easier for investors to assess relevant social criteria.⁸ The OECD also conducts extensive work on how investments can drive positive social impact, particularly in the context of financing sustainable development goals.³, ⁴, ⁵, ⁶, ⁷

Limitations and Criticisms

While social criteria are increasingly vital in investment analysis, they are not without limitations and criticisms. One primary challenge lies in the subjective nature of defining and measuring "social good." What constitutes positive social impact can vary significantly across different cultures, regions, and investor values, leading to inconsistencies in how social criteria are assessed and rated.

Another major critique revolves around data availability and comparability. Companies may not always disclose comprehensive or standardized data on their social performance, making it difficult for investors to conduct thorough analyses or compare companies across industries. Even when data is available, different rating agencies often use varying methodologies, leading to divergent ESG scores for the same company.² This lack of consensus can hinder effective decision-making and raise questions about the true materiality of social metrics to a company's overall value. Some critics argue that current ESG ratings, including those for social criteria, often focus more on a company's vulnerability to social risks (i.e., how social issues affect the company's bottom line) rather than its actual positive impact on society.¹ This "double materiality" debate highlights concerns that current approaches may not fully capture a company's broader societal footprint.

Furthermore, there are concerns about "social washing," where companies might make broad, unsubstantiated claims about their social initiatives without tangible actions or verifiable results. This superficial commitment can mislead investors and dilute the effectiveness of social criteria as a tool for driving genuine positive change.

Social Criteria vs. ESG

Social criteria are one of three core pillars within the broader Environmental, Social, and Governance (ESG) framework. While the terms are related, "social criteria" refers specifically to the societal aspects of a company's operations, whereas "ESG" encompasses a more holistic view of a company's non-financial performance.

• Social Criteria (S): Focus on a company's relationships and reputation with employees, customers, suppliers, and the communities where it operates. This includes issues such as labor standards, human rights, diversity and inclusion, product safety, data privacy, and community development.
• Environmental Factors (E): Pertain to a company's impact on the natural environment. This includes its carbon footprint, resource consumption (water, energy), waste management, pollution, and efforts towards climate change mitigation.
• Corporate Governance (G): Relates to the leadership of a company, its executive compensation, audits, internal controls, and shareholder rights. Strong corporate governance ensures accountability and transparency in decision-making.

The confusion often arises because social criteria are a fundamental and often highly visible part of a company's overall ESG profile. However, ESG provides the comprehensive lens through which all three non-financial dimensions—environmental, social, and governance—are considered together for a more complete assessment of a company's sustainability and long-term viability.

FAQs

Q: Why are social criteria important for investors?

A: Social criteria are important for investors because they can indicate a company's long-term stability and resilience. Strong social performance can reduce operational and reputational risks, attract talent, build customer loyalty, and potentially lead to better financial performance over time.

Q: How are social criteria measured?

A: Social criteria are measured through a combination of quantitative metrics (e.g., employee turnover rates, diversity statistics, safety incidents) and qualitative assessments (e.g., analysis of policies, stakeholder engagement practices, and community programs). Third-party rating agencies often collect and synthesize this data to provide ESG scores.

Q: Can investing in companies with strong social criteria still yield good returns?

A: Many studies suggest that integrating social criteria into investment decisions does not necessarily compromise returns and can, in some cases, enhance them by mitigating risks and identifying opportunities for innovation and growth. Investors increasingly recognize that companies committed to positive social impact may be better positioned for long-term success.

Q: Are social criteria the same as philanthropy?

A: No, social criteria go beyond traditional philanthropy. While philanthropy (donating to charities) is part of a company's community involvement, social criteria encompass broader operational practices and policies that affect people and society. This includes fair labor practices, human rights in the supply chain management, and responsible product development, which are integrated into the core business model rather than being separate charitable activities.