ESG – The Board Leadership Role
A company’s Environmental, Social, and Governance practices (ESG), are a focus for investors who demand responsible or sustainable management of their invested funds. ESG investing refers to a set of criteria or a framework for a company’s management and operations that socially conscious investors focus on when evaluating potential investments.
Environmental criteria consider how a company performs as a steward of nature.
Social criteria examine how it manages relationships with employees, suppliers, customers, and the communities where it operates.
Governance criteria deals with a company’s leadership, self-monitoring, and shareholder rights.
If investors, fund managers and individuals alike, are to better identify a corporation’s role in society and its prospects for long-term financial returns linked to ESG, board members of corporations need to articulate and disclose their company’s ESG strategy. A memo issued by the law firm Wachtell, Lipton, Rosen & Katz who specialize in corporate and securities matters, stated: “A corporation ignores environmental and social challenges at its own peril. Corporate boards are obligated to identify and address these risks as part of their essential fiduciary duty to protect the long-term value of the corporation itself.”
Leah Rozin, senior research manager at the National Association of Corporate Directors (NACD) in her article, Understanding the Board’s Role in ESG writes, “Directors are bound by fiduciary duties, which many argue now extend to considering ESG factors when providing oversight of strategy and risk. The broad scope and inherently dual nature of ESG—which i) facilitates the creation of business opportunities or reputational value, while ii) managing risks associated with ESG impacts—present a significant governance challenge for boards.” Rozen continues “ESG is an enterprise-level risk and should be viewed through the lenses of strategy and core operations. Boards need to assess their effectiveness in addressing ESG risk, in terms of both their own fiduciary responsibilities and their oversight of management’s activities.”
The business case for embracing ESG as part of corporate initiatives is compelling:
Investors are already using ESG as a screening method for choosing where to invest. Translation: This is not the next “big thing;” this is now.
Committing to an ESG strategy is a long-term mandate, which will provide significant understanding of risks and opportunities that had not previously been considered. By identifying these, the company will be better prepared to address and either embrace or mitigate these opportunities and risks respectively.
Implementing an ESG framework is complex, and by undertaking the process, corporate leaders will obtain insights into the interactions between departments within the organization, and how the organization relates to external business and societal forces, which in turn will shed light on different, more efficient processes for streamlining operations.
Because of its inherently forward-looking nature, the framework will position the company to better identify and anticipate trends in regulations and leading governance practices. Having a strategy and being prepared for future issues before they become mandatory will result in more nimble and responsive actions and minimize the risk of noncompliance.
Tools have been developed to assist corporate boards to integrate ESG into company strategy. Faculty members of the Saïd Business School at Oxford University describe a framework for getting directors behind ESG efforts in their article for Harvard Business Review. In the article the faculty team highlighted the problem that, until recently, boards did not have a mandate that included sustainability and ESG, including that a company’s commitment to enhance its positive impacts on the environment and society should be a part of the company’s ‘Corporate Purpose’. No longer ‘lip-service’ or ‘greenwashing’, the board must take responsibility for defining a sustainable corporate strategy. The team articulates, “The board has a duty to take an intergenerational perspective that extends beyond the tenure of any management team.”
The concept of Corporate Purpose provides the impetus that boards need to increase their focus on ESG concerns and manage their firms for long-term success. The Saïd team advocates for a framework to help boards deliver on their stated purpose. Called SCORE, it was initially devised by Rupert Younger, the director of the Oxford University Centre for Corporate Reputation and the chair of the Enacting Purpose Initiative. SCORE enumerates five actions, outlined here:
Simplify: Purpose needs to be simple and clear. Straightforward enough to be understood by the entire corporate workforce, the wider supply chain, and other stakeholders.
Connect: The purpose must be connected to strategy and capital allocation decisions. Connecting purpose to strategy gives a CEO the necessary foundation to prioritize long-term goals and resist pressure from those who care only about short-term returns.
Own: Ownership of purpose starts with the board, which must put in place appropriate structures for enacting purpose. The board can create and oversee communication strategies to ensure that the company’s purpose is being effectively diffused by management throughout the organization.
Reward: Today compensation is largely based on short-term financial metrics. That has to change. A broader set of financial and nonfinancial metrics should be used to evaluate performance over longer time frames.
Exemplify: Purpose must be exemplified in both quantitative and qualitative terms. A company should integrate its reporting on financial performance with its sustainability performance. It is also important to have a consistent narrative that includes stories about what the company and its people are doing to fulfill its purpose.
The report concludes, “If investors are to better identify a corporation’s role in society and its prospects for long-term financial returns, board members need to articulate and disclose their company’s durable value proposition and its drivers. The SCORE framework provides a tool to do that. We hope more boards will use it to promote long-term value creation and a more just and sustainable economy.”
This ability to track and monitor operating results that objectively indicate accomplishments in accordance with that philosophy is central to a board’s challenge to move the corporate strategy into an ESG-oriented mindset. Currently, in addition to the SCORE framework that the Saïd Business School recommends, there are other sustainability reporting frameworks in use, and they offer industry-specific data and analytical insights that can drive corporate strategy and meet stakeholder needs. These include the Dow Jones Sustainability Indexes, the Global Reporting Initiatives, and the Sustainability Accounting Standards Board. By integrating the results of the company initiative to pursue an ESG strategy into the operational reporting process, a board is broadcasting their commitment to provide their company’s constituents with meaningful performance results that meet the needs of the investing community.
The dual nature of ESG governance for boards, which Lia Rozen mentions as balancing the creation of business and reputational opportunities while also managing the risks associated with ESG needs to be viewed as an opportunity. Business leaders who view ESG as means to make a difference whilst delivering on company goals for their stakeholders will move their organizations forward, while improving own reputation for being innovative and socially conscious. Just as the pandemic has highlighted the need for changes and created opportunities to improve the way that we live that will help both quality of life and our environment, the implementation of an ESG framework across industries, is an opportunity to change how business can make significant impact on society and on the planet.