The ABCs of ESG

Like many fields of human endeavour, corporate board work is rife with acronyms. Remember CSR (Corporate Social Responsibility)? How about DEI (Diversity, Equity and Inclusion)? And of course, today’s topic, ESG (Environmental, Social and Governance).

I don’t know about you, but lately I can’t open my email box without reading about ESG. I guess it’s time for The Savvy Director™ to dig a little deeper to find out what it’s all about and what it means for board directors. Think of today’s blog as an ESG primer.

For many of us, ‘ESG’ brings to mind environmental issues like climate change, pollution and protection of natural resources. But it actually incorporates a broader view, including social issues like labor practices, product safety and data security, and governance matters like board diversity, executive pay and business integrity.

Why all of the attention to ESG these days? To answer that, we need to know a bit about its origins.

A Brief ESG History

In 2004, then UN Secretary General Kofi Annan invited the CEOs of major financial institutions to help find ways to integrate environmental, social and corporate governance issues into the financial realm of asset management and securities brokerage. A year later, when the resulting report was published, it introduced the term ‘ESG’ into common usage. The report, entitled 'Who Cares Wins', made the case that embedding environmental, social and governance factors into capital markets makes good business sense, leads to more sustainable markets, and results in better outcomes for society.

After that, the idea that companies have a responsibility to create positive change began to take hold. Many people felt that businesses were neglecting society’s needs, and that companies placed too much value on short-term gains for shareholders at the expense of the long-term well-being of a broader group of stakeholders. So began conversations about a ‘new kind of capitalism’ that would value and promote the environment, societal needs, and good governance.

Then, in 2019, the Business Roundtable put out a statement abandoning strict shareholder primacy and embracing stakeholder interests. And in 2020, the World Economic Forum updated its Davos Manifesto to explicitly call on companies to establish a clear societal purpose to serve the interests of stakeholders.

That made it official – ESG is something that corporate boards must pay attention to!

“To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society.” – Larry Fink, CEO of BlackRock

ESG Today

Every company has its own mix of ESG issues. Those that are prominent on agendas today include:

• Environmental Issues. Issues like climate change, water and waste management, natural resources, emissions, natural disasters, extreme weather, and food safety.
• Social Issues. Issues like human rights, public health, poverty, income inequality, community welfare, product safety, supply chain practices, labor practices, worker health and safety, employee relations, workplace diversity and inclusion, and talent management.
• Governance Issues. Issues like ownership structure, board composition, director independence, executive compensation, transparency and accountability, corruption, political contributions, governance policies, and cybersecurity.

At the core of ESG is the idea that corporations exist to benefit not just shareholders and investors, but all stakeholders – thus, the term ‘stakeholder capitalism’, a loosely defined concept that is still being hotly debated.

Who are these stakeholders that companies should be taking into consideration? They include owners of course (shareholders and investors), but also lenders, customers, employees, suppliers, government, communities, and society as a whole.

ESG Risks are Business Risks

It helps to frame the ESG discussion in the familiar words of risk management, because ESG is really about risk and opportunity. It’s about the ways in which value could be destroyed or created.

When it comes to ESG, organizations need to start out by identifying their ESG issues. In essence, this is a risk identification process. Allocating board time to these issues will ensure that management takes it seriously. The board should expect a systematic process for identifying the environmental and social trends that could impact their strategy, and regular updates on how those trends are being managed.

Once ESG risks and opportunities have been identified, organizations can turn their attention to communication. These days, publicly-traded companies are expected to disclose more and more ESG-related information to shareholders and investors. These companies use their public documents and websites to tell their ESG story.

For example, I recently came across the ESG portal for Vale, a global mining company. Although I can’t comment on the quality of Vale’s ESG efforts, I think it’s an excellent example of relevant and accessible communication. Shareholders and investors can use this kind of public disclosure to make investment decisions that conform to their values and their belief that sound ESG practices produce better outcomes.

What comes after ESG identification and communication? Experts in the area talk about integration. They want to see ESG integrated into strategy formulation and execution as well as enterprise risk management. ESG then becomes part of Who We Are and How We Do Things Around Here. In other words, part of the culture.

What If We’re Not Publicly Traded?

Our Savvy Director™ readers run the gamut of all sorts of organizations – private companies; member-owned organizations like co-operatives and credit unions; professional associations; educational institutions, healthcare providers, and social service agencies; not-for-profits, charities and foundations; crown corporations and government agencies, boards and commissions; elected boards and councils; and everything in between.

I guess in theory these organizations could choose to ignore ESG factors, as they are not driven by the demands of activist shareholders and institutional investors. But we all live on the same planet. In my experience, many of these organizations are having the same ESG discussions around the board table as their publicly-traded counterparts.

They have reputational risk, don’t they? They have members, donors and funders with high expectations for corporate behavior, don’t they? And they have an ESG story to tell too.

Let me put it this way. If I had some spare cash I wanted to donate to a worthy cause and I was considering two possible charities whose work I supported, I might choose the one with the better ESG story. It makes a difference to me.

“The time is always right to do what is right.” – Martin Luther King

The Board’s Role in ESG

The board has a pivotal role to play in helping set the context and driving the organization’s focus on ESG issues. When board directors become engaged in the discussion, they can push their organizations to take advantage of ESG opportunities, identify and embed ESG risks into their strategy, and take credit with stakeholders for their work.

Savvy Directors can kickstart the conversation with a few well-placed questions, like the following:

• Are ESG risks included in our enterprise risk management program?
• What are the key ESG risks the business faces and how are we addressing them?
• Is ESG baked into our long-term strategy?
• How might ESG factors spur innovations, add value, or reduce costs?
• Are ESG risks dealt with separately or included in our overall strategy?
• What are our competitors doing about ESG?
• Are our ESG efforts managed by different departmental silos? How are they connected?
• Do we have the right information to oversee our ESG strategy and risks?
• Is the board getting the right metrics to monitor ESG risks?
• How can we improve our ESG communication to increase stakeholder trust?
• How do we benchmark our ESG communication against others?
• Are we effectively telling our ESG story?
• Have we clearly conveyed to stakeholders how ESG is part of our company strategy?

Resources:

• ESG in the Boardroom: What Directors Need to Know. PwC Governance Insights Center.
• Stakeholder Capitalism: Translating Corporate Purpose into Board Practice. Diligent Institute.
• The Remarkable Rise of ESG. Forbes.
• ESG, Strategy, and the Long View: A Framework for Board Oversight. KPMG Board Leadership Center.
• Sustainability: Environmental and Social Issues Briefing. CPA Canada.

Your takeaways:

• ESG issues are the focus of publicly-traded boards because of pressure from shareholders and investors.
• Other organizations should be just as focused on ESG as their publicly-traded counterparts.
• ESG risks are business risks that can be integrated into an organization’s enterprise risk management program.
• Organizations should communicate their ESG story to stakeholders.
• Board directors have a pivotal role to play in driving their organization’s focus on ESG issues.

Leave a comment below to get in on the conversation.

Thank you.
Scott

Scott Baldwin is a certified corporate director (ICD.D) and co-founder of DirectorPrep.com – an online hub with hundreds of guideline questions and resources to help prepare for your next board meeting.

Share Your Insight: How engaged is your board with ESG issues?