Topics:   Corporate Social Responsibility,Risk Management

Topics:   Corporate Social Responsibility,Risk Management

May 3, 2018

The Relevance of Sustainability Performance to Board Risk Oversight

May 3, 2018

As discussions of sustainability move beyond financial performance, they tend to spawn divergent views. Many frame the term as what constitutes responsible behavior in driving continued development and growth without deteriorating the environment, depleting natural resources, or creating conditions that destabilize the economy and vital social institutions. Still others prefer to cleave to the traditional view of the corporation and remove external stakeholders and the environment all together to focus solely on the sustainability of the business and its profits.

The type of short-term thinking applied when formulating policy and the kinds of long-term thinking driving sustainability development discussions are like oil and water, and looking to the business world, short-termism on the part of senior management is a sustainability killer. Without a long-term outlook in both the private and public sectors, the sustainability discussion will continue to be over before it begins.

Straight talk about sustainability leads to acknowledgement of several important realities:

  • Sustainability performance without acceptable financial performance is untenable. The two must be integrated, and neither is a substitute for the other. Overreach in pursuing either preempts long-term progress.
  • Many directors and senior executives believe the focus on sustainability is inevitable and, of necessity, strategic. Some constituencies believe that investments on the environmental, social, and governance fronts are incompatible with positive near term returns.
  • Reasonable people can differ in their views as to the appropriate sustainability objectives for a given organization, based on the industry, stakeholder interest, and long-term outlook, as well as the time frame in which the entity should pursue those objectives.
  • A meaningful impact is only possible through the collective efforts of multiple entities in the private sector, sound policies in the public sector, cross-border global cooperation, and investors committed to the sustainability agenda.

The concept of selective investing offers a set of standards for a company’s operations that socially conscious investors use to evaluate investment alternatives. As professionally managed funds deploying environmental, social, and governance (ESG) factors to screen investments have increased assets under management into the trillions of dollars, directors and executives have taken notice. Earlier this year, the CEO of BlackRock issued a letter to chief executives calling for a “positive contribution to society” beyond financial performance in realizing their organization’s full potential, with emphasis on “understand[ing] the societal impact of [their] business as well as the ways that broad, structural trends—from slow wage growth to rising automation to climate change—affect [its] potential for growth.” As these and other related demands have increased from the investor community, so have requests for increased transparency.

Governance—the “G” in “ESG”—has steadily emerged as a significant differentiator and, increasingly, a make-or-break factor for investors. Bad corporate behavior during the Enron era at the turn of this century, reckless risk-taking precipitating the 2007-2008 financial crisis, catastrophic cyber breaches, egregious violations of laws and regulations, and wanton disregard of safety considerations in addressing cost and schedule pressures have accentuated the importance of effective governance and the strong organizational culture it encourages. As important as these matters are, they’re mere table stakes. The focus on sustainability raises the bar further, with the BlackRock letter calling for a “new model for corporate governance.”

There are other reasons why ESG is important. Younger generations place high importance on sustainability issues. A recent survey noted that 56 percent of public company directors believe that a corporate social responsibility policy increases a company’s ability to attract and retain employees. Also, deploying cost-effective technologies to increase process efficiencies and develop environmentally friendly products and services has become attractive in many sectors. While there is a long road to travel littered by brutal politics and more questions than answers, world opinion has been coalescing around achieving the goal of sustainable development.

Perhaps this is because the world around us all is changing so much. Advanced technologies make feasible what was impossible a decade ago. Global population growth continues to explode, and changing demographics and resource scarcity affect operations. Businesses are left to ask themselves what they are to do in the face of these changes, and corporate directors have a role in leading their companies to action.

Directors should ensure that management answers the question, “What does the organization do about sustainability?,” based on the nature of the entity’s industry, culture, markets, stakeholder priorities, regulatory environment, appetite to lead and invest, intrinsic challenges from an execution standpoint, and long-term outlook. Approaches to consider might include the following:

  • Articulate sustainability guiding principles and core values;
  • Assess current ESG performance to identify gaps and opportunity areas;
  • Conduct an assessment of opportunities to improve performance and address the risks of inaction;
  • Assess the entity’s current policies, processes, organizational structure, reporting, methodologies, and systems supporting the pursuit of sustainability objectives;
  • Based on the above, formulate a sustainability strategy and road map of key initiatives supporting that strategy;
  • Establish accountability for results by setting targets, assigning executive sponsorship, defining initiative ownership, specifying the appropriate performance metrics, and integrating those metrics with operational performance monitoring and the reward system; and
  • Establish disclosure controls and procedures to ensure reliable internal and external ESG reporting.

The strategy taken by investors in this age of sustainable development is challenging perceptions of the role of the corporation in society. The questions around sustainability—and how hard companies should be working to drive it as a goal—require serious reflection for executive management and the board. A strong commitment to sustainability places an emphasis on actions, not words; on disruptive innovation, not “business as usual”; and, most importantly, on leadership, collaboration, and transparency.

Jim DeLoach is managing director of Protiviti. 

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