Board members own the sustainability agenda; it requires taking the long view. Yet, directors continue to struggle with the subject, often referring to sustainability issues under the umbrella of environmental, social, and governance (ESG) matters. This is especially true today.
Consider the auto sector—undergoing more change in the current five-year period than the last 100 years combined. The century-long run of churning out cars and trucks (the linear economy model) is giving way to various forms of sustainable mobility (e.g., electric vehicles, autonomous vehicles, ride sharing, etc.).
It’s not just the auto sector. Every industry is undergoing transformation. Sustainability is not always the main driver, but ESG factors are indeed at play. Sharing economy companies such as Airbnb, Uber Technologies, and Lyft are great circular economy stories—with the increased utilization of assets, lower carbon emissions, and more.
“How do we stack up?” That’s the question I have been asked in over 50 board meetings over the past 25 years. In virtually every case, the directors wanted to know: Where does our company stand today, vis-à-vis sustainability, compared with competitors, peers, and best practices? Are we top quartile?
It’s a good question, and it deserves an answer. That’s why in 1997, after two Fortune 200 company board meetings where we discussed ESG, I began developing the Corporate Sustainability Scorecard—a board and C-suite rating tool applied one company at a time. The scorecard is a web-based tool created by industry for industry that maps a company’s posture and performance along a four-stage maturity path.
Fast forward 20 years: in early 2018, 60 blue chip companies completed the scorecard as a cohort. The results—the first of their kind for board-relevant sustainability data—suggest that many companies may not be “future ready.”
So what are directors to do? I distilled years of boardroom experience into a short book titled Sustainability—A Guide for Boards and C-Suites. The book has three key messages for board members:
1. Think of ESG within the scope of strategy, not just risk. The challenge for directors is to help your CEO think through how to profit from ESG trends, not just how to stay out of trouble. Ask strategic questions, such as:
How can we leverage ESG trends for growth?
What new market opportunities might we be missing out on?
Scorecard data suggest the boardroom conversation is still mostly about risk. Only 20 percent of companies rate themselves three or higher (on a scale of one to four) for growing revenue from more sustainable products and services. Nearly half of the 60 companies (47%) do not see ESG attributes as a revenue driver.
2. Build robust sustainability governance. Without getting governance right, it is hard to get anything else right. This is true in creating robust brands and delivering consistent and strong financial results. It is also true in showing how your company plans to capture value from leveraging ESG trends for growth.
Scorecard data suggests some big gaps here: only 11 percent of companies say their board is actively engaged on ESG issues between board meetings, and only 10 percent say they have planned ESG learning as part of board meetings.
3. Measure your company against your peers. By encouraging your company’s senior management to fill out a survey like the scorecard mentioned above, you will be doing them and yourselves the favor of getting an overview of your company’s comparative weaknesses and strengths in sustainability.
Knowing how your company stacks up on ESG is more important than ever. This statement was reinforced by BlackRock CEO Larry Fink in his January 16, 2018 letter to CEOs:
“Society is demanding that companies, both public and private, serve a social purpose…To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society. Without a sense of purpose, no company, either public or private, can achieve its full potential.”
The 2017–2018 NACD Public Company Governance Survey reinforces the need for board action. A strong majority of respondents in every industry sector ascribed importance to improving ESG strategy over the next 12 months, with only a small minority saying that improving ESG was “not at all important.” However, responses varied by industry. Improving board oversight of ESG is viewed as being most important in materials, utilities, energy, and healthcare—and least critical in information technology.
Every industry has its version of what “sustainable mobility” is doing to the auto sector. ESG factors will increasingly impact how companies choose new businesses to buy, old businesses to reshape or shed, new offerings to create, and suppliers with which to partner. Those decisions will be made in the boardroom.
Gib Hedstrom runs his own advisory firm, working with mostly large companies on oversight of ESG issues. He also runs three executive councils for The Conference Board. His latest book is available on Amazon or at www.hedstromassociates.com. Thoughts expressed here are his own.
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.
Vanguard Group CEO William F. McNabb III just tipped the list. The world’s top three asset managers—Blackrock, Vanguard, and State Street Corp.—are now calling the companies that they invest in to adopt climate risk disclosure.
In a recent open letter to corporate directors across the globe, McNabb explained that Vanguard, the $4.5 trillion mutual-fund management firm, expects businesses to embrace materiality-driven disclosures to shine more light on sustainability risks.
Summing up the challenge of climate risk, McNabb wrote that it’s the kind of risk that tests the strength of a board’s oversight and risk governance. That’s the crux of the challenge for directors. As investors ratchet up the pressure on companies to analyze their exposure to the impacts of a warming planet, they’re calling on boards to be knowledgeable about material climate risk and capable of preparing for its impacts and capitalizing on its opportunities.
As we heard in Karen Horn’s opening keynote of NACD’s 2017 Global Board Leaders’ Summit, directors can no longer ignore the inherent impact of these issues on the long-term value creation of the corporate world —ranging from climate risk, natural resource capital, and implications of the Paris Climate Agreement.
Board-level competence around climate change and other sustainability risks is the way forward. Through an understanding of what climate change means, why it matters to their business, and what their organizations are capable of changing, directors can successfully make climate risk part of their governance systems.
In a new report by Ceres called Lead from the Top, we outline ways that companies and boards can build up that competence.
But rather than settling with bringing on a director who is competent in sustainability, our report explains why companies must work to build an entire board that is competent to oversee these risks. By engaging thoughtfully on material sustainability risks as one cohesive body, this kind of board is able to ask the right questions of its management, support or challenge senior management as needed, and ultimately make informed and thoughtful decisions affecting corporate strategy and risk.
We identified three key principles that companies and boards can use as they work to build a sustainability-competent board:
1. Sustainability needs to be integrated into the director nomination process. Finding directors who can apply their knowledge about climate and other sustainability risk to relevant board deliberations is a good first step. Companies can get the right people on board by approaching this systematically as a part of the board nominations process, specifically identifying experience in material environmental, social, and governance (ESG) risks in the board skills matrix and by casting a wide net to consider candidates with diverse backgrounds and skills.
2. The whole board needs to be educated on sustainability issues that impact their company. For sustainability to become part of the fabric of board oversight and integrated into decision-making on strategy, risk, and compensation, all directors on the corporate board need to be well informed on material sustainability issues so they can lead thoughtful deliberations and make strategic decisions. Companies can do this through focused, ongoing training programs that bring in experts from outside the company and by educating the board on the connections between climate change and material impacts and the connections to risk and strategy. Embedding ESG into the existing board materials so it does not become one additional issue topic to vie for directors’ attention is essential. Sustainability managers embedded within companies can play a key role in driving this integration.
3. Boards should directly engage a diverse array of stakeholders, including investors, on sustainability issues impacting their company. With more investors paying attention to climate change and other sustainability issues, shareholders increasingly expect boards to engage directly with them on critical issues. One of the goals of McNabb’s letter was to nudge directors to engage directly with shareholders. Given this growing focus, material environmental and social factors should be made a part of any dialogue between directors and investors.
It all comes down to the bottom line. Risk and opportunity define business. Corporate boards will have a difficult time performing their fiduciary duty to the companies they lead and the shareholders that they represent without understanding the risks and opportunities created by climate change. Our report lays out practical steps directors can take as they consider how to make their board competent in addressing climate change and other environmental, social, and governance issues.
Veena Ramani is the program director of Capital Market Systems at Ceres. Ceres is a sustainability nonprofit organization working with the most influential investors and companies to build leadership and drive solutions throughout the economy.