Action not words on ESG

You may have come across a recent headline in the Financial Times which read ‘We’re all hypocrites on corporate finance’. It’s behind a paywall, but basically the opinion piece argues there is not a direct link between good governance and financial performance.

The subtext is that governance doesn’t matter. This misses the point – in fact, it’s dangerous.

Robust governance fit for the 21st Century is critical. Now is not the time for inertia or a return to credos of profit at any cost.

We are almost midway through the make-or-break decade in which the Intergovernmental Panel on Climate Change (IPCC) says we must halve global emissions or set ourselves and future generations up for a future where it is impossible to adapt to climate change.

That includes business.

The patterns of intense heatwaves followed by wildfires and floods continue to destroy livelihoods across the globe. UN Secretary General, António Guterres recently conceded that “climate breakdown has begun”.

While many boards see the need to engage, fear of greenwashing, increasing regulatory scrutiny and imperfect data can leave them feeling like they’re navigating a veritable minefield in unfamiliar territory. This is not the time to discount good governance.

In fact, the IPCC has warned that the “collective inability of institutions and governance systems to adapt and respond” is a growing global risk.

There are broader implications too, including the crisis of trust in corporations, markets and institutions, particularly when it comes to doing the right thing on big issues like climate change.

Boards need to understand and address changing expectations of performance. Expectations for financial performance, of course, and expectations of performance and governance that consider social and environmental issues.

The consequences of these changing expectations are already playing out in increasing disclosure requirements and regulatory scrutiny.

The US Securities and Exchange Commission issued subpoenas to several unnamed asset managers relating to their environmental, social and governance (ESG) marketing.

In Australia, the regulator ASIC commenced a greenwashing case against Vanguard Investments which had ties to fossil fuels.

The real risk of litigation is growing.

How boards approach these challenges matters. And it requires a fundamental rethink. How decisions are made, whose voices are heard and what gets done matters. The stakes are high.

The good news is that boards can still look to key markers that have defined their role and duties: What is the purpose of the corporation? What interests and consequences do we need to focus on? And what are the appropriate time horizons to optimise performance and meet market expectations?

In the 2023 Harold Ford Memorial Lecture, High Court Justice, Michelle Gordon AC pointed out that it is the answers to these core questions that have changed over time: “.. new and different answers may be emerging as increasing emphasis is given to how companies are governed and to the responses companies can or should have to ESG issues. And if new and different answers are emerging it is because the kinds of interests and consequences which directors should consider are seen as wider than once they were”.

With much more to come as markets, investors and governments grapple with the changing expectations of them, it’s unsurprising to see data from a recent survey of US and EU-based directors reflect almost half – 45 per cent – say they need better insights into how their ESG goals link to company strategy.

As boards engage, they need to mind the gap between commitments and action and pay attention to performance in all its dimensions.

In fact, it may be the links between governance and the social and environmental impacts of the company that hold the key.

What if decision-makers doubled down on understanding the impacts of the environmental and social factors to identify new opportunities for products, services, processes, alliances and business models and their potential for value creation? What if we moved away from assumptions of a necessary trade-off between profit and purpose?

In this context, it is telling that while board oversight on social and environmental issues has increased, still less than half said their board oversees performance on these issues.

There is a lot of work to do.

Organisations that focus on their purpose are more likely to deliver meaningful impact. They are also more likely to successfully navigate a rapidly changing strategic and operating environment of scarce resources, increased scrutiny and systemic shocks.

Leading economists including Professor Michael Porter and Nobel laureate Joseph Stiglitz tell us that we have overlooked the major insights of modern economics – that societal and economic factors have been misaligned. Indeed, that profit at the expense of people and the planet is self-defeating.

Whether the tipping point is regulation, stakeholder activism or other factors, we anticipate accountability for impact performance alongside financial performance will be table stakes within a few years.

Organisations that continue to separate their social, environmental and financial performance will not only limit preparedness for reporting and managing associated risks, they will miss strategic imperatives and opportunities.

Indeed, it’s the current approach of many organisations to focus selectively on social and environmental issues and only tell positive stories, a practice that recent research has called ‘explorations in organised hypocrisy.’

The imperative for good governance is not going away. It’s getting stronger and calling for something different. Boards need to understand the full picture.

Experience sitting at board tables and engaging with colleagues around the globe suggests boards that place purpose and impact at the heart of their organisations and strategies are better equipped to meet ESG reporting requirements – transparently and with confidence.

They are also more likely to identify opportunities for strategic differentiation as well as new products and markets.

Boards can start by looking at what the organisation is already doing, who their stakeholders are and what their strengths are in the market.

There are so many opportunities for boards to really differentiate themselves and find opportunities to contribute positively to society.

The most powerful thing boards can do is get started – put impact on the agenda and get increasingly clear about purpose. It informs their key decision-making role, helps them ask the right questions and to understand the choices for their business in a much more holistic way.

The smart money will build and strengthen dynamic governance as part of a board’s fitness to respond.

Leaders will continue to be asked to account for how their organisation has avoided doing harm. But visionary leaders will seize the value creation opportunities to differentiate, build resilience to the inevitable shocks coming and drive strong performance.

This article was published by Pursuit.