Companies have reached a critical turning point on their environmental, social and governance (ESG) journeys. Their stakeholders—including employees, customers, investors, regulators, and the wider public—expect them to proactively address ESG risks and opportunities as part of their business strategies.
In fact, 84% of the corporate executives and managers who responded to the latest EY Long-Term Value and Corporate Governance Survey say the Covid-19 pandemic has increased expectations from stakeholders that companies will drive “societal impact, environmental sustainability and inclusive growth”.
At the same time, there is growing scepticism around the authenticity of companies’ ESG performance, driven by allegations of greenwashing and stakeholders increasingly questioning the metrics behind ESG ratings.
This scepticism is putting companies under pressure to turn their high-profile “pledges” on sustainability into tangible results and action, or risk losing trust. So where do boards go from here?
Integration and implementation
While boards recognise that long-term value is closely intertwined with the ESG agenda, sustainability-related issues are not always sufficiently integrated into either company strategy or the oversight responsibilities of boards. Furthermore, companies can often be overly focused on ESG challenges and opportunities in the current context, rather than in future scenarios.
Our research highlighted that one of the major obstacles to companies generating long-term value through ESG is the fact that the board’s role in ESG is still evolving. Nearly half of respondents (43%) to our research said their board lacked the commitment to make decisions that would fully integrate ESG factors into strategy. A similar number (41%) cited a lack of internal processes or metrics to measure non-financial drivers of long-term value, such as human capital, as a challenge.
Although there is consensus on the need to integrate ESG into corporate strategy, that consensus dissipates when it comes to implementation. Over half of respondents to our survey (55%) noted “significant differences of opinion within their leadership team on how to balance short-term considerations with long-term investments and sustainable growth”.
Right board, right pay, right reporting
The research identified three opportunities to strengthen governance systems, so they can better support companies’ strategic decision-making and help drive long-term, sustainable growth:
1. Establish the right board operating model, composition, and skills. Today’s boards need an operating model that can respond to the fast-changing sustainability landscape. As well as access to credible, forward-looking data and the digital tools to analyse its implications, the board should consider whether it needs a dedicated sustainability committee or to view ESG as the responsibility of the board overall.
I question the usefulness of a sustainability committee unless it is temporary. Each company requires its own bespoke approach to review governance and to make specific recommendations for full integration of ESG into the board. The danger of a standing sustainability committee is that it absolves the board of having to think about these matters.
To ensure a healthy range of perspectives, the board should be sufficiently diverse in terms of skills, experience, outlook, and culture. The board should also have enough knowledge about ESG to challenge management. It may also be useful to set up a board advisory group on ESG, including leading academics and scientists. Finally, it is essential that the board devotes sufficient time to discussing ESG at meetings.
2. Use innovative approaches to reward and remunerate. Executive remuneration is a powerful strategic lever to ensure leaders are accountable for a company’s sustainability strategy. This tactic should be applied sensitively, however, considering the company’s own context, business priorities, and ESG journey.
When aligning compensation schemes with ESG strategies, boards need to identify the metrics and time horizons most appropriate for their organisations and ensure that suitable monitoring and governance structures are in place—for example, board committee oversight.
Executives’ objectives should be specific and measurable, but also flexible enough to accommodate the fluid sustainability landscape. To influence executive behaviours, and thereby drive long-term change to performance, it is necessary to link a meaningful portion of pay to ESG goals.
3. Focus on effective ESG reporting and investor engagement. An enhanced reporting model is increasingly being demanded by investors and other stakeholders. To move towards this model, companies should provide enhanced climate risk disclosures, based on robust climate risk scenario analysis. These disclosures should offer in-depth insight into the broad risks and opportunities that climate change presents to both the business and its industry.
By engaging with investors to understand their information requirements, boards will learn how reporting can better differentiate the company from its competitors.
Boards should also consider how the finance function can be used more strategically to help align financial and non-financial reporting, including through the implementation of controls and processes. If they are to build trust with their stakeholders, companies must effectively convey the impact of sustainability issues on their operating and financial performance.
Keep evolving
Stakeholder interest in companies’ ESG practices and performance is significant today—and it is only going to intensify in the future. So, to meet the expectations of their stakeholders, companies must evolve their strategies in ways that enable them to unlock long-term value while better managing their risks. This will only be possible with strong corporate governance.
Andrew Hobbs is EMEIA public policy leader for EY.