The Business Case for Expanding ESG Emphasis

Why U.S. corporate leaders must champion for change now.

Europe generally leads the way when it comes to environmental, social, and governance (ESG) matters. For example, the push for more female corporate directors began in 2008 with Norway passing legislation obliging public companies to reserve 40 percent of director seats for women. In the years since, more than a dozen countries, including Belgium, France, Germany, India, Italy, Netherlands, and Spain, followed suit, passing similar quota mandates and guidelines. In the U.S., however, only California, Illinois, and New Jersey have taken meaningful action and a federal mandate on such inclusion remains elusive.

Still, this diversity and inclusion development has not gone unnoticed in the financial world. Not surprisingly, analysts, bankers, consultants, investors, and finance publications around the globe have attempted to evaluate and quantify the impact female directors have on shareholder value. And while the results indicate a positive trend, the most strategic organizations and corporate leaders have already moved beyond focusing solely on shareholder value. If your company hasn’t revised its key performance indicators to include various ESG aspects, including not only elements around board diversity but also climate change and employee benefit programs, I contend it’s already behind.

Consider the following: The World Economic Forum in Davos has always been a hub for innovative ideas around corporate purpose and actions, and 2020’s meeting was no different. The entire event loosely focused on “stakeholder capitalism,” asking investors to stand shoulder to shoulder with customers, communities, employees, directors, creditors, unions, suppliers, and governments by expanding their focus from shareholder profits to ESG matters and a system that benefits all stakeholders. Last fall, Business Roundtable, a Washington, D.C.-based nonprofit association whose members are CEOs of major U.S. companies, redefined corporate purpose as “to promote an economy that serves all Americans.” BlackRock Chairman and CEO Larry Fink’s annual letter to CEOs this year spoke earnestly about climate change and the expected effect on the global economy. Fink also warned that his firm, which has some $7 trillion in assets under management, would avoid investments in companies that have a high sustainability-related risk going forward.

With this shift in focus away from just profits toward a larger combination of ESG values, all stakeholders, but especially institutional investors, are looking for data on public and private companies. Public companies are increasingly being rated on ESG initiatives by proxy advisors like Institutional Shareholder Services (ISS) and Glass Lewis. In turn, institutional investors and research analysts use this data for investment evaluation. If your public company isn’t reporting on all of its ESG efforts, it likely isn’t ranking as high as companies that are exceeding expectations by demanding their supply chain partners invest in environmental and conservation efforts; establish flexible work and wealth-building programs for employees; and upgrade diversity, inclusion, and executive compensation practices. The bottom line is that collaboration across the stakeholder chain is necessary to create maximum impact and corporate leaders should be evaluating all kinds of options. And while ESG policies are expected in the public company space, private companies should anticipate the same critical evaluation of their policies and practices.

Consider these ESG questions reviewed by proxy companies:

ENVIRONMENTAL

• Does the company have an enterprise-level environmental policy?

• How is the company influencing actions by vendors and partners all along the supply chain?

• Has the company disclosed a climate change policy that specifically addresses risks, counterparty exposures and related business strategy, and financial planning?

• Does the company disclose water usage or water recycling program metrics?

SOCIAL

• Does the company disclose its human rights policy?

• Does the company have labor rights policies, including formal grievance channels? Does this include all operations, suppliers, vendors, and partners?

• Does the company publicly disclose data on workforce equality connected with gender, race, ethnicity, nationality, religion, LGBTQ, or other potentially protected classes?

• Does the company state a commitment to a fair and living wage for all employees?

GOVERNANCE

• Is the board chair an executive director or a non-executive director?

• Is executive compensation tied to ESG factors?

• What proportion of the board has a lengthy tenure? What proportion is diverse?

• Are shareholders informed of each board member’s attendance to board or committee meetings below 75 percent?

• What is the size of the CEO’s pay as a multiple of the median pay for peers?

These are just a few of the hundreds of questions requiring greater disclosure. Annual report sections on ESG are expanding as additional topics are added each year. Some key takeaways are that stakeholders want to see real action where climate change is involved, all the way through the supply chain. They are expecting companies to hold their vendors and partners accountable for the policies each has in place—and if the policies aren’t environmentally friendly, stakeholders expect a change to be made. As large companies expand their policies and disclosures— Microsoft recently announced a plan to be carbon negative by 2030—anticipate stakeholders’ expectations for all companies to rise with the tide. This is true in the social and governance verticals as well. Other examples of companies that have adopted expanded ESG policies include Delta, which instituted a new profit-sharing plan which reportedly gives each employee an additional two months of compensation, and UBS Asset Management, which added an evaluation of sustainability and environmental concerns for all of its actively managed portfolios.

As awareness and interest in ESG has increased, so have concerns about “greenwashing,” where a company conveys a false impression of its environmental friendliness, have grown. Think of Volkswagen’s clean diesel scandal, or Nestle’s claim that its cocoa beans were sustainably sourced. Organizations who hope to reap the benefits of the appearance of being ESG conscious while cutting corners behind the scenes should beware.

But signs that ESG emphasis is not a trend are on the rise. In Chicago, the city treasurer’s office announced that financial firms looking to manage a portion of the city’s $8.5 billion portfolio must “demonstrate commitment to diversity hiring and social responsibility under a newly launched scorecard system.” Further, organizations like the Thirty Percent Coalition and 2020 Women on Boards now exist to help diversify and expand the board director pool for women, a governance expectation that can no longer be ignored.

For those of you at public companies, I suggest you assess all the materials that ISS and other proxy firms are reviewing. You likely aren’t telling your organization’s whole story. The momentum shift toward an ever-expanding ESG emphasis is creating an opportunity for companies that can be proactive and innovative in incorporating and evaluating ESG aspects in their business practices. By making decisions based on the good of all, rather than just the good of shareholders, corporate leaders can create opportunities for everyone to benefit along the continuum of doing good—and that brings more value to the entire organization