ESG puts unprepared corporate boards at risk
Mounting evidence suggests that boardrooms should prioritize sustainability. Research however demonstrates that although most boards acknowledge environmental, social, and governance (ESG) to be important, they do not incorporate it adequately into the committee structure. A failure to respond to and take ESG factors into account when making business and investment decisions represents huge risks for corporate boards and their stakeholders. Not only does this put the company at risk, but it also threatens community support and reputation as well as creates greater potential for stranded assets.
In their capacity as overseers of risk and stewards of long-term value, boards have a vital role in assessing an organization’s ESG impacts. While regulations make it inherently their fiduciary duty, there is also pressure on boards from investors and other stakeholders. The meaning of fiduciary duty has expanded to grasp the full scope of ESG, and boards are now being held liable for the all-encompassing sustainability performance of the company. A failure to address ESG effectively as a board is therefore not only a risk to the company and all stakeholders, but also to the reputation of the board itself.
It is time to renew boards by changing the board composition and adapting the current committee structures.
Boards unaware of renewed fiduciary duties
A key challenge for boards is ensuring a common understanding of, and alignment with, sustainability and ESG priorities throughout the organization. On average, boards are not prepared and do not adequately oversee the impact of ESG on the business. Although studies find that incorporating ESG into executive performance-related remuneration can be an effective way of incentivizing the right behaviors, there is a major skills gap in terms of experienced leadership professionals who can successfully deliver the organization’s ESG goals.
The WBA’s Nature Benchmark looked into the governance structures of 400 of the largest companies globally. Findings indicated that businesses generally do not have accountability systems in place for achieving their ESG objectives and targets. While nearly 70% of companies assigned the responsibility for their sustainability strategy to their board, a mere 2% of boards actually possessed the relevant sustainability expertise on nature. Not only does this highlight the fact that boards are unprepared, it also creates huge risk for business.
One reason for this is a skill and knowledge gap, especially within companies’ top executive roles. This impacts the boardroom’s understanding and subsequent ability to address ESG risks. Recent research finds that only 27% of boards fully understand ESG risks, while only 47% of directors believe their board to have sufficient ESG competence. These numbers also suggest a lack of knowledge on key sustainability issues like nature loss, climate change, and human rights across all levels of the business. Boards represent businesses and the risk of greenwashing accusations increases when issues are perceived to originate from the top. If companies want to contribute to building a more sustainable society and avoid greenwashing backlash, they need the right expertise and skills at the top from the start.
Mounting risks a liability for boards
ESG is the core focus of global risk perceptions over the next decade. According to WEF’s “The Global Risks Report 2023,” ESG-related risks are the ones for which we as a society are to be the least prepared. Climate and environmental concerns, technological disparities, and growing inequalities not only present communities and nations with extreme risks, but these large-scale challenges are also relevant to business success or failure. More frequently than ever before, ESG topics are top of the agenda for boardrooms. As the scope of these and the debate surrounding them continues to expand, so do the board’s oversight responsibilities in terms of how they address growing risks to the business.
The three primary ESG risks for companies include physical, regulatory, and economic risks. For boards, these risks pose significant threats if not addressed. As climate impacts worsen, physical risks will appear in the form of flooding, drought, temperature rise, and increased frequency of extreme weather events. From a business perspective, risks include infrastructure damages, supply chain disruptions, scarcity of raw materials, and human health declines. The regulatory landscape will also need to shift to accommodate these risks, as well as address economic pressures from changing consumer habits or economic downturns. Boards have the responsibility to ensure that a company’s sustainability practices and ESG commitments will serve as an advantage rather than a reputational or financial risk.
Investors hold boards responsible, with foot on the gas and the break at the same time
Investors continually hold corporate boards responsible. Currently, boardrooms face competing investor pressures where, on the one hand, they push forward on ESG when it is financially lucrative yet, on the other hand, they reverse course if ESG seems to impact returns in a negative way. Boards also must navigate and support the CEO’s agenda effectively on these challenges of the rapidly changing ESG investment landscape. There are growing ESG opportunities that boards are in charge of overseeing to maximize returns on investments in new growth markets, sustainable innovations, and product developments. New research from PwC finds ESG has now become a driving consideration for leading investors globally with more than a combined US$11.6 trillion assets under management. According to the investors surveyed, ESG strategy must start at the top with direction from the board. Interesting facts include:
- 49% of investors express willingness to divest from companies that aren’t taking sufficient action on ESG issues.
- 59% say a lack of action on ESG issues makes it likely they would vote against an executive pay agreement, while fully a third say they have already taken this action.
- 79% say the way a company manages ESG risks and opportunities is an important factor in their investment decision-making.
- 82% say ESG needs to be embedded in the corporate strategy.
- 66% say they are most confident ESG issues are being addressed if someone in the C-suite is accountable, and 53% think it should be the CEO.
Yet even with this positive progress, boards continue to encounter investor trepidation. While most investors are likely to take action if companies are not doing enough to address ESG issues, at the same time the majority expresses dissatisfaction with a company’s action on ESG if it significantly (or even slightly) impacts their investment returns. The vast majority – 81% – report they would accept no more than one percentage point decrease in investment returns for pursuit of ESG goals; and 49% were unwilling to accept any reduction in returns. It is therefore evident that boards need to have a sound ESG strategy in place while navigating a complex investor landscape.
Boards putting ESG at the heart of strategy is not enough
Even though ESG poses some risk, it is equally a business opportunity. The Business and Sustainable Development Commission found that companies could unlock $12 trillion in market opportunities by 2030 and create 380 million jobs when integrating the United Nations SDGs into their business strategies. Further, there is mounting evidence that sustainable brands are growing faster than non-sustainable brands, with 80% of next generations willing pay more for sustainable products versus less sustainable competitors. Boards overseeing business strategies would be remiss not to put ESG at the heart of their agenda to take full advantage of these revenue-generating opportunities.
However, when identifying ESG opportunities in growth markets, corporate boards are simultaneously confronted with new risks. An ESG-driven CEO is very much needed, yet when these CEOs make moves to implement their vision of ESG-related progress it is the boards that will be required to manage the associated significant risks and challenges. For instance, to seize new growth markets often it is decided to split the company into two parts – “commodity” and “specialty.” The latter being the new ESG-driven business, which generally requires a faster growth pace with a greater need for capital. Thus, new investors will be brought in and likely added to the board.
This boardroom movement and new energy for companies could signify an acceleration of ESG practices, thereby scaling business in new areas and leveraging advanced technologies. Updated business models that disrupt existing markets have the potential to invigorate the economy. Not only will boards benefit from knowing about ESG factors, but they will also need to be equipped to deal with the comprehensive structure of the risks or opportunities involved. This would suggest a reconfiguration in the composition of the board with a stronger forward-looking focus and depth of experience, a more robust innovation mindset, and an updated technological capacity.
Greenwashing and greenwishing add to boards’ responsibilities
Most of the world’s top companies have reacted to ESG trends via their sustainability reports and targets. Several have made strong pledges to a net-zero carbon objective. However, very few actually provide the necessary details to accomplish these targets, with strategies mired by ambiguous commitments. The data reported by corporate climate leaders often lack credibility and could be considered a form of greenwashing, or overstating how sustainable they actually are.
The negative aspects of greenwashing and greenwishing pose a major threat. Lofty pledges of CEOs, although ambitious and exuberant, put companies and subsequently boards at great risk if they are not backed-up with factual materialization, concrete objectives, and realistic milestones. It is therefore necessary for boards to know, check, and protect the content reported to investors and to the public.
Updating the boardroom
Boards must reinvent themselves to be able to see through a corporation’s presentation of data, monitor business promises and pledges, direct green promotion of the company, and drive an updated organizational sustainability agenda. It is vital that ESG governance is embedded into business and board functions so that sustainability initiatives are not just dispersed projects that disappear with CEO or executive committee pressures. Boards need to verify if ESG promises hold up after a fact-check and ensure that ESG progress will not be dramatically destroyed due to negative financial returns.
It is clear that sustainable business practices and sound corporate ESG strategies offer opportunities for long-term value creation that unlocks new markets and therefore drives profitable growth. As companies, investors, and wider stakeholder groups increasingly recognize that having strong ESG strategies will be linked directly to future business resilience, we see a positive impact on many business areas – from attracting an impactful next-gen talent pool to engaging employees to improving financial performance. Forward-looking boards will seize these growth opportunities to transform the business.
Global Thought Leader and Author on Sustainable Business and Investment