Recent trends suggest that corporate boards will need to pay greater attention to how ESG can impact a company’s bottom line. Institutional investors and other stakeholders are making the link between environmental, social and governance factors—or sustainability—and business strategy with greater frequency, and that means reviewing ESG policy should be a major agenda item for boards in 2020.
What we’ve seen over the last two years is that more institutional investors are integrating ESG factors into their investment decision-making. A recent survey by the Callan Institute reported that the percentage of institutional investors that incorporated ESG factors into investment decision-making grew from 22 percent in 2013 to 42 percent in 2019. State Street Global Advisors, BlackRock, Vanguard and other large investors have publicly called for companies to adopt specific policies, such as board diversity, that they believe contribute to sustainability.
More employees are expressing their concerns about ESG issues such as pay disparity and company culture through public protests and work stoppages. The recent strike over wages and benefits at General Motors and the employee walkout over sexual harassment allegations at Alphabet suggest these events will continue.
Additionally, shareholders continue to exert influence on companies by increasing the number of ESG-related shareholder proposals that are filed. The types of issues that fall into the ESG category are expanding. Shareholders have sought major changes in company policies around everything from compensation clawbacks for liability in the opioid crisis to mandating more robust climate change strategy disclosures.
Corporate directors must focus on identifying which ESG issues could most affect a company’s growth next year and in the future. In its 2019 ESG Review, Institutional Shareholder Services (ISS) forecast that “climate change, responsible consumption and resource use, data security and data privacy, and #MeToo and discrimination” would be areas that most corporate boards would be affected by. However, since ESG now covers such a vast area of corporate governance, boards must identify the aspects of ESG most likely to impact business operations and growth, and then craft policies that are appropriate for their specific industry. Boards must also be careful to address ESG issues that are of primary concern to their individual investors, employees and the communities they serve.
When attempting to align ESG policy with business strategy, each board must clearly define what ESG means and how aspects of that definition of ESG can be integrated into the company’s long-term goals and corporate vision or purpose. This is an opportunity for the board to proactively deal with any environmental or social issues that have been concerns in the past. The board then can order a fair financial analysis of different approaches to specific ESG issues, providing financial evidence to support enacting one ESG policy or rejecting another. As the board is redefining what ESG means for the company, management should engage shareholders, employees and other stakeholders to establish an environment of trust and to ferret out ESG issues that may potentially become problems in the future.
Armed with a new definition of what ESG means to the company and with information about the immediate concerns of all stakeholders, the board can be more confident about the process of integrating ESG-related policies into the business strategy. By focusing on matters that directly impact the company’s bottom-line, new ESG policies can be announced publicly, potentially giving the board increased credibility with shareholders. Generally speaking, ESG policy changes that are geared toward improving financial results or improving corporate culture are positively received, which is a win for stakeholders, management and the board.