Knowledge Center: Publication
Chief Executive Officer & Board of Directors
Boards and sustainability: Three best practices5/9/2017 Jeremy C. Hanson and Sachi Vora
As global warming turns up the heat on the planet, investors are turning up the heat on boards. And investors are not only concerned about the climate but also about other environmental, social, and governance (ESG) issues: sustainability, diversity and inclusion, human rights, labor practices, executive compensation, employee relations, and board independence. No longer a question of corporate citizenship, these issues have become a matter of the board’s fiduciary responsibility.
That’s a far cry from the laissez-faire days of the 1970s and 1980s, when responding to such concerns was seen as unprofitable, or even from the transitional period that followed, when responding was viewed as the right thing to do, even if it wasn’t great for business. What changed? Beginning in the early part of this century and continuing to today, a mounting body of research has shown that investment strategies that consider ESG factors lead to better performance over the long term.1 And investors are putting their money—and their mouths—behind that proposition.
In early 2016, for example, Larry Fink, chairman of BlackRock, which currently manages more than $200 billion across sustainable investment strategies, wrote to CEOs of companies in which his firm invests on behalf of its clients. He asked each of them to lay out for shareholders a strategic framework for long-term value creation—“one that provides a perspective on the future, articulates the impact of the ecosystem on their strategy, explains how changes in that ecosystem might force the company to change course, and identifies metrics that support a framework for long-term sustainability.”2 And he asked them to affirm that such a framework for long-term value creation had been reviewed by their boards.
Large pension funds are also applying pressure by increasingly incorporating ESG analysis into their investment decisions. They see ESG lapses as red flags signaling trouble ahead—trouble that undermines the long-term value creation that the funds seek in order to secure the retirement plans of their members. Some $8.1 trillion in assets are now managed using ESG factors, a threefold increase since 2010. In the past five years, TIAA-CREF Social Choice Equity Fund has doubled in size, to a current $2.3 billion; a $2.4 billion Vanguard social index fund has quadrupled in size since 2011; and ESG index and research providers FTSE Russell, S&P Dow Jones Indices, and Sustainalytics have multiplied.3 This is to say nothing of the trillions of dollars in funds that aren’t held in specifically social funds but whose managers include ESG factors in their investment decisions.
For directors, issues other than ESG may have loomed larger in recent years—how to deal with activists, staying ahead of technology both commercially and as a matter of risk, and the continuing churn of M&A, spin-offs, and spin-outs. Nevertheless, the risk of inaction on ESG is rising. And so are the opportunities for companies to set themselves apart from the pack through reduced operational risk, lower cost of capital, reduced operating costs through improved natural resource management, increased market appeal to consumers and customers, and the ability to attract and retain top talent. Says Paul Polman, whose eight-year tenure as CEO of Unilever has been marked by an unwavering commitment to sustainability: “We are showing increasingly that . . . other stakeholders and shareholders benefit over the long term, with, for example, the market cap having more than doubled over this period. We also see brands with a strong purpose and social mission now growing twice as fast as our other brands, and more profitably. Increasingly, we are showing that a more purpose-driven model makes a lot of business sense.”4
Faced with these pressures, risks, and opportunities, many boards increasingly review sustainability strategy, operational and reputational risk, regulatory compliance, and the like. And many continue to adopt best practices in corporate governance, even as the bar gets higher from year to year. But they may overlook or undervalue one of the most critical factors in ESG performance: the leadership and talent factor. Specifically, there are three leadership and talent levers a board can pull to help ensure that the company it oversees is best equipped to address ESG concerns: create an ESG early-warning system on the board, gauge the readiness of the top team to manage ESG issues across disciplines, and assess the ability of the organization to accelerate ESG performance.
Establish an ESG early-warning system. A study of 1,200 leaders conducted by Wharton Executive Education found that 60% of senior executives admitted that their organizations had been blindsided by three or more high-impact events within a five-year period. Of those executives, 97% said that their organization lacked an adequate early-warning system, leading to unforeseen impacts on the core business or product lines.5 Unexpected, high-impact ESG-related events can be particularly damaging—ranging from a company-caused environmental disaster to dangerous product failures to corporate malfeasance and many more. Less spectacularly, insufficient attention to ESG can mean missed market opportunities, sluggish operations, diminished profits, loss of investor confidence, and a depressed stock price.
Boards should of course make sure that management is systematically tracking ESG performance, looking for ways to turn ESG into a competitive advantage, and regularly reporting to the board on the state of ESG in the company. But they can also consider the composition of the board and its ability to foresee threats and opportunities. If the board’s capability is weak, then it might want to consider ESG expertise as one of the attributes required of new appointees. If the need for such expertise is particularly pressing, the board can also temporarily expand to meet the need for someone who can fully appreciate the material implications of ESG issues.
A number of high-profile boards have in recent years appointed directors who fit that bill. In January of this year, Exxon Mobil elected climate scientist Susan Avery to its board. A physicist and former president and director of the Woods Hole Oceanographic Institution in Massachusetts, she has authored or coauthored more than 80 peer-reviewed articles on atmospheric dynamics and variability. In 2012 ConocoPhillips named Jody Freeman to its board. She is the Archibald Cox Professor of Law at Harvard Law School and founding director of the Harvard Law School Environmental Law and Policy Program. She formerly served as Counselor for Energy and Climate Change in the White House from 2009 to 2010 and as an independent consultant to the National Commission on the Deepwater Horizon Oil Spill and Offshore Drilling in 2010. The board of General Motors, in 2014, elected Joseph J. Ashton, who served for four years as a vice president of the International Union, United Automobile, Aerospace, and Agricultural Workers of America (UAW). In January of this year, Jørgen Vig Knudstorp, executive chairman of the LEGO Brand Group, was nominated by Starbucks to stand for election to the company’s board at the annual stockholders meeting in March. Though he was recruited for, among many other things, his global leadership and consumer experience, LEGO is well known for being environmentally conscious, and Knudstorp said that he found Starbucks fascinating and inspiring not least because of its “ambitious responsibility agenda.”6
Make sure the top team has the right capabilities for driving exemplary ESG performance. Companies that want to maintain public confidence and protect shareholder value—especially those in industries with high ESG risks—will need leaders who think strategically about the issues, communicate clearly and persuasively, and possess sound business knowledge and judgment. In addition to strategic and communication skills, the heightened importance of ESG calls for a number of interdisciplinary and cross-functional competencies, including:
- The ability to develop trusting relationships with a variety of company constituents before an issue becomes a problem
- A solid grounding in a wide range of environmental processes, procedures, and technologies; social issues; and governance requirements at the local, state, federal, regional, and international levels
- A knowledge of financial operations that extends beyond budgeting to an understanding of how finance intersects with ESG and the ability to make a business case for a new direction
- Familiarity with technological and process advances and an understanding of the trends in ESG and their influences on the company and the industry segment
All leaders in the C-suite—not just the chief sustainability officer, chief risk officer, or chief diversity officer—should be aware of today’s higher ESG stakes. Does the CFO incorporate ESG factors into financial analyses? Does the CMO understand the difference between greenwashing and demonstrable corporate commitment to environmental goals—and that greenwashing not only alienates consumers but also signals to investors that integrity may be a problem in other areas of the company’s operations? Is the CHRO able to sincerely incorporate the company’s ESG performance into the company’s employer brand, or would employees and potential employees respond skeptically? Does the executive team as a whole see ESG as an issue of long-term competitiveness?
Make sure the organization has the ability to accelerate ESG performance. In today’s new normal of constant disruption and fleeting competitive advantage, performance depends on the ability to accelerate—to mobilize around a set of strategic priorities, efficiently harness resources, experiment and innovate ahead of the market, spot opportunities and threats, and pivot at a faster pace than competitors. The ability to accelerate performance in ESG is particularly important because, when approached with a competitive mind-set, the issues are future oriented and fast moving, requiring rapid innovation in technology, operations, and business models. Instead of acting only as wise overseers of ESG, boards will also act as catalysts of speed, making sure that management has in place the ability to accelerate ESG performance as needed.
In our firm’s research, we have found that an organization’s capacity to accelerate performance depends on 13 drive factors (see figure) and their corresponding drag factors. These drive and drag factors can operate at all levels of the enterprise—in individuals, teams, and the organization as a whole. When systematically cultivated, the drive factors prepare the organization to accelerate performance. The corresponding drag factors, when ignored, materially slow and at times completely inhibit performance. Boards that insist that the company systematically assess and address these critical drive and drag factors will help ensure not only better ESG performance but also better performance overall.
Superior performance on ESG issues at all levels of senior leadership—the board, C-suite, and the top tiers of management—generates substantial benefits that can increase investor confidence. Those benefits include difficult-to-quantify but highly valuable factors such as an enhanced brand and increased attractiveness as an employer (especially among millennials, many of whom insist on working for purpose-driven companies). They also include immediate financial benefits: lower insurance payments, lower operational costs, and avoidance of fines. And, most important for investors and directors alike, exemplary ESG performance confers competitive advantage over the long term, helping ensure that the company not only survives but thrives.
About the authors
Jeremy Hanson (email@example.com) is global managing partner of Heidrick & Struggles’ Financial Officers Practice and a member of the CEO & Board Practice; he is based in the Minneapolis office.
Sachi Vora (firstname.lastname@example.org) is a principal in the CEO & Board Practice; she is based in the New York office.
A version of this article article originally appeared in Governance Challenges 2017: Board Oversight of ESG, a report from the National Association of Corporate Directors.
1 See, for example, Deutsche Asset & Wealth Management, ESG & Corporate Financial Performance: Mapping the Global Landscape, December 2015.
2 Larry Fink, “To my fellow shareholders,” chairman’s letter to shareholders from BlackRock’s 2015 annual report, April 10, 2016.
3 Randall Smith, “Investors sharpen focus on social and environmental risks to stocks,” New York Times, December 14, 2016.
4 Alexandre Mars, “Doing well by doing good: An interview with Paul Polman, CEO of Unilever,” Huffington Post, May 9, 2016.
5 See Colin Price and Sharon Toye, Accelerating Performance: How to Mobilize, Execute, and Transform with Agility, Hoboken, NJ: John Wiley & Sons, 2017.