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Why ESG strategy is a complex corporate challenge for boards

Why ESG strategy is a complex corporate challenge for boards

Why ESG strategy is a complex corporate challenge for boards 700 467 ECODA

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ESG: three simple letters that can stand for total confusion unless it is fully understood by the board. It is not about compliance per se, although some boards may choose to view it that way. It is about three core areas of corporate responsibility that have to come together strategically. For boards that espouse its tenets, it is actually designed to signal thinking and acting for the future benefit of every single person on the planet.

The “E” is for the environmental impact caused by corporate activity. “E” attracts the most attention from the populace simply because we are now well aware of pollution, deforestation and plastic in our oceans. Board responsibility for looking after the environment is a no-brainer and the science to measure and monitor it is so advanced that there is nowhere to hide. But more on that later.

Less easy to measure and manage is the “S” for Society/Social; which covers corporate impact on, and responsibility for, the people on the planet, and “G” for governance; the board’s moral, ethical and professional oversight that imbues the corporation with its essential legitimacy; its social licence to remain in operation.

In terms of the level of board commitment required, there are no two ways about ESG. The board has to declare that it is dedicated to the task at hand with no room for ifs or buts. Otherwise, what should prove to be a business opportunity will very quickly turn into an existential threat: go and ask any chair or CEO in oil, automotive or even conventional management consulting.

ESG and corporate performance

ESG has let itself down in the past, by losing sight of the underlying complexity behind the simple messaging of corporate social responsibility; to the point where the simplistic version becomes meaningless. It has often turned into a box-ticking exercise, where most of the boxes, especially those in the “S” category (for example, diversity and inclusion quotas) can become part of the problem (failure to maximise the value of human capital) rather than the solution. Only a whole system solution will do. That means demonstrating how each part of ESG contributes to corporate performance and enhanced company valuation, while reducing corporate risk. So let us put any simplistic approach to bed, once and for all.

ESG requires nothing less than an absolute transformation of your company

The reality of ESG is that it represents the most complex corporate challenge that you have ever faced; or are ever likely to face. ESG is a fundamental break, a discontinuity, in the historical continuum that we have come to regard as capitalism. ESG requires nothing less than an absolute transformation of your company.

If you successfully navigated “total quality management” in the late 20th century then you should be in a good position to conquer the new corporate and socio-economic paradigm that is ESG. But you will have to remain open-minded long enough to learn how conventional measures of profit/loss and shareholder value, and accounting and reporting conventions, have to adapt. ESG could be described as a new paradigm of “valuism”; that is, a global system that measures the total, combined, global effect of the outputs, and ultimate outcomes, from corporations through the allocation of global capital. Welcome to a new world of heightened, and significantly widened, board responsibility that can produce benefits for all stakeholders.

Of course, any birth is a painful process and the growing pains of this fundamental transformation have been felt for some years. In November 2019 the Institute of Directors issued a 10-point manifesto “to regain the trust of wider society while at the same time avoiding an extreme lurch to heavy-handed regulation” and Roger Barker, its head of corporate governance, said: “Too often the debate around capitalism degenerates into simplistic binaries and slogans. We should be more ambitious, and explore new ways to combine the profit motive with social responsibility, to confront the challenges facing the economy, not least climate change.” When I met the then chair of the IoD, Charlotte Valeur, she agreed that there is currently no widely accepted development programme to qualify board members to handle this range of responsibilities.

Board education on ESG

So this is a new beginning for board education on ESG, and the issue of “evaluations of UK company boards” is back on the agenda of the UK’s Department of Business, Energy and Industrial Strategy (BEIS), who commissioned a “review into the effectiveness of independent board reviews” from the Chartered Governance Institute. However, in order to be both meaningful, and of practical use, there has to be both an agreed standard of conduct and the means by which it can be measured independently and objectively.

The measurement system deployed will have to produce convincing evidence that exemplary board behaviour produces both exemplary ESG outcomes and superior financial performance

At the same time, the measurement system deployed will have to produce convincing evidence that exemplary board behaviour produces both exemplary ESG outcomes and superior financial performance. If not, profit and shareholder value will remain disconnected from corporate responsibility and the global system of capital allocation will continue to pollute the planet and disadvantage literally billions of people. The stakes could not be any higher and the burden imposed on board members any heavier.

So it is time that boards recognised, and accepted, that either this is an unsolvable, wicked, Gordian knot or it isn’t. The Maturity Institute, comprising a multi-disciplinary group of professionals, and built on a set of common values and principles (the Ten Pillars of responsible governance), was established in 2012 to take on this challenge.

We saw it as untying the knot in order to reconcile societal value with shareholder value. Our starting point was a re-definition of value to incorporate and integrate conventional measures of company valuation with a universal measure of societal value—what we call “Total Stakeholder Value”. The instrument that enables this calculation is a set of 32 questions, incorporating ESG factors, that we ask boards to answer. The answers to the questions are all scored and the total produces a rating, very similar to a credit rating, on a typical AAA scale. This enables us to compare the performance of all companies, across all sectors, in terms of a common measurement of their combined ESG and financial value.

As an avowedly evidence-based institute, applying the scientific method to the tricky causality associated with intangibles, we subjected the question set to the toughest test we could find in 2020. We worked with equity analysts on the Redburn Purpose Project to integrate their conventional equity/financial analysis with our unconventional ESG analysis. This has now produced a rigorous and robust evidence base which shows, very clearly, that ESG performance and financial performance go hand-in-hand. It has also produced a new corporate index—OMINDEX—that shows how much “social credit” a board really deserves.

Paul Kearns is chair of the Maturity Institute and co-author of The Mature Corporation—A Model of Responsible Capitalism.

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