Stakeholders such as governments, customers, non-governmental organizations or investors increasingly pressurize companies to include the management of environmental, social, and governance (ESG) issues into their missions and strategies. The management of environmental (E) issues denotes efforts to reduce the negative consequences that business activity has in the natural environment such as resource depletion, emissions, or wastes. The management of social (S) issues involves the consideration of a broad set of stakeholder expectations in company strategy, mission and goals. The management of governance (G) issues entails the adoption of oversight mechanisms which ensure a high level of compliance with regulatory and normative expectations. The number of companies that adopt ESG strategies has steadily increased over the past years. In 2020, 90% of the globally largest 250 companies and 80% of the largest 100 companies in 52 countries issued an ESG report (KPMG Insight, 2020) that informs stakeholders about company ESG strategy and achievements.
Today, a companies’ ESG strategy has fundamental implications for businesses. Financial investors, in particular, demand reliable and comprehensive information about companies’ ESG performance to be able to makes well-informed investments decisions. It is estimated that at least one quarter of all professionally managed assets around the world is based on ESG considerations. Today, sustainable investing assets are more than 31 trillion USD, a 34% increase since 2016 (Global Sustainable Investment Alliance, 2019).
As a result, ESG has increasingly become an issue for corporate oversight and the board of directors must appropriately consider ESG in its oversight function. In a 2020 survey among directors, 45% of respondents indicated that ESG issues are regularly on the agenda of the board, up from 34% in 2019, and 41% think that ESG issues should be a priority for management (PwC, 2020). But how can organizations effectively include ESG in director’s oversight processes?
Essentially, ESG oversight is a responsibility that must be deeply embedded in all general corporate governance responsibilities, policies and processes.
1) Strategy. As the board oversees corporate strategy and risk management, directors need to examine whether a comprehensive assessment of the individual companies’ ESG risks and opportunities has been executed and that the results of these are included in the company’s strategy. In order to measure progress, the company must identify and track relevant key performance indicators pertaining to all material ESG dimensions.
2) Risk. In many respects, ESG is about reducing a companies’ exposure to economic, legal, reputational, and legitimacy risks (e.g. Barnett et al., 2018; Hartmann, 2021; Hartmann and Moeller, 2014) and, therefore, ESG must be an integral part of a company’s risk management. Directors need to assess whether the company has engaged in a thorough and comprehensive identification and quantification of relevant ESG risks and has defined appropriate action plans. Directors also need to understand whether there are clear responsibilities assigned for risk management and risk mitigation.
3) Reporting. Directors need to control whether company ESG reporting is balanced (i.e. involves both achievements but is also transparent about weaknesses), correct, comprehensive and of high quality. Directors should also carefully consider whether ESG reporting satisfies the information needs of all relevant stakeholder groups.
Beyond general oversight duties, ESG also matters for specific committees.
The audit committee should consider whether ESG must be included in the company’s general reporting and, thereby, be subject to audit processes and approval.
The compensation committee must find ways to effectively include ESG metrics and goals in management remuneration schemes.
The nomination and governance committee should assess whether directors have the skills necessary to oversee ESG-related procedures and ensure appropriate training.
In sum, the board of directors plays a crucial role in steering the organization in the best interest of its stakeholders. Forward looking companies and boards understand that ESG is key long-term sustainable growth, prosperity and legitimacy of their organization.
References
Barnett, M. L., J. Hartmann and R. Salomon. 2018. Have you been served? Extending the relationship between corporate social responsibility and lawsuits. Academy of Management Discoveries 4 (2): 109-126.
Global Sustainable Investment Alliance. 2019. 2018 Global Sustainable Investment Review. Accessed: 22 January 2021, http://www.gsi-alliance.org/wp-content/uploads/2019/06/GSIR_Review2018F.pdf.
Hartmann, J. 2021. Toward a more complete theory of sustainable supply chain management: the role of media attention. Supply Chain Management: An International Journal
Hartmann, J. and S. Moeller. 2014. Chain liability in multitier supply chains? Responsibility attributions for unsustainable supplier behavior. Journal of Operations Management 32 (5): 281-294.
KPMG Insight. 2020. The time has come: The KPMG Survey of Sustainability Reporting 2020. Accessed: 22 January 2021, https://assets.kpmg/content/dam/kpmg/xx/pdf/2020/11/the-time-has-come.pdf.
PwC. 2020. 2020 Annual Corporate Directors Survey. Accessed: 20 Jan 2021, https://www.pwc.com/us/en/services/governance-insights-center/assets/pwc-2020-annual-corporate-directors-survey.pdf.