5 ESG concerns for corporate boards with a social conscience

This article is brought to you thanks to the collaboration of The European Sting with the World Economic Forum.

Author: Jo Taylor, President and Chief Executive Officer, Ontario Teachers’ Pension Plan

• COVID-19 pandemic and climate change have pushed environmental, social and governance (ESG) issues to the top of the corporate agenda.
• New research conducted by Willis Towers Watson reveals how corporate boards are responding to these concerns.
• Here we outline the five key themes that stood out from the research.

Environmental, social and governance (ESG) issues continue to gain traction among corporate leaders. On 26 January 2021, 61 top business leaders across different industries announced their support for stakeholder capitalism metrics and disclosures released by the World Economic Forum and its International Business Council. But understanding whether and how corporate boards are prepared to address ESG goals is critical for companies to fulfil this commitment.

To understand how corporate boards are approaching ESG, Willis Towers Watson interviewed 170 board members in more than 20 countries and conducted a global Board of Directors Survey targeting corporate non-employee directors. The research reveals a heightened awareness of social issues, including those exacerbated by the COVID-19 pandemic, and a sense of urgency to tackle climate challenges as organizations strive to create long-term, sustainable value.

The research revealed five key themes:

1. Increased commitment to ESG issues

Most directors recognize the need to clearly define what a company stands for beyond maximizing shareholder value. Purpose differentiates a corporation from its competitors and can confer competitive advantage, which in turn helps create tangible value. This philosophy is fueling an increased focus on ESG issues.

Directors participating in our research emphasized that a well-articulated organizational purpose has the power to rally employees, and a company’s social and environmental contributions can help create a compelling employee value proposition. Consumers’ buying patterns are also shifting toward brands and companies that address important societal issues.

The majority of directors indicated that the COVID-19 pandemic has increased their focus on ESG issues. They emphasized the importance of a growing sense of social responsibility. We also found that resilience and employee wellbeing are top priorities; directors find comfort in knowing that the workforce is engaged, productive and feels supported while navigating the challenges of the global pandemic.

Generally, directors don’t view the interests of employees and other stakeholders as conflicting with those of shareholders. Fiduciary duty toward shareholders is carried out by advancing stakeholders’ interests as a way to drive sustainable value. Most believe treating suppliers, customers and employees well is just good business.

2. Stronger commitment to diversity, equity and inclusion (DEI)

With the spotlight on representation and equality, many directors expect their companies to strengthen their commitment to building a diverse and inclusive workforce. In turn, directors anticipate becoming more involved in overseeing these efforts. For example, in North America, over 70% of survey respondents report that their boards have been asking for more detailed information on matters related to DEI more frequently over the past six months.

Overall, directors believe that an organization’s CEO must set and sponsor DEI strategy. The Chief Human Resources Officer is a key stakeholder who provides input to the strategy and is primarily responsible for its implementation while the board plays a critical oversight role, which may involve requiring management not only to explain which initiatives are in place but also to provide evidence of progress. Roughly two-thirds of survey respondents (66%) globally indicate that the full board is most likely to oversee efforts in their companies with another 18% expecting them to do so within three years. Pay equity is also a prime concern for many directors in Europe and North America.

What’s the World Economic Forum doing about diversity, equity and inclusion?

The COVID-19 pandemic and recent social and political unrest have created a profound sense of urgency for companies to actively work to tackle inequity.

The Forum’s work on Diversity, Equality, Inclusion and Social Justice is driven by the New Economy and Society Platform, which is focused on building prosperous, inclusive and just economies and societies. In addition to its work on economic growth, revival and transformation, work, wages and job creation, and education, skills and learning, the Platform takes an integrated and holistic approach to diversity, equity, inclusion and social justice, and aims to tackle exclusion, bias and discrimination related to race, gender, ability, sexual orientation and all other forms of human diversity.

The Platform produces data, standards and insights, such as the Global Gender Gap Report and the Diversity, Equity and Inclusion 4.0 Toolkit, and drives or supports action initiatives, such as Partnering for Racial Justice in Business, The Valuable 500 – Closing the Disability Inclusion Gap, Hardwiring Gender Parity in the Future of Work, Closing the Gender Gap Country Accelerators, the Partnership for Global LGBTI Equality, the Community of Chief Diversity and Inclusion Officers and the Global Future Council on Equity and Social Justice.

Organizational culture is essential to promoting DEI. While most directors share the view that shaping organizational culture is management’s responsibility, they recognize the critical role the board can play in encouraging desired behaviors. Sixty-five of survey respondents say the full board is most likely to oversee culture with another 20% expecting to add this responsibility to the duties of the full board within three years.

3. Environmental and climate issues are top priority

When surveyed about the relative importance of different ESG priorities, directors ranked environmental and climate issues as their number one priority. Given the increased focus from the investor community, companies are beginning to measure and track climate-related goals such as greenhouse gas emission reductions, carbon intensity reductions, water security, waste management, biodiversity and renewable energy consumption etc.

In some primary and secondary industries (e.g. mining, oil and gas, chemical manufacturing, transportation, energy) directors commented that environmental matters have long been a top business priority and risk management focus. They noted that environmental impacts are at the core of their business strategies, and their companies are transforming their portfolios and product mixes accordingly. Not only do they need to focus on climate-impact measures such as carbon dioxide emission reductions but also on climate transition priorities that may involve, for example, energy companies shifting toward renewable energy production.

4. Alignment with executive pay

Board members view ESG issues as top business priorities and expect ESG goals to be incorporated into performance management and executive incentive plans.

According to Willis Towers Watson’s 2020 board of directors survey on Aligning ESG and Executive Incentives, nearly four in five respondents (78%) are planning to change how they use ESG within their executive incentive plans over the next three years. Forty-one percent plan to introduce ESG measures into their long-term incentive plans over the next three years, while 37% plan to introduce ESG measures into their annual incentive plans. Additionally, about a third plan to raise the prominence of environmental and social and employee measures in their incentive plans.

There’s been considerable focus of late on linking climate priorities to executive compensation. For example, principle 6 of the World Economic Forum’s How to Set Up Effective Climate Governance on Corporate Boards: Guiding principles and questions, covers incentivization and states that “executive incentives should promote long-term prosperity, including climate-related targets.”

More companies are beginning to include hard targets for climate measures as part of their executive compensation plans. A 2020 Willis Towers Watson analysis shows that approximately 11% of the top 350 European companies (but only 2% of United States S&P 500 companies) have carbon dioxide emission reduction targets in management performance indicators and incentives. There is certainly more work to be done to shift the needle on this important theme.

Although some directors felt that pursuing ESG priorities is the right thing to do and should not necessarily warrant additional incentives, most directors indicate that explicit linkages to executive incentive plans could help accelerate the ESG agenda and drive a cultural mindset shift within organizations.

5. Supporting long-term value creation

Several directors expressed the view that companies can generate sustainable long-term value because of a well-defined organizational purpose, diverse stakeholder interests and ESG priorities, not despite these factors. For example, one European director shared that his company’s board had urged management to cap its profit margin at a certain level – and by doing so, had encouraged management to invest in ESG and sustainability priorities, which in turn increased the company’s long-term value.

While directors recognize that companies must be profitable to survive, they also understand that generating sustainable long-term value requires carefully balancing the interests of shareholders and other stakeholders. Achieving this balance will help companies meet evolving ESG priorities while maximizing their value. Companies with better ESG profiles stand to benefit from preferential and lower cost of debt offered by financial services firms, as well as from an influx of capital in sustainable investing, which may result in valuation premiums. Boards are increasingly aware of the direct and indirect financial linkages of sustainable ESG practices and long-term value creation for all stakeholders.