ESG
The Big Picture, Not Just a Piece of the Puzzle
Our aim in writing this book was to help directors redefine the concept of total shareholder return by taking the long view and focusing on the key considerations of talent, strategy, and risk.
In the interviews we conducted with dozens of company leaders and directors, the subject of environmental, social, and governance (ESG) issues came up quite frequently. And from our own experience in working with boards, we know that ESG is top of mind for many directors. You may have noticed, however, that we did not include a separate chapter on ESG or address it as a stand-alone topic. Why not? Because ESG is not a separate topic, and ESG-related themes are woven throughout the book. In a sense, you can’t spell TSR without ESG.
When we talked about talent in this book, we discussed human capital management, diversity, and healthy corporate cultures. When we talked about strategy, we discussed the sustainability of business models and the ability to anticipate shifts in consumer demand. When we talked about risk, we discussed the things that can go wrong: banking scandals, airline disasters, pandemics, sexual harassment, social and economic injustice, the worsening climate crisis. These are all ESG conversations.
Ultimately, all of these matters fall under the purview of the directors who are elected to govern a company—the G in ESG. Boards must own and understand how their companies can affect or be affected by these factors.
Telling Your Story
How should companies report on ESG? There is no shortage of options or opinions. In recent years, we’ve witnessed an explosion in the number of market-based reporting frameworks, while regulatory reporting requirements continue to evolve around the world at an uneven pace. It has been a point of frustration for companies and investors alike. The common refrain we’ve heard from boards and management teams has been, “Just tell us which framework to use.” At the same time, investors have been calling for information that is clear, consistent, and comparable to enable better decisions.
We’ve been encouraged by ongoing efforts to drive standardization of ESG reporting practices—particularly through the work of groups such as the Sustainability Accounting Standards Board and the Task Force on Climate-related Financial Disclosures. This movement calls to mind the efforts to standardize accounting standards and principles nearly a century ago. Whether ESG reporting standards come into being through market-based initiatives, regulation, or a combination of the two, these standards are necessary for the benefit of operating companies and investors alike.
For investors, context can be just as important as raw data. Every company has its own ESG story, strategy, and unique set of challenges. Companies need to recognize the areas where they may be viewed as an outlier and ask: Are we a leader, are we a laggard, and how do we tell that story so that investors will understand?
In the Long Run, a Convergence of Interests
In the introduction, we talked about the Business Roundtable’s call for companies to serve more than their shareholders. Its 2019 Statement on the Purpose of a Corporation said that companies should also provide value to stakeholders such as customers, employees, communities, and suppliers. The statement caused quite a bit of confusion and debate, especially in boardrooms and among those charged with overseeing fiduciary duties to shareholders. Some people were worried that it signified a complete upending of the system, and that it relegated shareholders to being just another stakeholder. Those concerns have been unfounded, and we’re not seeing a rewriting of market expectations in this regard.
Shareholders provide capital to companies to generate returns. That’s the reason people invest, as survey after survey has confirmed. For all of the chaos, risk, and uncertainty that are inherent in the capital markets, the market also values order. When there is no structure or clarity of expectations for a company among its shareholders and stakeholders, then management and the board essentially become accountable for nothing. And when company leaders are not accountable, things fall apart.
We believe the consensus view of the Business Roundtable statement is that it’s a pragmatic recognition of the way companies are evolving. More and more companies understand that shareholder value is not created in a vacuum. If a company operates without care or concern for its customers, employees, suppliers, or communities, it will destroy shareholder value over the long run. Indeed, over the long run, the interests of shareholders and stakeholders converge.
Shelly Lazarus put this nicely in chapter 2 when she described the ongoing shift toward business sustainability. “It’s now part of how the best companies are run because it’s becoming increasingly important to all the constituents of any company,” she said. “If you’re market driven, the market has spoken about whether these things are important or not—how you treat your resources, how you interact with the community, how long term you are in your thinking about your impact on society.”
For instance, one focus of ESG is curbing waste. No company can improve air quality on its own, but any company can make a unilateral decision to stop polluting. It may need to change its business model and invest in new manufacturing and product development technologies, but in the long run, reducing waste will cut costs, boost profits, and create long-term value.
Educational initiatives can work in the same way. Many US companies have invested in education, either directly or through foundations. Far from being an act of charity, the aim is to help make sure that the employees of tomorrow have the skills companies will need. Such programs can also help redress the financial inequality that is threatening to tear this country apart. Public companies have a role to play in this realm. And a growing number of investors, especially younger ones, will expect companies to take that role seriously.
In the end, the essence of the debate is not shareholder versus stakeholder, but short term versus long term. For more than a decade, investors like Vanguard have been promoting the development of a longer view, one recognizing that long-term value creation is really what most investors are interested in.
Leading an organization for the long term is easy in theory. But the long term is made up of thousands of short terms, and it can be nearly impossible for a company to meet the interests of all of its constituents all of the time. The pressure to satisfy shareholders and stakeholders can be intense. Earlier in the book, Jeffrey Ubben said, “Sustainability is a solve for short-termism.” Well stated—though it takes courage and vision, and will lead to an organization that is focused on long-term sustainability.
That’s why boards are critical. A board is the steward of long-term value for a company’s shareholders and stakeholders. At any given time, the sitting members of a board can span several decades of service. That’s longer than most CEOs will serve and longer than many investors will hold the stock. As a perpetual governing body, the board has the unique perspective and ability to oversee, counsel, and ultimately empower the company to create sustainable long-term value.