Stakeholders including investors, clients, customers, employees and communities increasingly want businesses to focus on the environment, their social impact, and good governance. The organizations that focus on these “ESG” principles and measures are earning the trust and loyalty of those stakeholders, and are proving to be more sustainable, driving long-term, profitable growth. For a concept with a fluid definition and, as yet, no universally applied metrics, ESG draws increasing global attention from investors, corporate leaders, trade press and think tanks.
A COMMON UNDERSTANDING
“ESG (environmental, social and governance) is a generic term used in capital markets and used by investors to evaluate corporate behaviour and to determine the future financial performance of companies.
ESG factors are a subset of non-financial performance indicators which include sustainable, ethical and corporate governance issues such as managing the company’s carbon footprint and ensuring there are systems in place to ensure accountability.”
Ft.com/lexicon, Financial Times
So are ESG principles an emerging priority for investors, or an operational guideline for sustainability-minded companies? “Both, and that’s the beauty.” Kurt Harrison is co-leader of the ESG, Sustainability and Impact Investing team at Russell Reynolds Associates. He says, “ESG has become increasingly relevant in both an investment and corporate strategy context.”
In broad terms Donna Zarcone, President and CEO of the Economic Club of Chicago, says investors are looking for transparency. “Investors are asking for a clearer picture on what corporations are doing around sustainability related questions, around customers, employees, suppliers, and communities. Ultimately, if corporations do the right things for these stakeholder groups, the shareholders will benefit in the long run. The investors are saying, you've got to be doing things right on all these other fronts so that you will have a long-term, sustainable corporation that benefits your shareholders.”
For example, Harrison says, “If you ask a fixed-income investment manager, they will say ESG is one of their core investment metrics.They look at companies from a cashflow perspective, a revenue perspective, and also how thoroughly they are incorporating sustainable investment principles into their business model. It's just another part of their investment process.” He adds, “From a corporate strategy perspective, if you ask an oil and gas company how they think about ESG, they're working on how to move toward carbon neutrality in a world that is pivoting aggressively toward a sharp reduction in carbon footprints and fossil fuels. For them, it is more of an existential question – ‘If we keep doing what we're doing, we're going to be out of business in 20 years.’ So let's think about ESG from a corporate governance perspective and a long-term corporate strategy perspective; how we can actually change our business model to be more sustainable in the long run?”
ESG is about better long-term business decisions based on material factors that include more than traditional financial metrics. According to BlackRock, the world’s largest investment manager, “Our approach to ESG integration is to broaden the total amount of information our investment professionals consider in order to improve investment analysis, seeking to meet or exceed economic return and financial risk targets.” (BlackRock ESG Investment Statement, updated 29 August 2019)
And is ESG a global phenomenon?
Jason Johnson is Managing Partner at Johnson Partners. “Australia, happily, has been at the forefront in some respects of the ESG global movement. The enormous bushfires have catalyzed a tremendous, positive, constructive discussion. I think boards absolutely are now on notice. Most of them are naturally, appropriately moving the dial in their respective organizations to ensure that there is much better, a much more thoughtful approach to sustainability.”
For Bill McNabb, former Chair of Vanguard, “ESG as a broad topic is actually getting significant attention in Europe, Australia and New Zealand."
“Everyone’s definition of ESG really varies, especially the E and the S,” McNabb says. For example, “What is a company’s responsibility to the environment? What are a company’s societal responsibilities? You can put a hundred people in a room and have a hundred different opinions.”
In the broadest terms, the elements of ESG can be described as follows:
Environment: How a company uses natural resources, how their operations impact the environment, and how the company manages climate risk.
Social: How a company manages its impact on employees, supply chain, customers, and the communities where they live and work.
Governance: How a company’s board of directors leads, including board composition, executive compensation, and strategic alignment.
ESG ultimately reflects the expanding factors upon which a company is evaluated, and also illustrates the evolution of investor influence and priorities.
McNabb describes a sea change in investor thinking. “To me, the real evolution has been the transition of short-term thinking to long-term thinking." McNabb explains, “You hear the term all the time in the public markets about managing to the quarter, making sure if you’re a public company, you’re meeting Wall Street’s expectations about what your quarterly results are. But much of that kind of thinking leads to almost a rolling sense of short-termism. At Vanguard, so much of the investing is done through our index funds, which hold companies practically forever. So the quarter doesn’t really matter. What matters is whether the company is creating long-term value. Because that’s what our shareholders want.”
To counter the notion that ESG is about putting public good ahead of financial returns, Harrison makes clear that is not the case. “The major private equity and investment firms are not going to accept below market returns and change their investment processes, which have been successful for 20, 30, 50 years, just to make the world a better place. Instead, the people who run these organizations have to embrace and understand the fact that employing a more sustainable and ESG-compliant investment process is going to improve financial returns in the long run.”
For example, he says, “If you are a private equity manager and you're raising a new fund with a 20 year time horizon, you know that 20 years from now the world’s going to be a very different place. You have to incorporate forward-looking sustainable metrics into your investment process if you’re going to generate above-market, long-term returns. So we can’t sit here and say you should accept lower returns just to make the world a better place, because that’s just not going to work. No one’s going to embrace that.”
Long-term investors do embrace sustainable business practices that align with their investment horizon. McNabb is quick to remind us, “It’s not Vanguard’s money. We’re speaking on behalf of 30 million investors around the world,” he says. “I think that matters to board members, as well.”
McNabb says, “This has been a very rapid evolution over the last decade or so. If you went back, 15 years, no one was talking about governance in these terms. Part of what’s happened is the nature of the largest shareholders has changed quite a bit.”
Zarcone explains, “When you look at large corporations and they disclose their largest investment holders, Vanguard or BlackRock will often be number one or number two, and they can hold anywhere from five to seven percent of a particular corporation. These major institutional investors have been long-term, permanent investors and they had been taking very much of a passive investor role, investing in the companies that fulfilled their index strategy.”
Kit Bingham is a Partner in the Board Practice at Odgers Berndtson. He explains the shift toward ESG investor priorities over time. “Towards the end of the 80s we had the takeover wars, the concept of shareholder primacy and shareholder value, and that really began to dominate as the basis on which companies should be run, slightly different to Friedmanesque notion of all we care about is profit, but it incentivized management to run the business in the interest of shareholders. That was when you really started seeing CEO pay climb like a rocket and the beginning of big option schemes and all those sorts of things. And I think the philosophy was perfectly sound, which is we the shareholders want you to run our company in our interest, not yours. And I think we’re coming to the end of that sort of super cycle. So I think we’ve had a 30-year trend of shareholder primacy and I do see that significantly under assault. Why is that? I think because share to value isn’t the same as societal value, and in fact executive pay is often used as the sort of signature issue, the sort of litmus test issue.”
“What I've seen is a real shift,” Zarcone observes. “Vanguard and BlackRock have become more ‘active passive’ investors because now they are seeing the impact they can have in their long-term permanent investment portfolio. And they are recognizing that ESG issues such as climate change, diversity and inclusion, and a clearly articulated long-term strategy with a focus on innovation and growth must be there for the long-term benefit of the company and the long-term return on their investments.”
How does an organization like Vanguard leverage that influence? McNabb explains.
“In the investment world, if you look at fund managers with a very short-term focus that make bets on one company versus another, their motivation is quite different than ours and sometimes it’s going to be in conflict. To be overly simplistic about it, you may have a situation where a group of shorter-term oriented investors say to a company, we think you should sell these three divisions in order to maximize profitability and maximize your share price. Our view on that may be, well, what if that actually harms the company in the long run? Even though the stock price might go up in the short run, we’re there forever. We may be negatively impacted. So, again, as an indexer, we can’t sell the stock, but we can certainly vote and we can have conversations with directors and management teams on these kinds of issues. And if we find that we come to very different conclusions than the board, for example, then we can express ourselves through a vote against those directors when they stand for reelection. That’s an extreme case that doesn’t happen all that often, but we do have that ability.”
THE ENGINE FOR CHANGE
An important question is whether this shift is just about changing perspective from a short to a long horizon, or is it something more?
“It’s more than that,” Bingham explains. “It’s a recognition that businesses don’t exist outside of society. I remember Richard Lambert of the Financial Times saying a healthy society needs a flourishing business sector. And I think that is true. This notion that we have business and society as two separate things, we now understand it’s just not the case. Capital is mobile; we can’t just lift our companies and stick them in a far part of the world and ignore the communities in which people work or the environmental impacts of that company, and just say, ‘don’t worry, you’ll thank us one day when you’re cashing your pension.’”
Pressure to consider environmental and societal factors in corporate decision-making comes from more than the Vanguards and the BlackRock’s of the world.
"There are multiple stakeholders actually driving the movement: employees, customers, and increasingly owners, which is therefore making boards of directors sit up and take notice,” McNabb explains. "We don't look at it (ESG) as a separate thing; we look at it as a way of doing business. The whole idea here is: does a company serve a broader role than just creating profits and driving a stock price? Employees think about what kind of company they want to work for. Customers think about who they want to buy things from. And the owners, which would be your big investors, want to make sure that companies are thinking about these factors in a reasonable way.”
Dr. Bjorn Johansson is founder of Dr. Bjorn Johansson Associates – Global Board Advisors. “It is a combination of many things. First of all, it has become required. So you have no choice. You have to be part of this and you cannot hide and step aside. And then of course it’s pressure from politicians because politicians are looking at this as a way for them to position themselves in today’s world, and it’s pressure from the investment funds and the pension funds. If you would take my home country, if you look at the Norwegian state pension fund, which is the largest in the world, you know, they are placing enormous importance on the ESG question.”
ESG is a matter of metrics, as well as message. Those who seek the advantages associated with ESG will have to quite literally measure up.
“The National Business Council, incorporating 140 of the world's largest companies, agreed to support efforts to develop a core set of common metrics and disclosures that could be used to measure private sector progress against key environmental, social and governance goals."
Børge Brende, WEF President. Closing Remarks, World Economic Forum 50th Annual Meeting
As an advisor to organizations seeking to establish best-in-class ESG frameworks, Harrison observes, “There are a lot of initiatives being put forward about how to create reliable standards or metrics, there are a lot of opinions about how to do that and what those standards and metrics should be, but there is a lack of unanimity around that. So there’s not one definable standard you can point to and say, here’s what ESG means because PIMCO has their version of what they think ESG means and BlackRock has a different version and KKR has a different version. So nobody’s right, nobody’s wrong. It’s going to take time and eventually the standards and metrics will become more institutionalized and formalized and agreed upon. But right now we’re still in the early phases of defining what it is and what it means and how we incorporate it within an individual business or investment model.”
There is considerable pressure to quantify ESG-related efforts. Bingham points to “broad social pressure, media pressure, public pressure, political pressure on business leaders, and also shareholders saying ‘we demand evidence that you are doing this.’ And that’s where I think we’ve got to is a sense of… remaining accountable to shareholders for something broader than pure shareholder value.”
For example, he says, “I’ve had it described as the company report using 19th century tools to look at a 21st century business. Financial accounting is very, very old now, and it’s only ever a snapshot. The annual report says this is the financial condition of the business on the 1st of January, 2020 and it’s entirely retrospective. This is what happened in the course of last year.”
An important question is whether this shift is just about changing perspective from a short to a long horizon, or is it something more.
“I think where investors are is, ‘can we develop a suite of measures that tell us what’s going to happen in the future?’ And I think that’s around more engagement and strategy, but also some of these risk metrics or warning metrics. If a company is regularly failing the regulator or has a deeply unhappy workforce or has its local community up in arms or is dumping pollution in overseas markets, whatever it might be, those are all things that may not cost today and they may not have cost anything last year, but you can be pretty sure in today’s world that it’s going to catch up with you,” Bingham says.
McNabb says “We’d certainly like to see more reliable metrics in these categories. The flip side is you don’t want to create so much bureaucracy and so many reporting requirements that companies wouldn’t want to be public anymore.” He points to the Sustainable Accounting Standards Board (SASB), as one organization driving sensible progress on this front.
According to SASB’s ESG Integration Insights 2019 Edition, “A significant challenge to integrating ESG considerations in mainstream investment processes is the ESG data available from companies, which varies in quality, quantity, and investment relevance. Much of that problem is attributable to the fact that ESG disclosure standards lack consistency across global jurisdictions, where they may not exist at all.”
While the lack of consistency is a challenge, the volume of ESG reporting is on the rise. A 2019 World Economic Forum white paper highlights the growth-trend in ESG reporting. “In 2017, 78% of the world’s largest companies integrated non-financial information in their annual reports, up from 44% in 2011.” (“Seeking Return on ESG: Advancing the Reporting Ecosystem to Unlock Impact for Business and Society.” January, 2019)
ESG MEETS SEARCH AND LEADERSHIP CONSULTING
Helping companies integrate ESG into their corporate culture is an opportunity for the Executive Search and Leadership Advisory profession. Harrison says, “Because it is still being defined in real time, we can be very helpful from an advisory perspective to our clients. We are in a position to help our clients think about and define how to integrate and implement ESG into their culture, into their corporate strategy and into their investment philosophy if they happen to be a financial services firm. There's a lot of chatter in the investment management world about how to incorporate ESG into investment processes. Everyone's talking about ESG, but no one has developed a universal industry standard. We're helping our clients to define that, and implement that within their own corporate strategy and investment processes in a way that is consistent with their culture.”
Search firms are also positioned to help clients looking to build leadership teams that can drive ESG priorities in their organizations.
McNabb believes, “In terms of the characteristics and responsibilities of the future CEO, the ability to think long-term is going to be key.”
How does the ability to think long-term align with the tenure of organizational leadership? McNabb explains, “We’ve seen a shortening of tenure among CEOs over the last 20 years. I actually don’t think that’s a good thing.” He explains, “If the average CEO tenure is less than five years, that’s not enough time to implement a viable strategy that’s going to put the company on a good long-term path.”
In addition, organizational leadership must choose to execute a shift to long-term thinking, and consultants can only help a client when the clients are ready. For example, Johansson says, “Our Firm today executes 60% of our work in the area of Non-Executive Directors (2019 and 2020). ESG is in the majority of our searches, is one of the top priorities for selecting a new board member and is part of adding value to the board. All our clients provide a yearly ESG report, either separately, or integrated in their annual reports.”
However, Johansson says of the selection criteria, “It is not at the bottom of the agenda, but it is not one of the top three areas for selecting a new CEO or a new Chair. But that might change in five years from now.”
Johansson also warns, “Meeting the ESG expectations and at the same time delivering profit, growth, market share and shareholder value, and whatever it is that you’re measured on, that’s a tough balancing act.”
Does the rise in ESG mean that companies are going to make business decisions that run against their financial interests?
An observation regarding why board directors and CEOs should care about environment, social, and governance comes from Bingham. “It’s you and your reputation,” he says. “If something goes horribly wrong, people like me stop calling you. There are any number of people that I can think of, outstanding directors and they’ve had bad luck to be on a board of a company that has gone horribly wrong, or there’s some financial scandal or other kind of scandal and that’s it. They know perfectly well that people like me can never put them on the long list again.”
Search and leadership consultants who advise on culture have an opportunity to help organizations drive ESG principles deep into their organizations, and perhaps mitigate that risk.
Zarcone describes how these principles can become embedded in an organization. “In my mind, it's not any different than asking what are the corporation’s strategic initiatives, what is the mission, what is the purpose of a corporation? And then how does that corporation take the higher level-goals and operationalize them through strategic initiatives and an operating plan that’s executed and held accountable for within the organization?”
She says, “It has to start from the top down, it has to be embedded in the vision and the mission of the organization and it has to flow through the operating plan, be baked into the goals of the leaders, and leaders need to be held accountable for driving the results. The CEO has to be in the position to say that this is how we are going to act as an organization and how we’re going to exist within society. And it has to be supported by the board, as well.”
What does it look like, when ESG principles are so embedded in an organization that they are as important as financial ones? Bingham provides an example. “There is a big, multinational Danish company that as part of its internal audit team now audits culture. If there’s suddenly a problem, say hypothetically there are six sexual harassment accusations in Minneapolis, they’re on the next plane and they’re right there, as they would be if there was a financial problem. So the moment they see a black hole, whether culturally or in financial terms, they pull in the SWAT team.”
IS ESG HERE TO STAY?
“In 2006, when the UN-backed Principles for Responsible Investment (PRI) was launched, 63 investment companies (asset owners, asset managers, and service providers) with $6.5 trillion in assets under management (AUM) signed a commitment to incorporate ESG issues into their investment decisions. By April 2018, the number of signatories had grown to 1,715 and represented $81.7 trillion in AUM. According to a 2018 global survey by FTSE Russell, more than half of global asset owners are currently implementing or evaluating ESG considerations in their investment strategy.”
Robert Eccles, “The Investor Revolution,” HBR May-June 2019.
So is ESG a trend? A fad? The future? “One way to think about ESG is that it is a thematic wave, and it’s very similar to prior waves,” Harrison explains. “Think back five or six years ago. Digital transformation, was the buzzword du jour. Every company was going to transform digitally. Every company was going to be a FinTech company and every board had to have digital technology expertise to adhere to good governance principles. Two or three years ago, you saw the same thing around diversity and inclusion. Diversity and inclusion was a thematic wave. It swept over companies across industries, across geographies. You had to have a diverse workforce, you had to have an inclusive work environment and every board had to have a significant diversity component to it. So those are two thematic waves that are still with us to this day and never really stopped. ESG is the current thematic wave. It transcends industry, sector and geography. And every company is going to have to have an ESG-compliant or sustainable long-term corporate strategy. Every investment firm is going to have to have ESG metrics permeate every strategy that they invest in. And every corporate board is going to have some resident ESG domain expertise, sustainability expertise to be viewed as a credible board.”
There is no disputing the rise of ESG funds, which invest in organizations aligned with ESG principles. According to Johnson, “We’ve seen a tremendous inflow of funds towards those ESG funds, and I think that will only become a tidal wave as retail investors start to think about where they want to direct their monies. I think there’ll be an absolute increasing focus from the mom and dad pension investments as they think about driving better outcomes for the future.”
“I believe that this decade will be a true tipping point for ESG,” he says. “We in Australia have the third largest pension scheme in the world. And so our superannuation funds, as we call them, carry enormous influence over the organizations that operate in Australia. And for them, ESG has become a top tier issue as I think about investment allocation.”
For McNabb, “I think the reality is, there needs to be an array of investment products available so that people can reflect their own interpretations of what ESG means. And they can pick and choose. And in a sense the marketplace will determine whether or not those choices are fruitful in the long run. And again, interestingly, there are some investors who believe that by focusing on these factors they’ll actually create more outstanding returns. Some of that is time-dependent and we don’t know yet; we haven’t been through enough cycle. The flip side though is that there are some investors who say, ‘I don’t care. I’m willing to sacrifice returns if that’s what it takes in order to express my personal beliefs.’ So what we’re already seeing is that proliferation of ESG-oriented product that tries to cater to different values, different perspectives.”
Zarcone might argue that ESG is neither a trend nor is it new. “Some of the best corporations have been doing this for many, many years. I think what's happening now is the expectation that companies and CEOs are going to become the primary force for change around the globe. CEOs are focused on geopolitical issues, sustainable economic development, the threats posed by climate change, and the need to address environmental issues with a high sense of urgency. Businesses have the agility to respond quickly where governments cannot or have not chosen to address these issues.”
“We’ll see how that all evolves,” McNabb says. “We think being a good citizen on these topics creates a better long-term business. And then very importantly, the ‘G’ is the thing that we keep coming back to because it's the most practical thing that investors can impact. Good governance by a board will actually reflect the appropriate 'E' and 'S' considerations for a company that pertain to its employees, customers, communities, and ultimately its shareholders. And how that’s being managed is certainly part of a board’s responsibility.”
If ESG principles are good for business, the environment, and society, how long before these elective measures become mandated?
"I think there may be new regulation around disclosure requirements,” Zarcone says. “It's not unusual for the government to jump on the bandwagon after some things are already initiated. But I don't think that government regulation is going to be as demanding as the shareholder and investor influence. Think about how long it takes to get regulations and government changes through the full process. Institutional investors can move at a much faster pace, and political will is much more short term than Vanguard or BlackRock, which take the longer view.”
For Bingham, “It’s an argument going on here for 20 years, what your companies disclose and how. We are still in pretty hardcore ‘accounting wins,’ which isn’t to say that companies shouldn’t take their own steps as the triple bottom line and all of that, but it hasn’t really taken off. And whether the government can intervene in that, I’d be pretty wary. I don’t think that’s likely.”
That would be good news for Johansson. “I’m a believer in the Swiss system of democracy and of freedom to operate with less bureaucracy, but unfortunately I see tendencies certainly in Europe where I’m worried about regulations coming up, more on the environmental side, but also the social and governance side.”
“There is a growing body of data showing that companies adopting sustainability practices outperform their peers. In one study, Harvard Business School research found a $1 investment over 20 years yielded $28 in return in those companies focused on ESG versus $14 for those without the focus.”
Silda Wall Spitzer and John Mandyck, “What Boards Need to Know About Sustainability Ratings.” Harvard Business Review, May 30, 2019
From mitigating risk, driving high performing cultures, attracting and retaining talent, earning committed customers, and capitalizing on new business opportunities, ESG appears to be good for business.
“Clearly, ESG is expected today by most of all stakeholders including investors, analysts, customers and employees,” Johansson says. “ESG is part of a company corporate culture and values; you have no other choice. I am of the opinion that it will have an impact on the bottom line and share price mid- to long term.”
Environmental impact awareness and mitigation is no longer optional in publicly traded companies. Harrison warns, “If companies cannot credibly articulate how they have amended their corporate strategy to be more carbon neutral and more sustainable in the long run, then companies like BlackRock, which is the biggest asset manager on the planet, are going to divest of their shares of those companies, the stock price will go down, and the CEO will be under pressure. So CEOs are feeling the pressure to make sure that they are developing a sustainable, long-term corporate strategy and reducing their carbon footprint going forward.”
Corporate ESG-based environmental considerations are not exclusively about resource usage and pollution. They also include seeing the opportunities an environmental mindset presents. Johnson says, “I went to the Australian private equity conference in Melbourne last year and a number of global major private equity firms were there. So private capital were focused on green energy, wind, solar, and a whole bunch of the new technologies as well,” Johnson says. “And when private equity or private capital starts investing in green tech, it gives me a lot of comfort because they are incredibly rational, economic drivers. And they now believe that there is an economic case for green investment, which will drive strong economic outcomes.”
Much has been written about diversity driving financial performance. According to Johnson, “ESG-minded boards play a very key role in Australia now in ensuring diversity. We have a culture in Australia now which is sometimes framed through a gender lens, sometimes framed through a cultural lens, sometimes framed even more broadly than that to ensure that boards are representative of society and of their customer groups. Companies in Australia are under increasing pressure to ensure that they have highly diverse boards, with diversity in its broadest sense: diverse thinking, diverse experiences.”
Johansson describes some of the most successful companies in Switzerland committed to ESG principles. “Here in Switzerland you have Novartis, a big pharmaceutical company, you have Nestlé, the largest food company in the world and the largest company in Europe in terms of market cap. You also have companies like Swiss Re, the largest reinsurance company also based here in Switzerland. They are all investing a lot of time and energy in ESG reports.” Johansson cites the leadership of Andre Hoffman, of Roche Group. “He more or less forces the Roche group, the largest pharmaceutical company in Europe in terms of market cap, to move in this direction. And in the US there is Ecolab group up in St. Paul where Doug Baker, the Chair and CEO there is leading tremendous improvements when it comes to environmental and good corporate governance issues. These are companies that stand out in the crowd when it comes to responding to the changing world and the importance of the environmental, social, and governance questions.”
Talent is a key driver of financial performance, and next gen top talent is looking for employers who align with their values. For example, Bingham says, “A lot of business leaders will tell you that they’re in a room full of 20 graduate recruits who either work for the company or are thinking about it, historically they always asked, ‘how do I get your job?’ and now they say, ‘what are the values of this business? What are you doing about climate change? Why is there so much plastic?’ And so I think the Millennial focus is critical. Every organization says its people is its most important asset and that they will struggle to recruit if they operate by a set of values that don’t subscribe to how people think and what they want."
“Next gen” also applies to the upcoming generational transfer of wealth. Zarcone explains, “This next cohort is going to drive the change in investment expectation and I can tell you that they're not going to have a tolerance for some of the ways that we have been choosing to do business. Their expectation is much more of a purpose driven organization.”
Zarcone’s observation is supported by recent reporting from The Economist. “Young investors are driving the surge in interest: more than three-quarters of high-net-worth millennial and Generation Z investors have their assets reviewed for ESG impact.” (“American Sustainable Funds Outperform the Market,” March 1, 2019)
For McNabb, ESG priorities combined with purpose are a winning combination. “Purpose answers the question of why a company exists. As an investor, we’re not going to get in the business of telling companies how to shape their mission statement and strategic themes. But if I’m asked, I’m always going to encourage them to be thinking about that 'why.' I just think it’s a better way to frame your own strategy and attract the kind of talent, investors, and customers that you want.”
THE BIG PICTURE
“The number one question I used to get from investors is aren’t you limiting your options and sacrificing returns by doing ESG?,” said Karina Funk, a one-time civil and environmental engineer who runs the Brown Advisory fund. “I don’t get that question anymore.”
From “The Biggest ESG Funds Are Beating the Market,” By Mathieu Benhamou, Emily Chasan and Saijel Kishan. Bloomberg Green, January 29, 2020
Will the demand for ESG guided corporations change outcomes for the environment and society, and lead to greater business success? Will we go back to business as usual? Harrison argues, “Boards and C-suite executives will need to fully embrace how pivoting toward a long term-oriented sustainable business strategy will be crucial to their continued corporate success. Failure to do so runs the risk of fundamental underperformance and investor backlash.”
Johnson sees these demands catalyzing meaningful environmental innovation. “I’m optimistic that technologies that don’t exist today will be providing the platform for profoundly different mechanisms for power, for energy, for all sorts of things in the near term. That’s exciting, and that requires companies to have the culture, the courage, and the confidence and the support from their boards and investors. As an optimist, I have my fingers crossed that in 10 years we look back and say, ‘you know, this really was a profound inflection point.’ I really hope that’s the case. I believe that’s the case.”
In terms of the social element of ESG, “All of our employees and our suppliers and our customers live within a community,” Zarcone explains. “It's such an integrated existence, that you can't really just walk out of the corporation and go home. And if things are not good in your hometown or your greater community, then, can you close your eyes to it? Can you ignore it? I don't think so. It's part of the ecosystem within which we live; leaders have to have that awareness.”
Zarcone recalls, “When I became president of a financial services group in Chicago, I had a mentor who said to me, ‘not only do you have to be really good at running your business, taking care of your employees, and doing all the right things for your customers, you have to be engaged in the community in which your employees live and work. Your responsibility is to be an outstanding business leader, and an outstanding civic leader as well.’ I definitely think that there's a shift underway, and that the CEOs and the business communities are going to get in front of disruption rather than observe it, and really be a positive driver for change. And I think that's what the next generation of employees are expecting from their leaders.”
Talent is a key driver of financial performance, and next gen top talent is looking for employers who align with their values.
From a governance perspective, McNabb explains, “In the Wall Street Journal and the New York Times, there’s been this whole 'stakeholder capitalism' versus 'shareholder capitalism' debate. I think it’s just missing the mark. The big shift here is that we are on a path to redefine timeframes and that companies should be managed for the long run. It doesn’t mean that they’re any less accountable for creating good returns for their owners. It’s not their capital—hundreds of millions of hardworking global citizens around the world are entrusting their capital to these companies to do something with it: deploy it, grow the business, create profit and return some portion of that to the providers of capital.”
How much does all this really matter, in the long run? For Johansson, “I do see the topic of ESG increasing in importance, dramatically. And I think that’s a good sign. It is at the top of the agenda in many companies, but it’s not on the top of the agenda when I’m looking for a CEO, or a new Chair. There are other elements in the ideal candidate profile that have higher priority. But as I said, 10 years ago, it wasn’t even a topic. So we are making progress. And I’m sure if you and I would talk five years from now, we would definitely have another conversation than we are having today.”
Expectations are indeed on the rise. For example, Bingham says, “I’ve had it put to me by a company Chair here, who was wearing a lapel badge. I didn’t recognize and I asked him what it was and he said, ‘What do you mean you don’t know? It symbolizes the UN sustainable development goals!’ It was in the same week that I saw a presentation that said, ‘if your business is not either trying to advance one of these goals, or on the converse, if you’re actively doing the stuff that the sustainable goals are trying to prevent, you’re going out of business.’ It won’t be tomorrow, won’t be next year. But if you’re not in tune with this direction of travel, your business model is ultimately doomed. And I think both business leaders and the next generation of the workforce certainly think that.”
Companies are finding that they can operate with ESG principles without sacrificing long-term financial success. McNabb points to Vanguard Group as an example. “I use the framework that Vanguard serves three constituencies: our clients, our crew (that’s our employees), and our communities. Without vibrant communities you don’t have vibrant employees and without vibrant employees, you don’t serve your customers or clients. So those three Cs to me are inextricably linked are not an either/or. And I’d humbly submit to you that if you looked at our track record over the last 10 years in terms of delivering value to the end investor, we did okay.”
“The trend toward more corporate transparency will continue as investors across a wide range of asset classes show a growing interest in ESG issues. For example, the UN Principles for Responsible Investment has now been signed by 345 large asset owners, credit ratings are accounting for ESG considerations, and Amundi, Europe’s biggest asset manager, has pledged to fully screen for ESG in 100% of its investments by 2021. Social and human capital issues are also on the rise, as diversity, data privacy, and the treatment of labor in supply chains are being looked at with a closer lens. It is clear that company disclosure on ESG issues will be very important now that 49 stock exchanges have committed to publish ESG disclosure guidelines. Companies in the U.S., where there are no mandatory disclosure requirements, will be in the curious condition of competing for capital with companies located in emerging economies that have better ESG disclosure.”
From “2019 ESG Trends – What to Watch,” by Libby Bernick. S&P Global Market Intelligence, March 18, 2019
As Executive Talent magazine goes to print communities, employers, governments and world markets are reacting to the threat posed by and uncertainties regarding the COVID-19 pandemic. It is a unique moment where the vital interests of individuals, families, neighborhoods, workplaces, and economies converge. What role does corporate leadership have to play in this crisis? McNabb says, “It’s been terribly sad to witness the widespread effect of the virus. The crisis has reminded us of some basic lessons in leadership. The most important is that people come first. Prioritizing the health and safety of employees, customers, and our broader communities is always paramount, of course, but it becomes crystal clear in the weight of every decision made during a situation like this. The crisis is also a very tangible reminder of our global interconnectedness. Through technology, travel, migration, information flow, supply chains, and financial markets, we are connected in more ways—and more quickly—than at any other point in our history. Finally, the best leaders approach major crises with humility, knowing that they can’t know the all answers, but will learn from successes and mistakes, and will work to act on the best possible information. We’ve seen some great examples of that in the past few months.”