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Posted by Andrew & Nada on 19th August 2021
Boards need to stop ESG greenwashing and recognise reputational threats

There is no standard measure of corporate Environmental, Social and Governance (ESG). Instead the system is largely being used as greenwash. Boards need to take control and recognise the threat to organisational reputation, say Nada Kakabadse, Professor of Policy, Governance & Ethics, and Andrew Kakabadse, Professor of Governance & Leadership at Henley Business School.

The profile of business-wide ESG (environmental, social, governance) and sustainability initiatives are being increasingly driven by stakeholder demands for action on climate change and global catastrophes, ranging from deforestation and fisheries depletion, through to greenhouse gas emissions, financial Instability and corporate scandals. So what action should organisations take?

The push for ESG
The growth of educated stakeholders and social movements, including Occupy, #MeToo, Black Lives Matters, Extinction Rebellion and Landless Workers evidence the driving force behind the term ‘ESG,’ first coming to prominence in 2004 via a United Nations Global Compact and Swiss Federal Department of Foreign Affairs report titled ‘Who cares wins: Connecting financial markets to a changing world.’

The report, a collective effort by financial institutions and the United Nations Global Compact, had a principal objective of establishing global ESG standards in business and aimed to connect ESG factors and investment choices. The European Parliament’s 2020 ‘Green Deal’ similarly promotes environmentally sustainable investments: climate neutrality, biodiversity protection, the creation of sustainable food systems, and other balanced solutions.

Despite the availability of several non-financial reporting frameworks utilising elements of ESG reporting - such as those brought forward by the United Nations or the International Integrated Reporting Council - there is a lack of unity between these approaches, making it challenging to draw comparisons between various firms and industries.

No standard account of ESG measurement exists, which is exemplified by the failure of rating agencies to reach a consensus. Different agencies apply different ESG ratings to the same firm. In contrast to the positive screening process, there is also a negative approach to screening socially responsible investing (SRIs).

Thomson Reuters, Bloomberg, Sustainability Asset Management Group, and Ethical Investment Research Service, which measure ESG using positive screening, assess firms in accordance with their corporate social responsibility management and their corporate social performance. In contrast to the positive screening process, there is additionally a negative approach to screening SRIs. This approach focuses on exclusion, whereby firms that engage in questionable industries such as weapons, alcohol, gambling and tobacco are excluded from investment

The myth of stakeholder capitalism
The days of corporations existing for the sole purpose of making profits for their stockholders should by now have receded and been replaced by the widely praised ‘organisational responsibility’ approach, designed to serve society and match shareholders’ interests with those of staff, patrons, the community and other stakeholder groups.

However, the harsh reality is that it is an absolute myth that there has been any shift from shareholder primacy to stakeholder capitalism, with the exception being in academic writing and the popular press.

As part of our own ongoing Kakabadse research, we undertook a rudimentary investigation less than two-and-a-half years ago regarding the immediate capital available for investment in the City of London. At the time we estimated £1 trillion could be easily drawn upon for investment opportunities. By March 2021, in our role as part of an advisory group on behalf of the Institute of Directors, examining how to enhance stakeholder governance, we undertook a similar investigation of immediately available funding in the City for investment. Two colleagues estimated £3-4 trillion was immediately available at the time. Both hold top positions in the global investment community.

The point is that the UK is immensely cash-rich, but little to hardly any of that funding is funneled towards ESG initiatives. In fact, there are very few sources of investment that make ESG a critical consideration, with the exception of the Norwegian Sovereign Investment Fund.

ESG equals greenwash
In effect, the investment market is treating ESG as greenwash - a term leftover from the era of corporate social responsibility. Very few funds are paying attention to ESG and the notion that shareholder pressure is making a significant impact is quite simply false.

For example, In August 2018, a declaration by the Business Roundtable (BRT) in the USA that a corporation’s purpose is to deliver value to all stakeholders, rather than solely maximise shareholders’ benefits had 183 CEOs as signatories.

Only one year later, 145 of these companies failed to ‘walk the talk,’ attracting the attention of multiple environmental and labour-related compliance violations and penalties. Many have paid settlements in lawsuits, but such short-term thinking is likely to have these companies face scrutiny in future mergers and acquisitions transactions. It is exceptionally worrying to witness so much cash in the system inflating asset prices, rather than being used for social and environmental purposes.

No challenges to ESG entry
There are no costs or challenges to ESG entry. Effectively adopted ESG protocols are a critical part of the strategy, and this is a CEO and C-suite responsibility. Additionally, ESG is a part of the Chair and Board’s governance considerations relating to risk and reputation. In effect, neglecting ESG has damaging implications for the reputation of the company, and it is the board’s role to spot such omissions.

By contrast, a minority of companies across the world make ESG a central part of their strategy because of the deeply held values that drive strategy and competitive advantage. For example, the John Lewis Partnership is driven by its service value. The American giant Caterpillar cites quality as a core value. AS a result ESG becomes a central concern of current and future operations and investments. If ESG is positioned as a separate subject or concern, then it becomes little more than a slogan.

The will to change
All change management initiatives are driven by the efficacy of the strategy being pursued, the quality of thinking on competitive advantage, and the definition of sustainability which leaders have agreed.

From this point forward each company is likely to pursue change management in keeping with its mission, values, goals and objectives. Some organisations take a change management position on particular processes, technological considerations, structures or leadership philosophy. The maxim ‘get the strategy right’ is followed by ‘structure follows strategy,’ and then ‘cascade the message down the line.’ This order of affairs is as relevant now as it was 20 years ago.

It is important to recognise that ESG is a political slogan. While European based companies are more ‘E’ oriented, there is an absence of ‘S’ considerations in businesses across the world, while Anglo -American companies tend to be more ‘G’ focused.

The real value of an ESG-minded business is its strategically clear, differentiated and penetrating competitive advantage. The additional benefit is in having a board that understands the potential ESG-linked risk and reputational damage that can arise if these matters are not fully addressed in advance. High performing, ESG minded businesses are strategically on the ball, encountering minimal risk, and possess a raised reputation. In short they are sustainable corporations.

Diversity of thinking is uppermost in creating a sound strategy that takes into account corporate stakeholder needs and concerns. The challenge beyond this is how we embed ESG to create an equitable, healthy, and environmentally-conscious society?

Our continuing studies indicate that only regulation can achieve this desired outcome. There are undoubted benefits for the 18% of corporations globally which thoroughly embrace ESG fundamentals of service, quality, leadership and environmental sustainability.

However, the other 82% yet to adopt these values are unlikely to change until more than 10% of investors become ESG-oriented, and without legislation that forces their hand. In short, Government intervention is desperately needed.

This article first appeared in Board Agenda magazine.

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