Environmental, Social and Governance – Is it a Game?
Chess with my son on Red Mountain - Photo by Danny Smith
I recently hiked up to Grace’s Gap in Red Mountain Park with my son Noah to play a game of chess. It was a long game and I lost to the better player; however, it was a great time of fellowship, so I count it as a win for both of us. I have been thinking a lot lately about whether current societal expectations around sustainability performance is just a game to be played. This post looks at why that game is dangerous.
The sustainability policies and practices of a company are often described using the terms Environmental, Social and Governance (ESG). ESG performance is now a fundamental factor is how a company is viewed by stakeholders like investors, customers, employees, government regulators, and the communities where they are located. A lot of performance factors fall under the ESG umbrella ranging from how a company treats people to how it impacts the environment. There is a direct correlation between ESG performance, financial performance, and stock performance. Large asset managers like BlackRock have announced that they will invest trillions of dollars into companies that are sustainable. Investors increasingly require and analyze annual ESG reports of potential investment options. Public and private companies are now acutely aware of these stakeholder expectations; however, some companies view all of this as a game of perception where the goal is to be perceived as “green”. Unlike financial reporting, where there are prescribed accounting standards that are the same from one company to another, ESG reporting is voluntary in the U.S. and companies can select from a variety of standards or choose to do their own thing. Therefore, ESG reporting is often vague, sporadic, and perhaps better described as propaganda. Is ESG really just a “green” game to be played or is it of fundamental strategic importance to an organization?
ESG performance is strategically important for many reasons including, but not limited to, the following:
ESG performance is a risk mitigation strategy: When a company diligently seeks to comply with and even exceed environmental, health, and safety regulatory requirements, it significantly reduces the likelihood of potential liabilities and government enforcement actions.
ESG performance is a talent acquisition and retention strategy: More than ever before, people want to work for sustainable companies that make them proud to tell others where they work. Employers with outstanding ESG performance are usually incredible places to work. To attract and retain the best talent, ESG performance is critical.
ESG performance is a cost management strategy: The generation and management of waste streams is expensive and can present significant potential liabilities. Consumers, investors, and regulators are increasingly demanding the transformation of supply chains and processes from linear processes to those more aligned with the concept of a Circular Economy. In a Linear Economy we extract resources to manufacture goods and then dispose of those things at the end of their life, typically in a landfill. In a Circular Economy we recycle, refurbish, or reuse materials, products, and parts to the extent practicable in lieu of extracting additional resources.
ESG performance addresses a company’s carbon footprint: Investors, customers, and regulators are demanding carbon reduction and neutrality strategies. Those strategies can include better energy choices, improved energy efficiencies, and enhanced energy conservation. Significant cost savings are associated with many of these strategies. Publicly traded companies that miss the mark on this performance criteria are seeing a tectonic reallocation of capital away from their stock in favor of more sustainable assets.
ESG performance can be a factor in government enforcement actions: While a company with good sustainability management systems in place should have fewer non-compliance situations, these systems can be a mitigating factor in government enforcement actions should a mistake occur. For example, in determining penalty amounts, some administrative agencies consider the standard of care manifested by the violator.
ESG performance can prevent “green washing”: The Federal Trade Commission (FTC) is empowered to take enforcement actions against companies who make illegal green marketing claims. Green claims and certifications that are misleading, false, or unsubstantiated can present serious green imaging compliance problems. There are nonprofit organizations that monitor green claims and quickly label green imaging efforts as “green washing” when they believe these green messages are disingenuous. ESG performance can ensure that a company’s green imaging is genuine and well received by stakeholders.
ESG performance compliments ethical behavior: Playing the ESG game goes hand-in-hand with a risk-of-enforcement-based approach to regulatory compliance where regulatory requirements that are costly, with little to no enforcement, are ignored. Such business strategies are dangerous and on a slippery ethical slope to potential ruin. A company’s Chief Sustainability Officer and Chief Ethics Officer are complimentary functions.
ESG performance can be an insurability factor: A company’s ESG profile can provide early warnings as to whether a company has a higher probability of experiencing certain types of incidents. The better a company’s’ ESG performance, the lower the probability of it experiencing adverse incidents.
To achieve these benefits of ESG performance, companies are appointing a Chief Sustainability Officer (CSO) to develop, lead, and champion sustainability strategies in collaboration with a wide range of internal and external stakeholders to achieve the company’s mission, goals and objectives, in compliance with the company’s stated principles. The CSO typically reports directly to the company’s Chief Executive Officer (CEO).
A sustainable company is usually performing well in all areas. It is able to retain the most talented employees. It’s products and services perform well in the market. It has good relationships with external stakeholders. Regulatory non-compliance is minimal. Litigation is low. It’s stock likely performs well. Financial performance is favorable. Risks are eliminated or mitigated.
A company with good ESG performance meets the most simple definition of “sustainability” - the ability to endure.
