Understanding the ‘G’ in ESG

Of the three major elements in ESG – environmental, social and governance – it’s the “G” that often gets the least attention. However, as investors and businesses continue to adopt strategies that incorporates ESG, the governance issue is getting more focus.

The concerns addressed by initiatives in the environmental and social areas, including developing sustainable operations and promoting gender and racial diversity in the workforce, don’t do much good without sound, ESG-focused corporate governance.

As pointed out by the Harvard Business Review, most of the policy debate around ESG surrounds the “E” and the “S.” That will likely change as more companies focus on transitioning to governance that focuses on the long-term and supports the environmental and social goals that drive ESG.

What is Corporate Governance?

For those who don’t deal everyday with investing or running a corporation, the term “corporate governance” might seem a bit of a mystery. At its core, the term refers to the policies and practices put into place by corporate leaders to guide how an organization operates.

In creating governance rules, company directors seek to balance the needs of the company’s stakeholders, a term referring to company shareholders, senior company executives, customers, suppliers, investors and government regulators.

In short, corporate governance gives everyone involved in making strategic decisions a road map to follow. It encompasses every area and initiative of a company, ranging from “action plans and internal controls to performance measurement and corporate disclosure,” according to Investopedia.

The Role of the “G” in ESG

ESG puts environmental, social and governance issues into the mix when assessing a company’s success and investment worthiness, while also developing quantifiable methods to measure the effectiveness of a business. The term has become shorthand for a new way of looking at running a business, with a focus on issues beyond the bottom line.

Those issues include sustainable wealth creation, DEI (diversity, equity, and inclusion), climate risk and renewable energy. However, making any of them happen requires changes in corporate governance.

In the context of ESG, the board of directors at a corporation must adjust how they set policies and practices for company operations. ESG calls for changing their outlook from an exclusive focus on profit to a broader consideration of environmental and social issues.

According to PwC, a a Fair360, formerly DiversityInc Hall of Fame company, there are a number of issues related to governance in the context of ESG.

  • Diversity on company governing boards
  • Executive compensation tied to a company’s success in environmental and social issues, not just short-term profits
  • Oversight of board actions by an ESG-focused comptroller
  • Building stakeholder trust by going beyond setting goals and moving into taking action

Examples of Transparency and Corporate Governance

Transparency is also important in corporate governance. For example, Accenture (No.1 on Diversity Inc.’s Top 50 Companies for Diversity list),  provides access to the company’s governance principles. A page on the company website not only provides information on these principles, but also provides links to detailed reports on policies and committee charters.

Abbott (No. 3 on Fair360, formerly DiversityInc’s Top 50 Companies for Diversity list), also includes a webpage with links to information about governance-related issues. For both Abbott and Accenture, as well as other companies that practice sound governance, the company’s political participation is also transparent.

One of the guiding principles listed for political participation by Abbott involves a commitment “to ethical behavior and transparency and is guided by our Code of Business Conduct in all our activities, including public policy engagement.” The Board of Directors also has established a Public Policy Committee that reviews an annual report on the company’s public policy activities, including advocacy priorities, political contributions, and lobbying.

Challenges to ESG-Focused Corporate Governance

Not all companies have taken the steps by PwC, Accenture and Abbott. HBR reports that many corporate board of directors still focus too much on governance rules that favor short-term gain rather than the patient, long-term focus needed in areas such as sustainability and diversity. This short-term focus can make it more difficult for companies to invest in ESG initiatives that may not provide immediate returns.

An ESG Global Study from the Harvard Law School Forum on Corporate Governance found that acceptance of ESG is growing worldwide, led by investors and businesses in Europe. However, they also found roadblocks to a more ESG-focused corporate governance.

Standardization. There is not yet a standardized framework for ESG reporting, making it challenging for investors and stakeholders to compare the performance of different companies.

Resistance to change. According to the study, this is particularly an issue in North America, where business leaders are more likely to see ESG policies as a burden rather than an opportunity.

Greenwashing. Fewer investors than before are concerned about greenwashing, which refers to companies that publicly commit to environmentally friendly practices but do not put them into action. However, this is still an issue that can cause some companies to hesitate in committing huge investments in ESG initiatives.

Competing technologies. Tech-driven solutions are available to help drive more effective ESG-focuses governance. However, a lack of standardization and the customized data sets needed for different areas of an operation (human resources as opposed to the accounting department, for example), has led to difficulties for some boards in determining the right course to take, according to people who spoke with Thomson Reuters.

Lack of ESG expertise: Because ESG is relatively new, some corporations still lack the internal expertise needed to effectively manage ESG initiatives, making it difficult to develop and implement strategies.

Regulatory challenges: The regulatory landscape for ESG is rapidly evolving, with changing requirements and standards.

The positive news is that more corporate leaders than ever see overcoming these challenges as necessary for businesses to remain successful in the future. Thomson Reuters reported that ESG efforts have become more driven by the values of company leaders rather than a need to comply with investor demands or regulations.

This change in attitude is driven partly by commitments by many governments worldwide to provide incentives for businesses to invest in “green” technologies. But experts also told Thomson Reuters that the change is the result of “a higher level of corporate executive understanding about real systemic issues that professionals from underrepresented backgrounds face within their work environments and outside of work.”

These changes point toward a future where corporate governance will take a more long-term approach and look beyond short-term gain, a shift that will greatly benefit ESG policies.