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Article | Executive Pay Memo North America

Governance should be at the top of ESG priorities

Governance Advisory Services |Executive Compensation

By Don Delves , Shai Ganu , Kenneth Kuk and Jamie Teo | September 27, 2021

Effective governance is essential to guide decisions and results in environmental and social initiatives

In a series of roundtable discussions with board members, it has become apparent that the ‘G’ (for governance) in ESG is the most important aspect of this very popular acronym.

As companies adopt an expanded view of the constituents they serve, environmental and social issues have gained more prominence in management and board agendas. Stakeholder capitalism has become one of the key concepts guiding how companies and boards view their purpose and responsibilities. Investors, employees, customers and regulators are pressuring companies about their commitments to issues like climate change, pollution, energy efficiency, diversity, equity, inclusion and employee wellbeing.

All of this puts pressure on board members to “do something” about ESG. Good governance, then, is of paramount importance. Boards, working with management, have to sort through all of the noise — opinions, ideas and information — and make rational, informed decisions about how to set priorities, allocate resources and make investments.

The following diagram, putting the G above the S and the E in ESG, captures the critical role of governance:

Image showing three components of ESG; Environmental, Social and Governance, with Governance most prominent

We have learned a great deal from our series of roundtable discussions with board members about ESG. Some of the lessons are as follows:

  • Most board members view ESG as a combination of risks and opportunities. In a prior article, we postulated that ESG is all about risk. Board members have been clear that, while they definitely view ESG issues in the context of organizational risks, they equally view ESG through the lens of opportunities that can benefit their organizations. For example, while climate change presents physical and transitional risks for any organization, it also may present opportunities for brand enhancement, employee attraction and motivation, greater access to capital, and investment in new technologies.
  • The core governance principles for ESG decision-making are purpose and stewardship. When reacting to outside pressure and evaluating a range of risks and opportunities, boards and management need to remain focused on the purpose and mission of the organization. Board members are stewards of their organizations’ purpose and mission, and stewards of the shareholders’ interests, and all other stakeholders. Orienting to purpose and stewardship can help keep boards focused on the big picture and provide effective guidance and direction to management.
  • ESG risks and opportunities should be evaluated in the context of all of the major risks and opportunities an organization is facing. While ESG issues are popular and important, they are a subset of a much larger set of issues, and should be evaluated in that context. Board members expect management to maintain this broader perspective and to present rational, logical assessments of ESG risks and opportunities, tailored to their specific company, industry, markets and geographies. Rushing to a conclusion or direction because of outside pressure or optics should be avoided. Communication regarding ESG decisions and priorities can be made that reflects this tailored analysis.

Finally, as we have discussed in a previous article, including ESG measures in incentive plans may be an effective way to focus management attention on a mission critical measure that requires concerted effort and resources. However, there is likely a much wider array of ESG issues that require management and governance attention on a regular basis. And what gets managed and discussed in the board room often has as much or greater impact on what gets done than adding a new measure to an incentive plan.

In other words, effective governance — the G in ESG — comes first.

A version of this article appeared in Workspan Daily on September 16, 2021. All rights reserved, reprinted with permission.


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