What about the G in ESG?

While it’s the E in ESG that garners the most attention, issues associated with the governance part of ESG have also come to the fore, particularly in emerging markets.

Proactive Published 07/01/2022

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Post-COP26, investors may have noticed a raft of carbon-focused green initiatives from companies keen to demonstrate their environmental credentials.

And it is probably no surprise that COVID-19 has had an impact on the way CEOs think about corporate social responsibility.

CEOs in all markets taking note

Oxford Business Group’s (OBG) Global ESG CEO Survey, which canvassed the views of 350 executives around the world, including in emerging markets, noted that more than 60% of its respondents said that the pandemic had moderately or significantly impacted their understanding and/or appetite for ESG – only 11% reported no impact.

"This very much speaks to the idea that the pandemic has highlighted systemic weaknesses in markets, supply chains and legacy systems, whether concerning the movement of people or access to vaccines,” the report stated.

“Developing more sustainable approaches, therefore, makes sound business and moral sense.”

The research throws light on the way companies have tended to carve up the ESG pie, with the biggest slice allocated to the environment, while social and governance measures tend to lag behind a little – particularly governance.

Governance is key

The metrics for governance are more settled and agreed upon than those for the social and environmental aspects of ESG. Executive accountability, transparent reporting and the rule of law have been around for a long time.

And yet OBG’s report underscores that the governance component of ESG is the pillar least invested in or prioritised of the three areas of responsibility.

This is unfortunate because, while not all companies have heavy exposure to environmental or social issues in their day-to-day operations, every company has to be accountable for its actions from a regulatory, tax or shareholder perspective.

And COVID has shown us how important record keeping, resource planning and risk management are in uncertain times.

Importantly, these are the same mechanisms that build trust that companies will do what they say they will on green and social issues.

Good governance can be lucrative

One aspect of good governance that has been demonstrated to enhance company performance is board diversity.

Multiple studies point to boards with gender diversity delivering better returns for companies. Directors from a variety of different backgrounds can bring new or previously unconsidered perspectives that may serve the company well.

McKinsey’s 2020 report, Diversity Matters, goes as far as to say that the greater the representation, the higher the likelihood of outperformance.

“Companies with more than 30% women executives were more likely to outperform companies where this percentage ranged from 10 to 30, and in turn, these companies were more likely to outperform those with even fewer women executives, or none at all," the report stated.

Companies are now taking note.

Investment consulting firm JANA's head of sustainability Rachel Halpern said: "We have an unwavering commitment to unlocking value by encouraging and embracing diversity, equity and inclusion.

“This belief has been informed by our view that expansion of economic growth is reliant on unlocking value from, and providing opportunities to, all segments of the community and we think about it across our people, our supply chains and the financial sector.

"We also embrace our responsibility as an asset consultant to use our influence to encourage optimal diversity, equity and inclusion outcomes through our relationships with the rest of the global financial community.”

Impact on the bottom line

Recent research shows that younger investors are watching carefully to see whether the companies they invest in walk the talk on ESG.

Responsible investment is as important as a lucrative investment to the demographic aged 18-34, which is nearly twice as likely as the over-55s to care about the ethics of the companies they buy shares in.

But other research indicates that returns are still a priority for prospective investors.

However, it looks like some still see profit and sustainability as mutually exclusive – 27% of investors surveyed didn’t think ESG-driven investments would make them as much money.

It seems that some investors have trouble believing the environmental claims companies make.

Read: Returns more important than ESG for private investors, research finds

Restoring trust in institutions

Clearly what is needed is increased trust in the companies – both to deliver returns to shareholders and to mean what they say on sustainability. Good governance can restore that trust.

“Transparent, accurate and comparable data across all sustainability domains and asset classes continues to be a challenge,” Halpern said.

“For example, the climate change-related data for public equities is well developed whereas biodiversity-related data is nascent across all asset classes.

“We are delighted to see the creation of a Sustainability Standards Board as an announcement out of COP26 recently.

"We are optimistic that it will lead to a comprehensive global baseline of sustainability-related disclosure standards. This is fundamental to facilitating capital flows towards sustainability-related issues.”

Evolving into operations

How will company ESG policy continue to evolve? “We expect corporate social responsibility to move into a conversation about the real-world impact of a company’s core services and operations,” Halpern said.

“We see signs of ESG broadening in scope. In the past, it was often an ancillary side project run by human resources.

"However, there is growing recognition that the positive impact of a company on issues like climate change or diversity, equity and inclusion can be so much greater if they are seen as integral considerations when designing core products and services.”