ESG investors go in search of the boardroom G spot

With sexy, big-hit­ter issues such as cli­mate change and the liv­ing wage to pro­pel them onto front pages, it’s lit­tle won­der that envi­ron­men­tal and social mat­ters have dom­i­nat­ed the ESG agen­da to date.

Yet as the clam­our for pur­pose beyond prof­it con­tin­ues to build, gov­er­nance is shrug­ging off its whiff of wor­thi­ness to make 2021 a piv­otal year for the busi­ness world’s all-impor­tant G spot.

As fash­ion retail­er Boohoo dis­cov­ered last sum­mer, being on the wrong side of his­to­ry over alle­ga­tions as incen­di­ary as mod­ern day slav­ery pos­es a severe and imme­di­ate risk to a firm’s share price, putting every aspect of its day-to-day gov­er­nance square­ly in the dock. 

While boards could once claim immu­ni­ty to the con­cerns of soci­ety as a whole, sit­ting on the fence is no longer pos­si­ble. Yet with ESG asset man­agers keen to praise those man­age­ments will­ing to wres­tle with com­plex issues such as gen­der and race inequal­i­ty, and to call out those that are not, the dream of mak­ing mon­ey while also doing good has nev­er looked so attain­able.

Recent data from S&P indi­cates that its 500 ESG Index out­per­formed, suf­fered few­er loss­es and recov­ered faster than the S&P 500 dur­ing the pan­dem­ic, strong­ly sug­gest­ing what it terms “stake­hold­er cap­i­tal­ism” is a vir­tu­ous cir­cle that rewards busi­ness­es and soci­eties alike.

“Although it doesn’t always get the atten­tion it deserves, the piv­otal role played by stew­ard­ship in both envi­ron­men­tal gov­er­nance and social gov­er­nance under­lies all the achieve­ments made by ESG so far,” says Peter Swabey, pol­i­cy and research direc­tor at the Char­tered Gov­er­nance Insti­tute.

“When you look at recent gov­er­nance dis­cus­sions, which have led to board­room pay cuts and the sus­pen­sion of div­i­dends to ensure the finan­cial pain of the pan­dem­ic is shared equal­ly across organ­i­sa­tions, you may agree with me that ‘G’ has become an extreme­ly sexy top­ic.”

Reassessing the value in values

Unilever’s pledge to cut ties with sup­pli­ers that fail to pay the liv­ing wage by 2030 is an eye-catch­ing exam­ple of how organ­i­sa­tions can use mas­sive buy­ing pow­er to reflect the soul-search­ing of a nation. But are oth­er man­age­ments pre­pared to fol­low its lead?  

Dur­ing the 2007–8 finan­cial crash, client spend­ing on eth­i­cal projects was swift­ly and bru­tal­ly cut, notes Gareth Thomas, who leads on anti-cor­rup­tion and ESG at ethics con­sul­tan­cy Good­Cor­po­ra­tion.

This time, the bud­gets allo­cat­ed to sup­ply chain and human rights risk assess­ment, for exam­ple, have been main­tained, if not scaled up.

“I’ve nev­er seen such enthu­si­asm for this sort of work before and it sug­gests that active­ly man­ag­ing a com­plex set of gov­er­nance-relat­ed risks requires a far broad­er set of capa­bil­i­ties and exper­tise than those asso­ci­at­ed sim­ply with prof­it and loss,” says Thomas.

“While ‘G’ was once rou­tine­ly rel­e­gat­ed to out­side organ­i­sa­tions, it is now seen as crit­i­cal by any busi­ness leader look­ing to shape an organisation’s think­ing on key issues such as bribery, exploita­tion or human rights. In short, gov­er­nance is fast becom­ing a proxy for good man­age­ment.” 

If mak­ing mon­ey and pro­vid­ing employ­ment were once seen as suf­fi­cient rea­sons for a busi­ness to exist, employ­ees and investors are now look­ing for evi­dence of a far more pro­found pur­pose in the board­room, he believes.

“Although the ear­ly days of cor­po­rate social respon­si­bil­i­ty were char­ac­terised by paper-thin pledges to do this or that, the demand among a whole range of stake­hold­ers for inde­pen­dent­ly ver­i­fi­able gov­er­nance pro­ce­dures is ris­ing fast, par­tic­u­lar­ly among younger investors who can spot green­wash­ing a mile away,” says Thomas.

What gets measured gets managed

Fund man­agers have access to a wide range of qual­i­ta­tive and quan­ti­ta­tive data with which to assess the suc­cess of organ­i­sa­tions at man­ag­ing gov­er­nance-relat­ed risks in their sec­tor.

“There’s a huge amount of ESG data out there,” says Dominic Rowles, invest­ment ana­lyst at the sav­ings and invest­ment plat­form Har­g­reaves Lans­down, some of it pro­vid­ing “leader”, “aver­age” or “lag­gard” rat­ings, depend­ing on a firm’s expo­sure to a par­tic­u­lar risk.

“The way com­pa­nies man­age crit­i­cal inci­dent risk will be a par­tic­u­lar focus when analysing those involved in heavy indus­try, for exam­ple, while oth­er sec­tors will be more vul­ner­a­ble to legal and reg­u­la­to­ry change,” he explains.

With man­agers now hav­ing to make deci­sions based on still-emerg­ing and unpre­dictable vari­ables relat­ed to the coro­n­avirus cri­sis, it is “more impor­tant than ever there is prop­er over­sight of their deci­sion-mak­ing,” Rowles adds. 

Although the last major over­haul of the UK Cor­po­rate Gov­er­nance Code dates back only to 2018, fur­ther reg­u­la­tion around finan­cial dis­clo­sure is await­ing clar­i­fi­ca­tion. The Task Force on Cli­mate-Relat­ed Finan­cial Dis­clo­sures, which requires firms to dis­close how cli­mate change impacts their gov­er­nance, strat­e­gy and risk man­age­ment poli­cies and to detail rel­e­vant met­rics and tar­gets, will be in force by 2025. 

Well-governed companies winning out

While the pan­dem­ic has claimed a num­ber of high-pro­file cor­po­rate scalps on issues as var­ied as under­weight cor­po­rate tax lia­bil­i­ties and even-skin­nier school meal parcels, Rowles cites cur­rent city dar­ling Next as a “well-gov­erned com­pa­ny”, which has respond­ed well to the cri­sis. 

In March 2020, Next closed its UK ware­hous­es and dis­tri­b­u­tion net­works to make them COVID-secure, while stores were repur­posed to oper­ate with­in social dis­tanc­ing guide­lines. Boost­ed by brisk demand for online house­wares and cloth­ing, its share price climbed, while sus­pen­sion of div­i­dends and share buy­backs helped reduce over­all debt at a time when retail as a whole was suf­fer­ing the biggest slump in its his­to­ry. 

All shares, along with cor­po­rate and per­son­al rep­u­ta­tions, can rise and fall over time, but for any busi­ness look­ing to sus­tain both growth and pur­pose for the long term, active, respon­si­ble and sen­si­tive stew­ard­ship is the way for­ward, argues the Char­tered Gov­er­nance Institute’s Swabey.

“At the end of the day, com­pa­nies are run by fal­li­ble human beings and bad things can and do hap­pen in board­rooms,” he says. “It’s the job of good gov­er­nance, includ­ing the inde­pen­dent scruti­ny of key deci­sions, to make it much hard­er for any indi­vid­ual with rogue inten­tions to have their way.”