Stakeholders are increasingly putting pressure on corporate boards to demonstrate that they understand and can oversee ESG issues. Stakeholder governance brings the stakeholder voice into corporate decision making and helps companies create long-term value and mitigate ESG risks. A new approach to “Governance” in ESG.
The new G in ESG: bringing the voice of the stakeholders into corporate decision-making
Events in recent years have fundamentally changed the pace of business and transformed the way organizations operate. The COVID -19 pandemic has raised awareness of public health challenges, the climate crisis has reached a point where action is needed, social justice movements have come into sharper focus, and the war in Ukraine shows that European and global stability isn’t nearly as secure as we’ve long believed.
As a result of this unprecedented market and political momentum for ESG, investors, employees, regulators, and the general public will scrutinize corporate sustainability efforts more closely. Pressure will increase on corporate boards to demonstrate that they’re adequately equipped to understand and oversee ESG issues. This will enable them to create long-term value and mitigate ESG risk in uncertain times.
Long-term value creation
Investors have publicly acknowledged that they’re paying more and more attention to the long-term value creation of companies than to short-term returns. These confident, sophisticated investors feel able to demand action and disclosure on a growing number of issues, and they’re more willing than ever to vote against companies and individual directors at annual shareholder meetings if these demands aren’t met.
In addition, legislation in many countries is evolving to require boards to consider stakeholders in order to support the long-term success of the company, and to report on how they’re trying to do so. Companies and their boards need to be aware that the likelihood of being sued by stakeholders and regulators increases if ESG expectations aren’t met, as policies are reflected in common law, regulations or legislation.
Bringing stakeholders on board
Addressing the needs of all key stakeholders expands the scope of management’s responsibilities. It starts with companies knowing exactly who their stakeholders are, how they’re affected by the company, and how the company affects them. Stakeholder governance brings the stakeholder voice into corporate decision-making and helps build trust between companies and their stakeholders. A new approach for the “Governance” in ESG.
A first step in bringing the stakeholder voice into the business is to identify which stakeholders are important for the business to fulfill its purpose. Most likely, shareholders, employees, customers, suppliers, capital providers, the environment, and the communities in which the companies operate all play important roles.
Once stakeholders are identified and integrated into key aspects of the company’s strategy, the board needs to assess whether the existing governance framework (from board composition to business organization, risk control, incentives, transparency and accountability) is appropriate for implementing the strategy and engaging with stakeholders.
Considerations for the board
- consider not only the stakeholder group as a whole, but also any voices within that group that may not be heard to ensure they’re heard. For example, the board should consider whether there are certain minority groups whose members aren’t being heard. How does the cultural context change as the company expands into other markets? What are the cultural differences among stakeholders?
- decide where responsibility lies for implementing the stakeholder aspects of the strategy. The board also needs to consider whether the company has the right values and culture to do this;
- consider appointing individual board members responsible for overseeing each key stakeholder (stakeholder ombudsman), or appointing stakeholder representatives (as is already the case in some countries, notably Germany, Denmark and Sweden);
- retain responsibility for dialog with shareholders and investors on purpose, culture and values, corporate governance and long-term prospects;
- require management to make the stakeholder voice heard by the board at each board meeting;
charge management with developing policies to ensure that effective stakeholder governance is achieved throughout the company;
- monitor and oversee the effectiveness of these policies.
Considerations for management
- regularly assess stakeholder engagement practices to ensure they inform the impact of actions (or inactions) on key stakeholders;
- stakeholder engagement mechanisms – what are they; how can technologies be used?;
- ensure that board-approved policies and procedures are in place – e.g., policies for subsidiaries to ensure that the stakeholder governance agenda is implemented not just by the board, but by the entire group;
- bring stakeholder voice to the boardroom – provide regular updates, stakeholder feedback/impact dashboards, board papers and agendas.
Risk management and opportunities
Integrating ESG principles into core business functions and engaging stakeholders can reduce a company’s exposure to risks. Companies with good ESG performance and stakeholder trust are also less likely to experience these risks. As well as sanctions for noncompliance, a key risk is reputational damage, impacting talent recruitment and retention, as well as supplier, customer and other stakeholder relationships, all of which potentially undermine the company’s long-term success. There is a real risk of litigation being brought against companies in connection with statements they make about their net-zero targets and other sustainability claims. ESG issues that aren’t addressed or are inappropriately addressed can lead to crises. Community grievances can escalate into violent protests, a worker welfare issue can escalate into a public scandal, and local pollution can trigger environmental activism. Preventive identification and management of these problems can help reduce the likelihood that a crisis will occur in the first place.
However, despite the challenges, the focus on increased transparency, monitoring and accountability into a governance framework also brings opportunity to be ahead of the curve, showcasing a company’s purpose, sustainability goals and progress toward them, its engagement with key stakeholders and the corresponding impact on the company’s approach to ESG issues.