- Governance describes how a company holds itself to standards of transparent and ethical behavior.
- A central role for boards is a critical component of ESG standards, an EY executive told Insider.
- This article is part of the "Financing a Sustainable Future" series exploring how companies take steps to set and fund sustainable goals.
In the evolving field of environmental, social, and governance, or ESG, governance is perhaps the most critical pillar for setting and executing sustainability objectives.
This criterion reflects how a company holds itself accountable to its purpose and larger strategy and includes how organizations measure risk, transparency, and ethical behavior.
But governance can also be abstract, compared with sustainability metrics like carbon emissions or data measuring a company's diversity. Yet it's the foundation that enables companies to create and execute robust sustainability goals.
The World Economic Forum's International Business Council invokes three of the United Nations' 17 Sustainable Development Goals aligned with the principles of governance:
- Goal 12: Responsible consumption and production
- Goal 16: Peace, justice, and strong institutions
- Goal 17: Partnerships for the goals
Often in response to shareholder and investor pressures, corporate governance sets the standards for transparent reporting, compensation tied to sustainability or diversity metrics, and an aligned and diverse board.
Environmental issues and corporate governance often intersect at the top. For example, in June, Engine No. 1, an ESG-activist hedge fund, ousted three high-profile Exxon Mobil board members with the goal of creating a new fund designed to exert ESG pressure on some of America's biggest companies.
After an intense shareholder meeting, Engine No. 1 — backed by larger shareholders like BlackRock — claimed three seats on the oil giant's board. Despite holding just 0.02% of the company, Engine No. 1 saw a victory for sustainability and presented a model for the ways that impact investors can change how a $250 billion company votes.
Holding the world's most powerful boards accountable contributes to increased ESG considerations across corporate culture and in the stock market, Boris Khentov, a senior vice president of operations and sustainable investing at Betterment, said.
"It's evident that robust corporate governance and a central role for boards are critical for getting on the front foot with ESG and achieving the strategy shift and cultural mindset change needed to drive a sustainability transformation," Julie Linn Teigland, EY's Europe, Middle East, India, and Africa area managing partner, told Insider.
The role of the board
In EY's annual survey on long-term value and corporate governance, which sampled 200 C-suite and board members across Europe, 49% of leaders said their boards discussed ESG strategy and reporting at every meeting, versus just 15% who said the same in 2020.
Additionally, 43% of respondents said their biggest challenge in establishing strong ESG targets was a lack of commitment from the board to make decisions that fully integrate ESG factors and create long-term value.
In the survey, 84% of respondents said the pandemic increased stakeholders' expectations that their companies would prioritize sustainability goals and action. Without robust governance and a clear standard set from the top, Teigland said, it will be extremely difficult for companies to meet this new standard.
Meanwhile, companies are beginning to publish metrics and objectives they're certain about. The Nasdaq, for instance, released a listing rule to provide a standardized disclosure framework to improve transparency about board diversity.
In addition, Teigland said EY used the World Economic Forum's stakeholder-capitalism metrics to integrate ESG performance into its larger business strategy. To create the report, the International Business Council — composed of over 120 global CEOs — intentionally set metrics based on existing standards so companies could measure, track, and compare their sustainable contributions.
Creating a set of standards is one way boards can meet ongoing reporting expectations. In fact, 83% of respondents in EY's survey said they would benefit from companies being required to measure their ESG performance against a globally consistent standard.
When companies are pressured to respond to short-term demands from the news cycle and trending social issues, it will be governance that actually forces them to meet the long-term goals they set.
"For executive teams to be proactive and build a strategy that leads to long-term value — while dealing with competing priorities — they need a board that is committed, empowered, and has the operating model, data, and capabilities it needs to provide strong direction, challenge, and support," Teigland said.
Additional reporting by Lily Katzman