Why do environmental, social, and governance (ESG) issues matter, and what role should directors play?

According to a recent report by PwC, ESG is all about risk. FEI Daily spoke with Paula Loop, leader, Governance Insights Center at PwC, about the risks, common misconceptions, and three stages of ESG.

FEI Daily: The report makes an important point that, for many of us, the term “ESG” brings to mind environmental issues like climate change and resource scarcity. But it also covers social issues like a company’s labor practices, talent management, product safety, and data security, as well as governance matters like board diversity, executive pay, and business ethics. According to the report, when it comes down to it, ESG is about risk. Tell me about the risks associated with ESG.

Paula Loop: You have to think about it in the risk framework. Not that it’s an environmental thing that we should do to be good citizens for our environment. That may also be true. But that’s not the angle that investors are focused on. Investors are saying, “If you don’t address this environmental risk, if you don’t address the social risk or the governance risk, that could be a very big risk for the company.” And that’s what they’re concerned about.

FEI Daily: What surprised you about the findings?

Loop: I think the lack of understanding about what ESG means [surprised me]. A lot of people automatically go to the “E.” They’ll go to environmental. But the “S” and the “G” are a little bit harder, and as you mentioned, more all-encompassing. So, it is hard to imagine that we have directors and companies that say ESG really isn’t that relevant to them. It’s really not an important data point for them.

When actually, it should really affect every company because every company has governance issues, and social issues: Every company has employees. You’re going to come across these issues whether or not you’re in an environmentally sensitive sector or not.

I think that’s the dilemma. A lot of people just subtly assume that it doesn’t really apply to them. When actually, in a broader sense, it really does.

FEI Daily: I was surprised to see that 35% of directors think board gender diversity is given too much attention by shareholders. Were you surprised to see that?

Loop: If you look at our annual corporate directors’ survey, the respondents were split 81% male and 19% female, which is a good representation of what the overarching director makeup looks like.

I think a lot of directors would say, “We understand it. We get it. We’re going to get to it. We’re looking for diverse candidates for our board. We haven’t found the right ones yet, but we’re still looking. We hear you.” But not really actually getting it done.

And so then they’re saying, “Quit harping on it, because we’re working on it. It’s going to take us some time.” And investors are saying, “Well, actually, we’ve been talking about it for some time. You’ve had a lot of time.”

FEI Daily: Why are corporations so wary when it comes to ESG-related reporting?

Loop: I think one of the issues around ESG reporting right now is, first of all, we’re hearing the interest from investors, but it’s not mandatory, it’s not absolute. They don’t feel pressure yet. So I think there are some that are cautious and say, “Why do I want to put my toe in the water when I don’t absolutely have to yet? I’m going to step back here and see what’s going on and watch.” And [some] are the people that we call the mid-tier category. They may be doing a lot of the right things around ESG. They definitely have a corporate responsibility report that has data in it, but they’re not connecting it to their long-term value-creation story. They’re not embedding a lot of other things they do, because they’re feeling that they can still wait and see a bit.

It’s the front-runners who really are saying, “This is a huge opportunity, and let’s be opportunistic about this and tell our story, rather than having somebody else try to tell our story for us.” It’s those companies that I think are really impressive, that are saying, “We think of this as an opportunity, and we want to come out and really drive the story.” So, one of our focuses is to try to get directors to push CEOs to bring this topic into the boardroom by asking questions. Executives are hearing from investors, but it would be also a great thing if they started to hear from directors, as well. And I think the topic is going to get a little bit more attention.

FEI Daily: The ESG evolution has three stages: laggards, middle tier, and front-runners. What’s happening to the laggards, and what do the front-runners look like?

Loop: The laggards are probably smaller companies that just haven’t gotten to it yet. They’re starting to hear the discussion about it, but they just haven’t made it a priority. They haven’t gotten themselves organized to either do a robust corporate responsibility reporting, much less think about how they would embed it into their long-term story, and their plan, and their ERM process and everything. Size and sophistication of the company play a significant role.

Front-runners are more sophisticated, more progressive, the ones that have been doing more listening to institutional investors. They are listening to their broader group of stakeholders, their employees, communities, and others, and they’ve decided that they think this is an opportunity.

This article originally appeared in FEI Daily and is republished by permission.

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