ESG (Environmental, Social and Governance) dominates discussions in the boardroom. The reason for the growing importance attached to ESG is that it will significantly affect the landscape in which companies and boards operate. A relevant example is the CSRD (EU Corporate Sustainability Reporting Directive). Starting in 2024, companies with more than 250 employees, more than E40 millions in turnover and/or more than 20 million in assets will have to disclose risks and opportunities related to the business model and the value chain in the domains of E, S and G. Estimates are that this will affect 49000 companies in the EU. A pro-active and forward-looking engagement with this emerging new landscape offers significant advantages. Five issues are key.
Core actors in the domain of corporate governance (CG), including investors, governments, standard setters and central banks are becoming increasingly concerned about long-term systemic risks related to ‘business as usual’. The European Union estimates that a ‘business as usual’ approach will lead to a 3-4 degree increase in global average temperature, which presents massive risks to markets, market institutions and the private sector. This macro-economic threat has prompted the European Union to adopt the Green Deal, which seeks to make these risks measurable, reportable and comparable and, thereby, to shift significant amounts of investments to more sustainable business models before 2030 (Veldman and Jansson, 2019). The reason for the development and adoption of a new institutional framework across finance, company law and accounting is, therefore, the desire to enable a market-led response to systemic risk.
ESG as a concept was conceived by major investors, (central) banks and standard setters from 2004 onwards to cover the full set of risks related to business models on a 10-year+ timescale. The development of standards that incorporate ESG is, therefore, driven by the actions of core actors in the domain of corporate governance.
ESG is a much-criticized construct for two main reasons. Firstly, because ESG was conceived as a means to measure risks for financial actors, standard setters typically treat it as an ‘agnostic’ concept, which delivers information in three separate thematic areas. Because information gathered in three separate areas cannot be easily aggregated, a company like Tesla may score well in one domain, but still does not achieve stellar scores across all three domains. Likewise, a company with a business model with negative consequences in one domain may yet achieve a good overall ESG score. Treating ESG as a single or compound concept is, therefore, likely to provide a skewed picture. Secondly, ESG is prone to what is known as ‘alphabet soup’ (Pollman 2022). Although ESG standards and reporting tools have been under development from 2004 onwards, there is still a lot of discussion on the intended audiences, topics and time-frames for ESG disclosures andm relatedly, about the content, scope and comparability of ESG standards. As Serafeim argues: “ESG has rapidly become a household name leading to both confusion about what it means and creating unrealistic expectations about its effects.” Both types of critiques have recently led commentators to argue that ESG reporting should be limited to a much smaller set of issues.
Despite ongoing debates and criticism, it is very likely that ESG is here to stay. Beyond the support of core actors, there are two more reasons for its staying power. Firstly, better ESG scores have been correlated with better corporate performance and more innovative capacity; improved risk management and more stakeholder trust, translating into consumer, employee and public procurement preference as well as investment resilience and outperformance. Relatedly, there is growing pressure from a broad range of stakeholders - including investors, industry bodies, insurers, frontrunning companies, consumers and employees - for the adoption of and disclosure on ESG-issues. Secondly, the early development of a clear institutional framework helps create clarity with regard to expectations and time-horizons regarding the future ‘level playing field’ and associated incentives for frontrunners and disincentives for laggards in the EU and beyond. The timely development of and early compliance with such a new institutional framework has been associated with competitive advantages in the medium to long run.
With ESG standards and regulations still under development, research typically reports limited knowledge of and a passive or ‘compliance’ mentality with regard to adoption. But with ESG standards linked to the agency of core actors in corporate governance and to positive outcomes for companies, it is worthwhile to adopt a more forward-looking approach. Early anticipation of and agility in response to the new institutional landscape has been linked to competitive advantage over companies that yet have to become compliant; to the identification of future bottlenecks, which helps streamlining and securing the continuity of the production and supply chain, and to the development of successful new business and financing models. Key to this early anticipation is the development of strategic partnerships and ecosystems in which experiences and best practices may be shared.
KPMG and Nyenrode have set up the ESG Innovation Institute to help organisations make the transition to sustainability. Organisations can create added value in their business operations by balancing financial and economic results, transparency, social interests and the environment. We aim to make the latest ESG knowledge, skills and ecosystem accessible to executives who want to accelerate the route to sustainability in a professional and informed way. In addition to its educational offering, the ESG Innovation Institute also includes an academic ESG chair at Nyenrode, from which research, scientific publications and opinion and debate take place. By building and harnessing a community within the ESG Innovation Institute, we want to start a movement among business leaders – to inspire them and facilitate innovative, sustainable and responsible leadership.
Dr. Jeroen Veldman is Professor of Corporate Governance, Nyenrode Business Universiteit
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