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Board

Sustainability

The crucial role of the board in driving sustainable business transformation

Published 15 May 2023 in Sustainability • 7 min read

SUSTAINABILITY TOOLKIT no.4

In the fourth of a series of practical guides, Knut Haanaes and Salvatore Cantale look at the vital role played by boards in driving companies’ sustainability strategies. Board members often feel ill-equipped to tackle environmental, social, and governance (ESG) challenges, but there are concrete steps they can take to get on top of the sustainability agenda. 

If board members were in any doubt about their responsibilities for ensuring that their companies tackle sustainability challenges, the legal suit recently filed by environmental law charity ClientEarth, against the directors of oil major Shell, will have made things abundantly clear. 

ClientEarth, in its capacity as a shareholder, is suing the 11 members of Shell’s board personally for allegedly mismanaging climate risk and breaching company law, by failing to implement an energy transition strategy aligned with the 2015 Paris Agreement on climate change. The claim has the backing of institutional investors with over 12 million shares in the company, including UK pension funds Nest Pensions and London CIV, Swedish national pension fund AP3, French asset manager Sanso IS, and Danske Bank Asset Management. 

The claim is thought to be the first case in the world seeking to hold a board of directors liable for failure to properly prepare for the energy transition; the outcome could have significant implications for other companies and their boards. 

Meanwhile, two of the UK’s largest pension schemes have said they will vote against the renewal of top directors at BP and Shell, unless the companies strengthen commitments to tackling carbon emissions. The Universities Superannuation Scheme and Border to Coast, which manages the pension assets of local authority workers, say the move is part of a drive to push oil companies and banks to make faster progress on climate-change pledges. Other asset managers are also increasingly targeting board members over a lack of progress on climate change. 

Of course, pressure from investors is not the only reason why boards need to take decisive action on sustainability. They face mounting demands from customers and other stakeholders for engagement on ESG issues too.  

New regulations are also imposing additional reporting requirements on companies. From 2024, large companies with operations in the European Union will be subject to mandatory sustainability reporting as a result of the EU Corporate Sustainability Reporting Directive. And the US Securities and Exchange Commission has proposed new rules that would require listed companies to disclose sustainability-related risks and the greenhouse-gas emissions of their whole value chain.

But sustainability is not only about external risks for companies – it also offers opportunities for growth, and the increasingly evident link between sustainable business transformation and long-term company performance is a powerful argument for action. 

So there is a growing realization among board members of the importance of sustainability for their companies, and of the need for the board to take a leading role on this topic. Boards are charged with steering the direction of the company over the long term, and sustainability is clearly a long-term project.  

And boards are upping their game. The Sustainability Board Report, an independent, non-profit project set up to measure the ESG preparedness of the boards of the world’s largest 100 publicly listed companies, found that 80% had a committee with a clearly stipulated sustainability role in 2022, up from 54% in 2019. Meanwhile, 25% of Fortune 500 board appointments in 2022 were of people with sustainability committee experience, up from 14% in 2021 and just 6% in 2020, according to executive search firm Heidrick & Struggles 

Sustainability is not only about external risks for companies – it also offers opportunities for growth.

Yet despite such efforts, board members still lack confidence that they are doing enough to keep pace with demands for more action on sustainability. 

A 2022 survey of board members by Boston Consulting Group and the INSEAD Corporate Governance Centre found that 70% of directors felt they were only moderately, or not at all, effective at integrating ESG into company strategy and governance; 43% cited the ability of their companies to execute as one of the biggest threats to delivering on ESG goals. Many board members feel ill-equipped to act on the ESG imperative in a structured and sustained way, according to leadership consulting firm Egon Zehnder.  

However, there are some key actions that boards can take to get started on sustainability. 

Adding value through strategic reflection 

The most important thing is to ensure that sustainability is part of the whole purpose and strategy of the business. This sort of strategic thinking is where boards can add most value, by analyzing societal trends, and considering the risks and opportunities that these might present. Most directors say the board should focus more on the strategic aspects of ESG than on monitoring operations, but boards are rarely effective at driving such strategic reflection, with too much time being spent on regulatory, reporting, and compliance matters instead. 

Strategic reflection means being proactive rather than reactive: thinking about the company’s purpose and material ESG issues; allocating capital to sustainability capabilities; engaging with stakeholders; and preparing for crises by developing ESG resilience. 

It is also essential to think about the capacity and effectiveness of the board. 

Finding the right governance model 

The board needs to decide how to structure its ESG activity so it adopts the most appropriate governance model for its business.  

Options include: 

  • Dedicated sustainability committee: this ensures a constant focus on ESG at board level and works well for companies that are behind on sustainability and want to make fast progress. 
  • Sustainability responsibility given to an existing committee: this can work when sustainability issues are straightforward, but it can also lead to distortions in priorities. 
  • Multiple committees addressing sustainability: this can work well for companies with a broad committee structure, but complications can arise with coordination. 
  • Sustainability board champion: a good fit for small companies where sustainability impacts just one line of product or services. 
  • Full board responsibility for sustainability: this ensures that ESG matters receive a broad and diverse set of perspectives, experiences, and ideas, but can create inefficiencies in the case of large boards. 

Studies show that at present, oversight of sustainability is most commonly assigned to the full board, but board committees are playing an increasingly important role. 

Expanding the board’s knowledge and expertise 

The board also has to take steps to increase its stock of knowledge on sustainability issues. 

A lack of relevant skills among board members was cited as the biggest barrier to improved governance in this area, according to an Egon Zehnder survey of global executives. Adding ESG topics to board training may therefore have a useful role to play. In Singapore, directors of listed companies are actually now obliged to attend sustainability training courses so they are equipped with basic knowledge on ESG issues.  

Boards can also address their knowledge gaps by bringing in outside experts. A survey of global corporate leaders last year, by executive search firm Spencer Stuart, found that bringing in external consultants (42%) and additional training for board members (38%) were the most frequently used methods to build board knowledge on ESG matters.  

But recruiting new board members with sustainability expertise is likely to become a much bigger part of the solution, as the topic occupies a more central position in corporate strategy. And beyond the question of expertise, research suggests that having the right mix of individuals on the board is also key. 

ESGBringing in external consultants (42%) and additional training for board members (38%) were the most frequently used methods to build board knowledge on ESG matters

Egon Zehnder found that a board with more environmental experts, but also more women, a younger average age, and shorter tenure, tends to have a positive impact on corporate sustainability.  

Boards also need more cognitive diversity if they are to carry out their role as stewards of sustainability effectively. This means having directors with a different mindset or outlook, who are able to challenge current business models, deal with uncertainty and complexity, and drive innovation and change, so that their companies can capture the competitive advantage that full engagement with sustainability can offer. 

So, to sum up, the first key steps for boards on their sustainability journey are: to put the topic on their agenda; decide the most suitable governance model; and build up their basic knowledge of the subject. 

The next step is to conduct a materiality assessment to identify the most significant ESG issues for the business. We will look in more detail at how to carry out a materiality assessment in a forthcoming article in this series. 

This is the fourth in our Sustainability Toolkit series. To read the previous articles click  herehere, and here.

Authors

Knut Haanaes

Knut Haanaes

Lundin Chair Professor of Sustainability at IMD

Knut Haanaes is a former Dean of the Global Leadership Institute at the World Economic Forum. He was previously a Senior Partner at the Boston Consulting Group and founded their first sustainability practice. At IMD he teaches in many of the key programs, including the MBA, and is Co-Director of the Leading Sustainable Business Transformation program (LSBT) and the Driving Sustainability from the Boardroom (DSB) program. His research interests are related to strategy, digital transformation, and sustainability.

Salvatore Cantale - IMD Professor

Salvatore Cantale

Professor of Finance at IMD

Salvatore Cantale is Professor of Finance at IMD. His major research and consulting interests are in value creation, valuation, and the way in which corporations structure liabilities and choose financing options. Additionally, he is interested in the relation between finance and leadership, and in the leadership role of the finance function. He directs the Finance for Boards, Business Finance, and the Strategic Finance programs as well as the Driving Sustainability from the Boardroom program and the newly designed Bank Governance program.

 

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