Environmental, social and governance issues are now recognised as a strategic priority by business, investors, society and political leaders alike. What can we learn from boards already wise to the challenges and opportunities that the quest for a sustainable future present?

While sustainability and ESG issues are rising up the corporate, political and public agenda, progress towards a more sustainable future remains slow.

Ahead of the crucial COP26 climate conference in Scotland this November, a successful outcome to the talks remains very much in the balance. Governments and businesses are facing criticism for dragging feet on turning commitments into material and measurable action. There are doubts whether the world’s richest nations will meet their pledge to finance a “just transition” to a more sustainable way of life.

While many boards are sincere in their desire to operate in a more sustainable way, they face significant challenges. It calls on boards to understand the dynamic demands, opportunities and risks presented by a broad range of stakeholders. Then to make tough choices about the mindsets, behaviours and tools they need to adopt and embed within the business.

Some business leaders are clearly ahead in their thinking and are wise to the challenges, and, importantly, the opportunities, that lie ahead.

So what can businesses, and the professional firms that advise them, learn from what sustainability-savvy boards are focussing on?

Drawing on our work with boards, independent advisory roles to NGOs such as The World Economic Forum and on the latest academic research, we have distilled the top five challenges far-sighted boards are grappling with.

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Julia Hayhoe is leading a panel at the Law Firm Marketing Summit on 5 October, a virtual event. Click here to view the programme and here to book a ticket. For sponsorship enquiries email [email protected].

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Fundamental paradigm shifts

Before we tackle these challenges, we first need to understand two paradigm shifts in board thinking that are influencing these business leaders - stakeholder capitalism and the just transition.

Stakeholder capitalism – Much has been written about the shift in boardroom thinking from one focused on the primacy of creating shorter term profits for shareholders (shareholder primacy) to where long-term value is created for and with its material stakeholders (stakeholder capitalism).

It is an oversimplification to set these two approaches as binary choices. Indeed, it is a false dichotomy. For a business to create shareholder wealth, it must understand, and adapt to, the changing expectations and needs of its material stakeholders.  

This debate has stimulated progressive boards to reflect deeply on what is the fundamental purpose of their business in today’s much-changed world. In particular, to deliberate on the time horizons over which a board seeks to create and protect value; how it assesses value in financial, environmental, social and ethical terms, and with and for whom it achieves this value – its material stakeholders.

Professor Colin Mayer articulates this version of business purpose well when he writes that “the purpose of business is to solve the problems of people and planet profitably, and not profit from causing problems.”

A recent study also shows that authentic corporate purpose, experienced through the brand and lived through the strategy, creates both shareholder and broader stakeholder value. The key, as we see later, is how purpose is operationalised within the business and embedded into management decision-making.

Sustainability-savvy boards recognise they are part of the solution and have a key role to play in ensuring the substantial benefits of a green transition

The just transition – The pandemic and social and racial justice movements have thrown a dramatic spotlight on pre-existing inequalities in healthcare, education, technology and jobs, the majority disproportionately impacting minority groups.

At the same time, we are witnessing the impact of climate change first-hand through more frequent and more devastating wildfires and floods across the world.

Sustainability-savvy boards recognise they are part of the solution and have a key role to play in ensuring the substantial benefits of a green transition and economic recovery are shared widely, particularly for those who stand to lose out economically – be they minorities, communities, industries or countries.

This brings to the fore, what does sustainable growth mean for business today?

Sustainable growth draws upon both stakeholder capitalism and the just transition. So for business today it means creating and sustaining value that is ethical and responsible to, and for, its current and future material stakeholders. It has three main pillars of likely most material opportunity and risk to evaluate: environmental, social and governance issues.

Regardless of this incredible challenge, progressive boards are not thinking solely in terms of sustainability risks. They realise that opting for the bare minimum means missing out on structural shifts in markets, loss of customers and talent and ultimately the trust on which their license to operate is based.

Sustainability is now equally about the opportunities it presents, seen as a pre-requisite to achieving more resilient business performance and, when embraced genuinely, offering a real competitive advantage in its marketplace.

So, with these significant changes in mind, what are the five issues dominating the agenda of the boards that are most advanced in their thinking?

1. Embedding sustainability into purpose, strategy and culture

As a starting point, sustainability-savvy boards are reflecting upon, and in many cases re-evaluating, their core purpose and holding it as their guiding star in making strategic choices and investments.

To inform and shape their purpose, they are asking fundamental questions, including:

• Why do we exist as a business?
• Whom do we serve?
• What needs do we meet?

By asking these bare bones questions, boards can ensure that sustainability is embedded into the enterprise-wide strategy-setting process and corporate governance. It helps inform and identify which investments are likely not sustainable in a Net Zero economy. Crucially it means they avoid the old practice of shunting sustainability into a separate strategic initiative box or vested just in an arms-length CSR Committee.

Boards are the ultimate guardians of companies. Those that fail to effectively embed sustainability into purpose, strategy and culture face the risk of being unable to convert good words into material action.

But how to do this?

A report by the Enacting Purpose Initiative has a useful framework for boards on how to turn purpose into action, utilising a SCORE framework.

A great practical example of enacting purpose is Ørsted, the Danish energy group, which has restated its purpose as: ‘to create a world that runs entirely on green energy’. By embedding sustainability in its purpose, strategy and culture, the company has undertaken a massive transformation from a fossil-fuel-based energy company to a green energy company.

Boards are the ultimate guardians of companies. Those that fail to effectively embed sustainability into purpose, strategy and culture face the risk of being unable to convert good words into material action. And being accused of green or social washing, in the process damaging brand reputation, revenues and the trust put in them by key stakeholders.

2. Developing effective stakeholder governance

Effective boards have always taken a critical look at whether their composition, succession, competency and compensation are up to the task of delivering on strategy. Compensation alignment to strategy and purpose is now under a particularly acute stakeholder spotlight.

Ahead of these questions, sustainability-savvy boards are considering afresh:

• Who are our material stakeholders?
• How are they becoming more segmented in different groups and generations?
• How effectively are we listening and engaging with each segment to understand, create and protect long-term value?

This fundamentally different approach to decision-making in the boardroom –connecting value creation and stakeholder outcomes – lies at the heart of stakeholder governance, as articulated in The World Economic Forum board report co-authored by Julia Hayhoe and Beatriz Araujou, Baker McKenzie partner and WEF fellow.

Boards have always focused on shareholders, investors, customers and employees as material stakeholders. Increasingly other stakeholders are having a material impact on business, such as regulators, suppliers, communities, and, ultimately, the planet itself.

In addition, minorities or distant voices within stakeholder groups are often not heard. This makes business blind to newly evolving market trends and customer demands and risks failing to attract, engage and retain talent and diverse perspectives, thus damaging optimal business performance.

So, the board’s task is to identify its own unique set of material stakeholders, in all its diversity. A ‘materiality assessment’ is often used to do this, as a method to understand the most material ESG issues to stakeholders.

But doesn’t this cause boards to lose focus, or become captive to special interests?

Martin Lipton of Wachtell, Lipton, Rosen & Katz, a longstanding proponent of stakeholder governance, calls upon directors to exercise their ‘business judgment’ for the corporate entity that they represent. That means balancing the rights of, and the company’s obligations to, all material stakeholders. You can read more about this approach here:

Measurement and materiality are fundamental to ESG transparency and accountability. The origins of sustainability reporting on material ESG issues stem from the work of the Global Reporting Initiative (GRI) more than 20 years ago. Whilst there are harmonisation initiatives underway, today there are still no common standards in ESG reporting.

That is not getting in the way of forward-looking directors. Rather than getting stuck waiting for ESG metrics to be harmonised, sustainability-savvy boards are adopting science-based targets to bake in action, transparency and accountability for today and to guard against complacency in the short term.

They also know that what counts as material risk and opportunity is not fixed. Instead they focus on dynamic materiality, recognising that what is material for an industry and an individual business is changing rapidly due to new regulations, technologies, knowledge and social expectations.

3. Funding the transition 

Governments globally are introducing sustainable finance regulations with the clear purpose of stimulating and directing investment towards activities benefiting the environment. At the same time, public and private investors are piling unprecedented levels of cash into sustainable funds and financing.

As sources of capital shift, so is the quantum of capital required to achieve sustainable business transition. The cost of the UK Government’s 2050 Net Zero commitment is estimated to range from £70bn to £1.4tn. In the US the Senate has just approved a sweeping new bill to inject around $1tn over five years into America's infrastructure. For some programmes, at least 10 percent must be spent through small businesses, owned by socially and economically disadvantaged individuals.

Boards have whole new sources of sustainable capital to consider from government subsidies, project finance and sustainable finance. Private equity sponsors, too, are bringing in new investment practices that favour prospective portfolio companies poised for success in embracing new consumer preferences, new regulatory regimes and with their own responsible business house in order. Sustainability now stands as a key priority for CFOs and CIOs.

Meanwhile, investor activism is rising dramatically, requiring boards to think proactively and analytically about their investor stewardship to ensure they attract and retain their preferred investor base.

Climate and human rights litigation are also increasingly being used to advance environmental and human rights protection through the legal system

4. Re-evaluating the value chain

Sustainability-savvy boards recognise that a great source of value, and often the greatest source of risk, sits outside their immediate corporate boundaries within their wider supply and value chain. They recognise too that their own business will sit in someone else’s supply chain. So, there is a key question boards need to consider: To what extent are we a source of value creation, or risk mitigation, to our customers, communities and the natural environment?

The risks for business in not measuring its impact across its supply chain, meaning it leaves itself open to claims of green or social washing from a range of stakeholders whose voices are magnified by social media. Climate and human rights litigation are also increasingly being used to advance environmental and human rights protection through the legal system.

It can, however, be difficult to locate the most material sources of value or risk in complex supply chains. For that reason, business partnering along the value chain has become critical in this endeavour.

Within the legal sector, The Chancery Lane Project (TCLP) is a stellar example of a focused and collaborative partnering effort. Lawyers from around the world are working together through the TCLP to develop new contracts and model laws that deliver climate solutions for businesses across the supply chain. A move that is embedding practical material change into contracts, at a far faster pace than can be achieved through regulation.

5. Digitising the transition 

Closely linked to re-evaluating supply chains, forward-thinking boards recognise how big data, when twinned with blockchain technologies and AI, create a tremendous ability to unravel the value and risks in every part of the value chain.

Take coffee as an example. It is the world’s most popular drink, yet the supply chain bringing this staple from crop to cup is full of adverse social and economic impacts that heavily impinge on local growers. Using blockchain technology in the supply chain can help businesses ensure that growers are not only given fair payment for their crops but are also using sustainable farming practices. It also enables consumers to see where their coffee comes from and make more informed purchasing decisions.

AI is also being used to identify and assess the sentiment of stakeholders, to alert the board to new opportunities and issues among consumers, investors, activists and regulators.

Of course, AI does contain significant risks for perpetuating inherent, systemic bias within algorithms and data sets, along with ownership and security issues. Advanced boards know they need to challenge themselves and hold to account operational managers to build diversity, equity and inclusion into AI design.

A shift in leadership mindsets and behaviours

As we have seen, sustainability and ESG presents great opportunities for new sources of value creation, and attendant risks and responsibilities.

Sustainability-savvy boards recognise that this requires a mindset shift in thinking about who are the company’s material stakeholders and how to create, maintain and protect value for the longer term.

It also requires translating these mindsets into action. We offer here our guide on how to do this, through the lens of the top five aspects being tackled by leaders who were early to understand the issues and opportunities, and quick to act. For professional advisors to boards, our aim is to reveal the areas where boards are likely to most value professional advice in their quest to transition to a more sustainable, resilient business.

Julia Hayhoe leads Hayhoe Consulting, advising professional services on how to achieve strategic, sustainable growth for themselves and for their clients, while Iris Mol is a graduate student of International Business Law at Vrije Universiteit Amsterdam specialising in the changing regulatory field of (non-) financial reporting in the EU