Cracks in the Alignment on ESG

Ask a board director to name an area that is complex and evolving, divides opinions and is yet crucially important to organizations; they will often name ESG, the umbrella term for environmental, social, and governance considerations. From what it means, to how to apply it in practice, to where to take it next, ESG has been a source of both excitement and consternation for many boards and organizations.

More recently, the news is full of stories about the pendulum swings on ESG. Is it an essential priority for boards who want to ensure their organizations are resilient and responsible? Or a passing fad that distracts boards and management alike, with uncertain impact on value for shareholders and stakeholders?

In our view, we are entering a new era of maturity for ESG. It is no longer about rushing to put frameworks, practices, benchmarking or reporting in place to satisfy the expectations of others; it is about thoughtful and nuanced conversations that position ESG as a framework to secure value, reduce risk, and sustain impact into the future. But that more thoughtful and integrated work requires a deeper kind of alignment about ESG, and that is where we are seeing boards challenged today.

ESG is a very short term for a very wide area. Very few aspects of what an organization does or impacts are not somehow associated with environmental, social, or governance considerations. This makes ESG somewhat hard to grasp, sparking reactions of “I’m not an expert and therefore leave it to others” to “this permeates all the board’s work, and we all need to be deeply involved.”

And, depending on a director’s view as well as where they focus their reading and learning, feelings about ESG can range from a deep desire to expand and embed that thinking in the organization, to a feeling that too much attention has been paid there already. On some boards, these cracks appear and sometimes widen. ESG can be anything from a rub point to a flashpoint for the boards we work with.

Overall, we find that Canadian boards no longer question that ESG is an important and worthwhile area of focus. This is in line with research that continues to indicate how ESG factors contribute to long-term sustained business success, such as common purpose, diversity of thought, innovation and change capacity, healthy governance, climate risk management, and more.

Within that, however, we observe a considerable range of views and engagement around three key aspects of ESG: the motivation muddle (the why), the aspiration gap (the what), and the diligence divide (the how).

The Motivation Muddle

The motivation muddle is about the fundamental drivers behind a board’s focus on ESG.  Almost always there will be a mix of concerns and rationales. The motivation muddle comes from a lack of clarity and intention around ‘why’ an ESG topic is on the agenda.

It is important to appreciate that directors come to the ESG topic with different underlying views. For example:

• Some directors will be of the mindset that efforts into ESG topics should be limited to compliance concerns: disclosure obligations, statutory compliance and investor or proxy firm requirements.
• Other directors will examine ESG matters through a prism of return on investment considerations. Those returns may be quantitative and/or qualitative and are for them the reason for ESG topics making it onto the agenda. Their queries and input will frequently come back to measurable payback or cost avoidance.
• Others still will believe that time allocated to ESG topics is justified by a moral or ethical obligation; that the ESG focus is about doing what is right. While not advocacy per se, this perspective on ESG topics is informed by a sense that those who can, should, a commitment to ‘do no harm’ and a broader take on traditional balance sheet assets and liabilities.

When directors underlying motivations for ESG differ, it makes sense that they will then not be on the same page around which actions to take, and how to approach them. And, if motivations are not discussed and brought to the surface, frustration can arise; other directors’ views can seem out of alignment with what we believe is logicial and right, because we are making implicit assumptions about the ‘why’.

Clarifying the motivation muddle is not about limiting motivations to a single source or point of view, but rather about surfacing the mix of motivations, in an inclusive and appreciative way, and deciding how to weight them for a particular ESG topic or item, at this organization, at this specific time.

The Aspiration Gap

The aspiration gap is about the value ESG represents for the organization and the board, and the appetite to lead based on that value.

Often, the value of ESG focus and investment will slow gradually, over time; it may also be hard to quantify, because it is relative to what might have been or could have happened with insufficient attention to ESG. At the same time, there are usually investments and trade-offs required in the short term.

The aspiration gap sits between the definitions and expectations of the board, management, and others with an interest in the organization. It is about how strongly an organization can and should lead; how deeply it should invest in ESG and prioritize ESG considerations in its decision-making, including relative to short term cost and value. Filling the gap requires dialogue and alignment around what ESG looks like for the organization; for example, where on the spectrum the organization sees itself between basic compliance or baseline adoption, and a stronger leadership position where ESG is part of the organization’s difference.

The Diligence Divide

The diligence divide is about the “how” of ESG. It is about the investment of effort and resources invested in research, benchmarking, analysis and reporting around ESG, as well as in ESG governance. Even if the board and management are clear on their aspirations (the “what”), it is not always obvious how to get there, and how much management and board time should be invested. The differences become deeper when aspiration gap and diligence divide come together, as both can interrelate and overlap in the broad space that is ESG.

Getting on the Same Page: What Helps

Boards are at their best when their differences in perspectives contribute to stronger decisions and actions; not when they start to distract the board or fray relationships. Boards can benefit from getting to stronger alignment on their ESG priorities, desired leadership position, and level of diligence, even while they value differences amongst themselves. Getting there is not always easy, because ESG may edge into values and professional standards, including spoken and unspoken norms.

There are things that can help. Here are some things that we have seen make a difference to our clients.

Surface the Why

• Before you dive into the what and how, align around the why. Knowing why the topic is on the agenda will help to keep the conversation focused and grounded in purpose rather than personalized. You can get started by asking these questions:
  • Is this predominantly an exercise in cost avoidance or an attempt to capture an opportunity?
  • How is the discussion grounded in the organization’s strategy or risk register?
  • Are you pursuing a point of differentiation against your competitors?
  • Are the legal requirements governing the issue the starting point or the finish line for this topic’s exploration?
  • How do the organization’s values, public statements, good fortune and/or desire to invest in stakeholder relationships factor into decision-making?
  • What is the right mix of motivations, for this specific item/issue, at this moment in time?
  • What might cause the balance to need to shift over time?
• When it seems like the differences on the board are becoming more long-term gaps in alignment, consider starting related agenda topics with space for open-ended discussion of the why; why is this topic important to us? It will be important that the chair or committee chair, with the help of directors, sets the right tone, that this is about hearing and appreciating the diversity of ‘whys’ and seeing them as a source of strength, not about debating which motivation is best or ‘right’ – a no-win proposition.

Get Clear on the What

• Demystify ESG by unpacking it. Your organization is already doing work that touches upon environmental, social, and governance work. Move away from the single “ESG” label and be specific where you can, using “ESG” to signify a connected domain, not a single item.
• Test the ESG appetite of the board and management. Ask questions and seek true understanding. Talk about where ESG contributes to long-term value creation and risk reduction for the organization; what specifically are you trying to achieve here and what with the value be?
• Map who the key rightsholders and interest holders are, and what they want and expect on ESG; for example, employees and prospective (ideal) future employees, investors and their advisors, partners, government and regulators, clients, suppliers, communities you impact, etc. Consider how important they are to you and how much their views should inform your ESG priorities.
• Where you sense gaps, surface them and put words to them, so they do not grow out of proportion while unrecognized. Seek and facilitate dialogue about a way forward, so the board can speak with one voice.
• Anchor conversations about ESG in the purpose and values of the organization, rather than in directors’ personal values and views; bring the conversation back to what is best for the organization and its positive impact.
• Use evidence and data to anchor conversations about what exists, where the opportunities are, and what the outcomes may be, so that as much as possible you are making informed and fact-based decisions. At the same time, be practical about the data; because ESG is about the future, there will not always be perfect or predictive data, and over-analysis will not serve you well. In fact, it can lead to arguing about quality and validity of data as a proxy for arguing about what is important.
• Embrace the diversity of thought in the room; invite everyone to stay in the mindset that differences in views are a strength that will lead to better decision-making, to offset any inclination to become frustrated with the views of others, or to try to push people into line. Harness the best from diversity by practicing inclusion, keeping in mind that you want different perspectives to achieve the best result, even if this means a process with more twists and turns. Recognize different voices and integrate their contribution in the outcome of what ESG means for the organization.

Work on the How

This is about the effort the board and the organization want to invest in ESG governance, analysis, process, benchmarking and reporting. Work on the how helps decrease or close any diligence divide as the board and the organization approach ESG. Sometimes this is the place to start; moving forward where you can, where you are aligned today, can break you out of discussion mode, especially if the discussion is about assumptions or scenarios and difficult to ground in data.

• Be practical and start doing what you can. Find the places where there is alignment and move them forward. They can be focused and specific; all progress is valuable. Working on something practical will help you get beneath the words and also collect more data about different views and the impact of different actions. Pilot and iterate. Reduce ambiguity by moving forward and gaining more clarity with every step.
• Embrace good change management to communicate the organization’s aspirations on ESG and to arrive on what that looks like in practice. Be aware of the importance to engaging both hearts and minds, especially in areas of ESG that can resonate in a deeply personal way, for example harassment and bullying or managing risk of environmental catastrophes.
• Look outside in from the perspective of rightsholders and stakeholders to determine the appropriate level of effort for the organization in areas under ESG. Consulting others also has the additional benefit of engaging those who are important to the organization and making them part of the effort.
• Make the work tangible with scenario planning. ESG can feel like an abstract concept sometimes. To understand the effort related to moving initiatives forward, workshops for scenario planning can be a way to make this more accessible and engaging for the board and management.

If You See Gaps

If as a director you are sensing gaps, here are some ways to help as an individual director:

• Map where you think the gaps are – where you and others sit, and whether it is about one issue or more, and whether it is about aspiration or diligence. Pay as much attention to the places you are aligned as the gaps, because those areas of alignment give you a platform from which to work on the differences.
• Ask yourself in which areas and how you may best bring value to the board conversations. Consider how you can contribute to a productive path forward. Prioritize listening and curiosity over trying to bring others over to your view; the irony of influence is that it is better accomplished through listening than telling.
• Check in with other directors about their perspectives, including to understand if others are seeing these differences and have more or less concern about them, relative to other board priorities. Get the chair’s perspective on the board’s alignment and your contribution to board conversations about ESG. If there is a specific ESG committee, or committee with ownership for the ESG issue you are concerned about, explore with the committee chair. If there is no committee – but work to be done that requires that level of attention – it may be timely to explore a committee, or a shorter-term task force, to give space to dig into ESG areas.
• Explore opportunities to invite guest speakers to the board; people with expertise and/or practical experience and stories in the areas of concern. A less formal setting can help make space for wide-ranging conversation where different views are embraced. Speakers can come from a wide range of sources, such as from the organization’s audit firm (which will often have experts and a research base), a stakeholder who sees other organizations in the industry and their impact, or a director from another board that recently worked on a similar matter.

Watson is here to help, as you explore these areas and work on the dynamics and effectiveness of directors and boards. Reach out to us at letwatsonhelpyou@watsoninc.ca.