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Pushing back, moving forward: Understanding the evolution of ESG

By Carl Hess | December 5, 2022

Written by Economist Impact and sponsored by WTW, the report contains extensive research, data and expert interviews.
Climate|ESG and Sustainability|Executive Compensation|Inclusion and Diversity
ESG In Sight

As consideration of environmental, social and governance (ESG) factors has grown from a niche investor issue into a mainstream corporate focus, it is understandable that the topic would attract its share of criticism — especially when you consider how broad and far-reaching it is. We see the pushback as a sign of the maturation of ESG among a broad range of stakeholders who bring a wide range of philosophies, strategies and approaches to the subject. As such, without agreed-upon definitions or road maps, debate is to be expected.

Organizations tend to address ESG through compliance, corporate social responsibility, business strategy or some combination of all three. And success of ESG initiatives has varied widely, prompting criticism and skepticism from multiple fronts.

Criticism of ESG is a necessary step in its evolution. It spurs introspection and evaluation, helps challenge underlying assumptions, separates what matters from the superficial and requires advocates to refine strategies and tactics to pursue both the achievable and aspirational aspects of ESG. For example, a key tension point is that many existing ESG analytics started out as a way of considering the impact of these factors on the value of a business, yet there is now also a focus on second-order materiality such as the impact of the business on the planet and society at large.

The governance aspect of ESG, with its focus on business management processes such as risk management and regulatory compliance isn’t questioned — or criticized — to the same degree as the environmental or social aspects of ESG because governance has long been a primary focus of leadership.

One of the main questions about ESG — addressed thoughtfully throughout this paper — is how to reconcile these more controversial aspects, including climate change, equity and the energy transition in particular, with profitability and capitalism. Though some may debate the compatibility of ESG and business performance, we believe that while it is unrealistic to expect ESG and profitability to always align in the near term, that doesn’t mean that profits and social and environmental sustainability are mutually exclusive. And getting ESG right clearly should support long-term profitability and business sustainability.

A new model based on stewardship

We believe that profits, value creation, ESG and sustainability are all inextricably connected. We see ESG as wholly compatible with capitalism but, as the report notes, aligning conflicting interests will require a new mindset and a re-examination of the roles of shareholders, voters, the financial services industry, policymakers and regulators.

We would also add boards of directors and corporate officers to that list. Boards and corporate leaders must assume the role of stewards who preserve, protect and increase value over time. It is through their role as stewards that boards and leaders define ESG for their organizations, prioritize based on the business’s unique needs and objectives, and ensure that all stakeholder needs are sufficiently addressed.

It is through their role as stewards that boards and leaders define ESG for their organizations, prioritize based on the business’s unique needs and objectives, and ensure that all stakeholder needs are sufficiently addressed.”

Carl Hess | CEO, WTW

With its focus on environmental and people issues, ESG has a leading role to play in stewardship. But boards and leaders must take a more holistic view, prioritizing performance and protection (governance) to ensure long-term resilience, viability and growth. If a business is not profitable, it ultimately will not be able to address ESG, meet other stakeholder expectations and remain viable.

Five key elements of stewardship

The stewardship model we envision establishes a new paradigm for boards and leaders to set priorities, rectify and balance conflicting interests, and measure progress. We see it as the means to create win-win solutions that align with business fundamentals by incorporating five elements into decision-making:

  1. Performance: Strong, consistent and sustainable financial performance and value creation are essential to meeting the needs of stakeholders and pursuing broader purpose. Performance drives all the other elements of stewardship.
  2. Protection: Risk management and mitigation are essential to preserving long-term value. By managing a portfolio of risks at the enterprise level using data and analytics to inform decisions, organizations can mitigate a wide range of complex risks, including cyberattacks, political and social disruptions, reputational risk and risks associated with natural disasters.
  3. People: The role of people cannot be overstated, as they play a vital role in an organization’s success and in all aspects of stewardship. Boards and leaders are responsible for a wide range of people issues, including protecting employees’ financial, physical, social and emotional wellbeing; fostering diversity, equity and inclusion; and ensuring skills align with organizational goals.
  4. Planet: Leaders are also tasked with managing their organizations’ environmental impact as well as the orderly transition to a net zero economy. They will need to manage climate risks through new forward-looking metrics rather than just carbon footprint, while overseeing efforts to reach climate goals.
  5. Purpose: By connecting employee and customer values to what the organization does, boards and leaders can maintain a consistent corporate culture and nurture their brand amid continual change. Purpose is closely linked to essential elements of ESG such as supporting employee needs and delivering on environmental commitments.

Final thoughts

Ultimately, we think criticism of ESG, while healthy, tends to overemphasize short-term costs over long-term value. A broader perspective — through the lens of stewardship — presents the opportunity to create more responsible, future-focused and profitable businesses that are fit for purpose. We’re calling on corporate leaders and boards of directors to rise to the challenge of stewardship as the means to effect that change.

To learn more, fill out the form to the right to download the report, “Pushing back, moving forward: Understanding the evolution of ESG,” in its entirety.

Author

CEO, WTW

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