Australian companies are embracing environmental, social and governance (ESG) issues despite facing a recession and the ongoing fallout from the coronavirus pandemic, according to a Governance Institute of Australia roundtable.
Economic crises traditionally prompt organisations to concentrate on their core operations to ensure they survive, but the unusual nature of the pandemic has brought traditional corporate purpose and ESG principles closer together.
That view was supported by recent Diligent Institute global research, which found that directors are spending more time considering ESG issues since COVID-19 and expect to continue doing so.
‘Going through the pandemic, it became pretty clear that board level decisions that impact stakeholders really took centre stage,’ said Diligent Institute Executive Director, Dottie Schindlinger.
Governance Institute of Australia recently brought together a diverse group of specialists to consider how the events that have made 2020 unlike any other year have shaped local perspectives on ESG.
Agreement isn’t universal
Just over 12 months ago, the influential US Business Roundtable redefined the purpose of a corporation from purely delivering profits to shareholders, to instead promoting an economy that serves the entire community.
The issue has divided business and academia, with Harvard Professor Lucian Bebchuk and Oxford Professor Colin Mayer two prominent voices on opposite sides of the debate. The ASX Corporate Governance Council's proposal to include social licence to operate in its Principles and Recommendations sparked similar discussion.
However, the participants in Governance Institute’s roundtable largely agreed that corporate purpose and social purpose are not working in opposition but are deeply intertwined.
Tim Nelson, Executive General Manager, Energy Markets at Infigen Energy and an Associate Professor of Economics at Griffith University, explained it from an investor’s perspective: ‘If I see a company that's not practising this stakeholder inclusion, then it's just not going to generate long term returns.’
His view was share by ASX Special Counsel, Regulatory Policy, Kevin Lewis. ‘I think the two things stand together,’ he said. ‘You can't achieve your outcomes for your shareholders if you don't have employees or if you don't have customers.’
It’s an interdependency that’s echoed at an economic level, according to Komal Jalan, Principal, Pacific Investment Management at Mercer Australia.
‘Our investment activity has an impact on the environmental, social and governance construct of the economy, which in turn feeds back in our investment return,’ she said.
Taking the pulse of ESG in a pandemic
Diligent Institute recently surveyed 406 directors and business leaders on how boards are responding to the increased focus on stakeholder interests in its report Stakeholder Capitalism: Translating Corporate Purpose into Board Practice.
An overwhelming majority (91%) of surveyed directors agreed with the updated Davos Manifesto on broader corporate purpose, according to the Diligent Institute report.
About 84% agreed that capitalism must focus on all stakeholders rather than just shareholders (the result was even higher if US directors were excluded). The report also found:
- ESG is being talked about more frequently at board level.
- Customers, employees and local communities are the most important stakeholder groups.
- Top issues for boards are centred first around the pandemic and then on ESG.
The groups which boards are most commonly considering in their current decision-making according to the Diligent Institute report are employees (79% of respondents), customers (70%), and local communities (47%).
‘There's this overwhelming sense that this experience that we've all lived through of COVID-19 is going to forever change the way directors think about the impact of their decisions on more than just their shareholders,’ said Diligent’s Dottie Schindlinger.
The roundtable participants said protecting staff health and wellbeing was a top priority for boards and executives.
Darian McBain, Executive Advisor, Corporate Affairs and Sustainability at major seafood producer Thai Union Group, emphasised that if people were unable to work, organisations’ whole supply chains could collapse.
AdvertisementClimate change and diversity in focus
Sustainability is seen as part of the solution to Australia’s current economic downturn, rather than a distraction from it.
In August, Global Compact Network Australia, a United Nations affiliate, wrote to Prime Minister Scott Morrison, urging the government to use the United Nations’ Sustainable Development Goals as a framework to help steer the economy through the pandemic.
The letter’s 52 signatories, which included Governance Institute, highlighted the growing sentiment for meaningful action on sustainability amid the pandemic, and the shared responsibilities of government, business and individuals.
While diversity is slowly increasing across corporate Australia, roundtable participants called out the lack of diversity in senior executive ranks and the limited focus on other dimensions of diversity as areas where more progress is still needed.
For Andrew Buay, Vice President, Group Sustainability and Acting Vice President, Human Resources, at Optus and Singtel and Optus, diversity begins with considering the philosophy behind why it matters. That includes understanding diverse customer segments as well as supporting a strong culture of innovation.
‘You’ve got to look at diversity from a more holistic perspective… The diversity of the organisation comes from the diversity of the community because that’s where we’re hiring from. So, having congruence between how the company operates, its values, and what it does to foster diversity in the community is actually quite important.’
There is a greater acknowledgment that ESG principles are deeply intertwined with financial outcomes, but the issue is when they crystallise.
Effective governance requires more than reports
Accounting standards have limited ability to reflect the value of organisations’ human capital and environmental impact on the balance sheet but, while it’s an opportunity for change, the roundtable participants didn’t see it as a major limitation.
In a clear sign that disclosure does not always guarantee transparency, participants said that creating new reports wasn’t always cost effective, or even valuable.
On similar lines, there was scepticism for risk management processes that appeared to exist for their own sake rather than to inform decision-making. Kerry McGoldrick, a partner at ShineWing Australia and a member of Standards Australia’s Risk Management Committee, observed that risk management needed to be reflected in culture and action, rather than being an encumbrance.
The market already demonstrates that ESG factors are increasingly incorporated in how companies are valued. Major investors have made it clear that environmental destruction and sexual harassment will not be tolerated regardless of strong financial performance.
There is a greater acknowledgment that ESG principles are deeply intertwined with financial outcomes, but the issue is when they crystallise.
One perhaps surprising outcome of doing business in 2020 has been a focus on good governance extending beyond the board and into the management ranks.
‘COVID-19 has brought out in a number of organisations how important governance is,’ said Susan Campbell, Legal Counsel and Company Secretary at Queensland Sugar Limited. ‘Managers are having to embrace governance more and more in their day-to-day roles.’
Roundtable participants had a number of suggestions on how boards could go further in addressing ESG issues. Some of those included:
- Actively connecting profit with broader corporate purpose to create greater congruence, rather than seeing ESG as a separate area.
- Greater input into setting board meeting agendas, including bringing external perspectives to the table.
- Achieving greater diversity in executive teams, particularly in roles with P&L responsibility.
Rewarding change for the better
Australian boards are increasingly tying executive remuneration to ESG factors. One participant said their organisation had recently included diversity measures among multiple ESG-related remuneration KPIs for top executives.
Not all attempts to link ESG and remuneration work successfully in practice. A clear relationship between culture and remuneration is essential to make sure people are rewarded for what matters and avoid creating disincentives.
The unusual operating environment this year means boards need to be more actively involved in reviewing remuneration, particularly in relation to incentive pay.
EY partner, Mathew Ronald, highlighted the importance of boards carefully considering remuneration in a broader context and exercising discretion where necessary, whether that means withholding incentives despite hurdles being achieved or making limited payments. In a climate of rapidly escalating unemployment and widespread financial pressure, awarding significant payments to executives is likely to feel tone deaf to ordinary Australians.
This year has been a major test of organisations’ resilience and their ESG frameworks have a part to play in how they emerge from the economic and health crises. Those who actively consider and address how they can best contribute to positive outcomes across a range of stakeholders stand to generate long term value for investors and better outcomes for future generations.
Diligent supports modern governance
As the pioneer of modern governance, Diligent has unparalleled understanding of the challenges facing directors and company secretaries. We specialise in integrated corporate governance solutions for the boardroom and beyond.
