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Why sustainability must sit firmly on the board agenda

Photographic portrait of Andre Toh

7 minute read 28 Jun 2021

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Board governance and oversight

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Sustainable development goals

A strong organizational focus on sustainability will help realize long-term value from environmental, social and governance opportunities.

In brief

Corporate sustainability initiatives have been linked to better business and financial performance.
Boards should steer the organization toward sustainable development beyond a mere focus on profit generation for shareholders.
Sustainability must be integrated into the overall business strategy and enterprise risk management to create long-term value for stakeholders.

The COVID-19 pandemic has reinforced the importance of environmental, social and governance (ESG) issues. Investors increasingly believe companies that perform well on ESG are less risky, better positioned for the long term and better prepared for uncertainty. Numerous studies have linked the implementation of corporate sustainability initiatives to improved business and financial performance. Similarly, from a valuation perspective, it is believed that sound corporate ESG practices would increase a company’s value, reinforcing the need to make sustainability a top board priority.

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The 2020 EY Climate Change and Sustainability Services (CCaSS) fifth global institutional investor survey affirms this. The report found that an overwhelming 98% of investors surveyed evaluate nonfinancial performance based on corporate disclosures. Among them, 72% said they conduct a structured, methodical evaluation. Yet, it appears that ESG considerations have not been adequately addressed. Investor dissatisfaction with ESG risk disclosures has risen since 2018 and 86% of investors dissatisfied with environmental risk information received said it is critical for disclosures in this area to improve.

A strong board mandate is needed for organizations to embrace a paradigm shift away from the sole purpose of generating profits for shareholders toward advocating sustainable development. Boards should make it a priority to integrate sustainability into the overall business strategy and enterprise risk management to help enhance the organization’s business model, navigate ESG risks and opportunities as well as create long-term value for stakeholders.

Increase likelihood of sustainable profitability

The Business and Sustainable Development Commission estimates that achievement of the UN Sustainable Development Goals could result in at least US$12t worth of market opportunities a year for the private sector by 2030.1 This represents about 10% of the global GDP forecast for that year. The opportunities span a multitude of sectors, including food and agriculture, energy as well as health and wellness. Boards that can adeptly steer the management to integrate ESG considerations into the corporate strategy will help differentiate the organization within the global sustainability ecosystem. This will also better position the organization to capitalize on ESG opportunities and generate new revenue streams.

Boards that can adeptly steer the management to integrate ESG considerations into the corporate strategy will help differentiate the organization within the global sustainability ecosystem

Andre Toh

EY Asean and Asia-Pacific Valuation, Modeling & Economics Leader

The increasing influence of environmental and social factors on consumers’ purchasing decisions has also allowed sustainable companies to charge higher price premiums on their products and services, commanding a greater share of wallet of existing customers. There is therefore a great opportunity for organizations to consider how they can transform their existing business model, products and services to meet a higher sustainability level.

At the same time, integrating ESG considerations as part of company decision-making often leads to operational and process efficiencies within the business, thereby helping to improve profitability. This can typically be achieved through better resource management policies to reduce and eliminate wastage, sustainable supply chain management practices to reduce the environmental impact across the value chain and costs, and cultivation of an innovative culture to reinvent existing processes.

Higher ESG-rated companies have also been associated with lower idiosyncratic risks. According to The Journal of Portfolio Management, sustainable companies experienced a lower frequency of large, adverse idiosyncratic stock price moves between 2009 and 2019, compared with those that had a lower ESG rating.2 This could be attributed to better risk management and compliance standards across their operations and supply chain practices, resulting in organizations that are more resilient and less susceptible to the risks of black swan events, including compliance breaches and supply chain disruptions.

In other words, companies that focus on corporate sustainability tend to be less vulnerable to systematic risks, resulting in higher risk-adjusted returns for investors.

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Improve access to capital and drive sustainable investing

According to a study by Bloomberg, global ESG assets are on track to exceed US$53t by 2025, accounting for more than a third of projected total assets under management for that year.3 Most institutional investors incorporate ESG considerations in their investment framework and apply negative or positive screening techniques to integrate ESG elements with traditional financial analysis. Against this backdrop, companies that demonstrate a strong commitment to sustainability will be viewed more favorably by providers of capital, and therefore have access to more sources of financing at a lower cost.

Investments in ESG-related initiatives undertaken by companies may also be valued at an “ESG-specific multiple” that is at a premium compared with the rest of the business. Boards should steer the executive team to actively deploy ESG investing strategies and drive sustainable investing to build a long-term competitive advantage.

Embed purpose in operationalizing sustainability

Despite overwhelming evidence validating the case for corporate sustainability, many companies may struggle to develop a clear business plan that embeds a sustainability strategy. This underscores the importance of putting rhetoric into action.

Embarking on the sustainability journey entails an end-to-end, iterative process. Boards can spearhead the journey by helping the organization to focus on its purpose, which should drive management decisions on the portfolio strategy and capital allocation, and ultimately influence day-to-day activities.

Boards should challenge the management to drive a comprehensive, purpose-led approach to integrate the tenets of sustainability into the organization’s activities — rather than advocating fringe programs with the sole intent of assuaging stakeholders.

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The board and management must understand that a purpose-led approach is not intended to dilute a focus on profit. Rather, it is a complementary addition to the company’s value-measurement framework: one that should improve the chances of higher profitability levels in the long term.

Boards should consider the following questions:

Does the organization articulate a clear purpose that drives its strategy, culture and actions?
What are the challenges in integrating ESG considerations with the company’s broader business and risk management strategy?
How is the board monitoring ESG strategy development as well as related goals and metrics, including the identification and integration of nonfinancial key performance indicators?
How can the organization’s executive remuneration approach be aligned to the focus on ESG performance and long-term value creation?
How is the company telling its ESG story with validated quality data and consistent messaging?

1. “Better Business, Better World,” January 2017, Business and Sustainable Development Commission, 2017.
2. Guido Giese, Linda-Eling Lee, Dimitris Melas, Zoltán Nagy and Laura Nishikawa, “Foundations of ESG Investing: How ESG Affects Equity Valuation, Risk, and Performance,” The Journal of Portfolio Management, July 2019, Pageant Media Ltd, 2019.
3. “ESG assets may hit $53 trillion by 2025, a third of global AUM,” Bloomberg website, www.bloomberg.com/professional/blog/esg-assets-may-hit-53-trillion-by-2025-a-third-of-global-aum, accessed 23 June 2021.

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Summary

There is a clear link between corporate sustainability and long-term value creation. Boards therefore play a pivotal role in integrating environmental, social and governance considerations into the organization’s broader business and risk management strategy.

About this article

Photographic portrait of Andre Toh

EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients.