ESG investors go in search of the boardroom G spot

Governance looks set to dominate the corporate agenda this year as painful decisions around restructuring and headcount reinforce the ongoing debate around the impact of business on communities


With sexy, big-hitter issues such as climate change and the living wage to propel them onto front pages, it’s little wonder that environmental and social matters have dominated the ESG agenda to date.

Yet as the clamour for purpose beyond profit continues to build, governance is shrugging off its whiff of worthiness to make 2021 a pivotal year for the business world’s all-important G spot.

As fashion retailer Boohoo discovered last summer, being on the wrong side of history over allegations as incendiary as modern day slavery poses a severe and immediate risk to a firm’s share price, putting every aspect of its day-to-day governance squarely in the dock. 

While boards could once claim immunity to the concerns of society as a whole, sitting on the fence is no longer possible. Yet with ESG asset managers keen to praise those managements willing to wrestle with complex issues such as gender and race inequality, and to call out those that are not, the dream of making money while also doing good has never looked so attainable.

Recent data from S&P indicates that its 500 ESG Index outperformed, suffered fewer losses and recovered faster than the S&P 500 during the pandemic, strongly suggesting what it terms “stakeholder capitalism” is a virtuous circle that rewards businesses and societies alike.

“Although it doesn’t always get the attention it deserves, the pivotal role played by stewardship in both environmental governance and social governance underlies all the achievements made by ESG so far,” says Peter Swabey, policy and research director at the Chartered Governance Institute.

“When you look at recent governance discussions, which have led to boardroom pay cuts and the suspension of dividends to ensure the financial pain of the pandemic is shared equally across organisations, you may agree with me that ‘G’ has become an extremely sexy topic.”

Reassessing the value in values

Unilever’s pledge to cut ties with suppliers that fail to pay the living wage by 2030 is an eye-catching example of how organisations can use massive buying power to reflect the soul-searching of a nation. But are other managements prepared to follow its lead? 

During the 2007-8 financial crash, client spending on ethical projects was swiftly and brutally cut, notes Gareth Thomas, who leads on anti-corruption and ESG at ethics consultancy GoodCorporation.

This time, the budgets allocated to supply chain and human rights risk assessment, for example, have been maintained, if not scaled up.

“I’ve never seen such enthusiasm for this sort of work before and it suggests that actively managing a complex set of governance-related risks requires a far broader set of capabilities and expertise than those associated simply with profit and loss,” says Thomas.

“While ‘G’ was once routinely relegated to outside organisations, it is now seen as critical by any business leader looking to shape an organisation’s thinking on key issues such as bribery, exploitation or human rights. In short, governance is fast becoming a proxy for good management.” 

If making money and providing employment were once seen as sufficient reasons for a business to exist, employees and investors are now looking for evidence of a far more profound purpose in the boardroom, he believes.

“Although the early days of corporate social responsibility were characterised by paper-thin pledges to do this or that, the demand among a whole range of stakeholders for independently verifiable governance procedures is rising fast, particularly among younger investors who can spot greenwashing a mile away,” says Thomas.

What gets measured gets managed

Fund managers have access to a wide range of qualitative and quantitative data with which to assess the success of organisations at managing governance-related risks in their sector.

“There’s a huge amount of ESG data out there,” says Dominic Rowles, investment analyst at the savings and investment platform Hargreaves Lansdown, some of it providing “leader”, “average” or “laggard” ratings, depending on a firm’s exposure to a particular risk.

“The way companies manage critical incident risk will be a particular focus when analysing those involved in heavy industry, for example, while other sectors will be more vulnerable to legal and regulatory change,” he explains.

With managers now having to make decisions based on still-emerging and unpredictable variables related to the coronavirus crisis, it is “more important than ever there is proper oversight of their decision-making,” Rowles adds. 

Although the last major overhaul of the UK Corporate Governance Code dates back only to 2018, further regulation around financial disclosure is awaiting clarification. The Task Force on Climate-Related Financial Disclosures, which requires firms to disclose how climate change impacts their governance, strategy and risk management policies and to detail relevant metrics and targets, will be in force by 2025. 

Well-governed companies winning out

While the pandemic has claimed a number of high-profile corporate scalps on issues as varied as underweight corporate tax liabilities and even-skinnier school meal parcels, Rowles cites current city darling Next as a “well-governed company”, which has responded well to the crisis. 

In March 2020, Next closed its UK warehouses and distribution networks to make them COVID-secure, while stores were repurposed to operate within social distancing guidelines. Boosted by brisk demand for online housewares and clothing, its share price climbed, while suspension of dividends and share buybacks helped reduce overall debt at a time when retail as a whole was suffering the biggest slump in its history. 

All shares, along with corporate and personal reputations, can rise and fall over time, but for any business looking to sustain both growth and purpose for the long term, active, responsible and sensitive stewardship is the way forward, argues the Chartered Governance Institute’s Swabey.

“At the end of the day, companies are run by fallible human beings and bad things can and do happen in boardrooms,” he says. “It’s the job of good governance, including the independent scrutiny of key decisions, to make it much harder for any individual with rogue intentions to have their way.”