ESG in the Boardroom and on the Balance Sheet
The essentials of ESG governance
Tracking and accounting for enterprise-wide ESG progress is a monumental task that requires committed governance and thoughtful decision-making. In a conversation with Modern Healthcare Custom Media, Paul Washington, executive director of The Conference Board ESG Center, shared his advice and strategies for organizations embarking on this journey.
What foundational governance characteristics must be in place for organizations to make progress on ESG, whether in healthcare or another industry?
You need to approach this area as you would any strategic opportunity, which means asking three basic questions: Where are we today, where do we want to go and how do we get there? First, look at what you’re already doing in ESG. For example, healthcare companies are already doing a ton in the social arena. Second, figure out where you want to go in this competitive landscape. The North Star for any organization is where they can have the most positive impact on the organization, stakeholders, society at large, and the natural environment. That’s where you focus your efforts.
Healthcare leaders are weighing ESG investments against shrinking margins and other competing priorities. How can they strike the right balance to ensure ESG progress continues?
Open the aperture for assessing the return on investment – think about how it will help you attract and retain your employees, clients and business partners. You want to look at all the ways you can benefit from these investments in the long run, but you also want to look at the cost of not making these investments.
Another critical (point) is organizations don’t have to do this on their own. Look at where you can pool your resources and collaborate with others to make this effort more affordable. Whether it’s in disaster philanthropy, sustainability or addressing racial inequality, a lot of organizations are doing this on their own or with nonprofit partners. Look across your peers, look across the value chain to see how you can collaborate. Then, especially for the healthcare industry, it’s awfully important to make the case to government and regulators – to explain how regulations can either impede or assist these investments.
How can healthcare leaders ensure accountability for ESG priorities, both inside and outside the organization?
You have to make the business case for why this matters. It can’t just be bolted on; it needs to be built in. Inside the organization, leaders will face understandable skepticism from board members, senior executives or employees who say, ‘Why does this even matter?’ and, ‘I’m too busy to do this.’ A few things can help. First, the person making the business case should be the CEO or the top executives. Second, it’s often helpful to bring in outside perspectives. If you’re a public company, you bring in your investors, business partners, major clients, regulators and others from the outside to explain to folks internally why this really matters.
Third, you want to engage people in a discussion where they’re contributing their ideas to the solution. Sometimes the best ideas – about process improvements, new products and services, changes in procurement – come from places like legal or human resources or finance. Of course, once you’ve generated those ideas, you need to follow through and report back.
What are some financial opportunities that ESG progress can open up for organizations?
On the capital side, having a strong ESG record can make you more attractive to stock investors and equity investors. It can also help you in debt markets and in credit markets. For example, firms can use what are known as green bonds for funding for specific environmental projects. But the markets have moved well beyond that, and now there are sustainability-linked bonds where you can lower your cost of capital and lower the cost of your debt payments by achieving certain ESG metrics.
Why is ESG expected to have a larger impact on corporate governance in the near future?
Our recent report found about three-quarters of companies believe ESG will have a durable impact in three to five years. Stakeholder capitalism is also going to have a big impact on boards in three to five years – about half of the respondents surveyed think that’s true. Why? Well, investors and lenders are all focused on the ESG stockholders. You can see there has been a dramatic increase in the growth of ESG funds on both the equity and the debt side. Investors are flowing more money toward ESG from the capital markets than ever before. Just focusing on the stock market, the passive investment funds that invest in a broad swath of the market are focused on systemic risk and long-term social and environmental risks. That’s not going away; they’re going to continue to put pressure on companies to reduce those risks.
On top of that are regulators. If you’re a public company in the U.S., you’ll face SEC regulation. But (we’re seeing developments in) Europe as well. Europe has a regulation coming down the pike called the Corporate Sustainability Due Diligence Directive that will require companies with a certain presence in Europe to report on their environmental and human rights impacts – and to address them to eliminate them. It’s not just affecting those companies, but their entire value chain.
What is your perspective on tying executive compensation to ESG performance?
While over 70% of the S&P 500 is now linking executive compensation to some form of ESG performance, most view such measures as being of medium importance. You don’t want to tack on a greenhouse gas emissions goal and a diversity, equity and inclusion goal into your executive compensation program and call it a day. To help drive performance, there are three key considerations: First, if a company is serious about ESG, factoring it into the annual bonus calculation isn’t enough. To ensure accountability, achievement of relevant ESG goals should be considered in the broader annual performance evaluation of management. Second, to motivate executives to achieve ESG goals, include them in business plans and budgets. Third, companies should consider how ESG applies to corporate performance beyond the C-suite.
Furthermore, before you tie executive compensation to goals, a best practice is to apply them in your operating plans first to make sure they’re reasonable goals you can make progress against. Make sure they are effective in driving performance, and then you can tie executive pay to it.
Are there any common mistakes that healthcare leaders make when driving ESG progress?
One mistake is they try to do too much. There’s often the desire to be bold. That’s great, but you really want to make sure that you can follow through. Focus and be mindful of resources; you can’t lead in everything. There’s a scale, from compliance to cost production to risk reduction to true leadership. Recognize there are some areas where you can be a leader, some areas where you can reduce reputation risk, some places where you can reduce costs and some places where you can just comply with the law.
It’s important to set your ESG performance goals in the context of your strategy. Some companies made a mistake by setting net zero goals without figuring out how it related to their business strategy or sharing them with their board of directors. Suddenly, they’re finding their carbon offsets are a lot more expensive than they thought they would be. … You’re going to learn as you go along. Accept that this is a fast-moving environment and approach it with some degree of flexibility.
Board members must prioritize creating and supporting an ESG strategy – backed by measurable goals and meaningful investment – to ensure it will become integrated in day-to-day operations and management.
Two healthcare leaders who strongly advocate for ESG adoption across the industry discuss how the culture shift, investments and significant operational changes required to support ESG can only be achieved if those at the helm are champions of the effort.