G is for glue. Why we need to talk about the ‘G’ in ESG

By Stuart Lambert, co-founder

One of the consequences of ‘ESG’, an investment framework created to help identify risk to asset values, becoming appropriated by the communication industry and co-opted into public policy is that it has become shorthand for ‘anything to do with the environment and society.’

At a time when legislators are on the greenwash warpath about misrepresenting sustainability activity and overclaiming on commitments and impact, it’s a potentially dangerous shorthand. That’s a larger topic for another time, though it is relevant here, as I shall come on to.

Firstly, though, what’s interesting about all things cause-related, or old-fashioned CSR, being badged ‘ESG’ is that the third letter is typically ignored – another indicator that the underlying concept behind the abbreviation may not be as widely understood as it is used.

The definition of Governance, within an ESG context, depends on who you ask. But you can’t go wrong by starting at the beginning: the ‘Who Cares Wins’ document published in 2004 by the then embryonic UN Global Compact, which first used the term ‘ESG’. It says:

“Sound corporate governance and risk management systems are crucial pre-requisites to successfully implementing policies and measures to address environmental and social challenges. This is why we have chosen to use the term “environmental, social and governance issues” throughout this report, as a way of highlighting the fact that these three areas are closely inter-linked.”

In other words, good corporate governance is required before you can even think about work to address environmental and societal impact and risk. Common sense.

Apart from that, the most useful understanding of G today can be gleaned from the ESG ratings agencies, which are mandated to pin down definitions in order to create a scoring methodology that will inform multi-billion dollar investment decisions in a capital market system.

For MSCI, for example, a Governance score comprises detailed analysis of six metrics:

  • Accounting (Is there an external audit firm? What are the findings of its audit report?)

  • The Board (How independent is the Board from management and/or other interests? How experienced is the Board? What is director attendance? Are board members compromising their effectiveness by serving on too many boards?)

  • Business Ethics (What oversight and management of business ethics issues such as fraud, executive misconduct, corrupt practices, money laundering, or antitrust violations are evidenced?)

  • Ownership and control (What is the ownership structure? What is the proportionality between the economic exposure and voting power of the largest owner?)

  • Pay (What are the CEO and other executive-pay practices?)

  • Tax transparency (What is the estimated corporate tax gap? How transparent is the company’s revenue-reporting? What involvement is there in tax-related controversies?)

What can we discern from all this?

Firstly, an irony. For the original ‘ESG’ audience – that is, large institutional investors – ‘Governance’ factors were (until relatively recently) always the primary focus, rather than the Environmental or Societal issues that are now more synonymous with the term. (If you want a recent example of consequences of investors feeling the G has gone missing in action look no further than Tesla. Mr Musk had a blue fit about Tesla stock being downgraded by the S&P 500 ESG Index, missing the point that Tesla was kicked hard in ESG rankings because of perceived “G” weaknesses synonymous with his own idiosyncratic leadership, irrespective of the fact its core product solves an Environmental problem.)

More importantly, however, an obvious conclusion: corporate governance is the most non-negotiable aspect of all this.

Investors demand that box be ticked before anything else: no sensible asset manager is going to buy stock where there are clear risk factors regarding bribery or fraud or corruption.

But other stakeholders – regulators, policy-makers, employees, customers and the public at large – also need to trust that the company they are working with, working for or buying from is sincere about what it says it is doing and trying to do and has credible people and processes in place to deliver results.

In other words, every audience a company needs to engage is invested in G factors, even if they don’t realise it.

Because Governance is the glue that binds everything else – trust, reputation, credibility, impact, accountability, environment, society, value-protection, value-creation – together.

Let’s break this abbreviation soup down:

  • ESG is about your long-term strategy to ‘do no harm’ (minimise negative impacts) to Environment and Society, and thereby reduce and remove material risks to asset value

  • Purpose – done properly – is about your long-term strategy to ‘do good’ (create positive impact) for Environment and Society, and thereby generate value for the company’s stakeholders as well as people and planet

  • Governance is about two things:

1.     Mitigating risk to company value by preventing, for example, bribery and corruption.

2.     Maximising opportunity to create value by ensuring appropriate alignment to the ESGP strategy

That last point is crucial. Governance is the deepest, most vital of the four dimensions – E, S, G and P – of a Board’s strategy. It is about mitigating risk, but it is also about guaranteeing the leadership, the commitment, and the accountability needed to make any of this meaningful and substantive – to generate real value and positive impact.

Without Governance, environmental and social targets will at some point be missed – and the missing of the targets won’t matter because it is Governance that makes sure the right motivation for those targets is there in the first place: not “to be met” as much as “to be a forcing function for betterment.”

Without Governance, Purpose will float about the company’s internal and external communication channels, unmoored to anything substantive, rudderless until it is inevitably seized by well-meaning marketers who then end up misusing it as a strapline.

Without Governance, in short, sustainability aspirations will deteriorate into shallow CSR – or worse, comms offsetting, where “nice things we’ve done” are used to distract from the lack of real action on the urgent issues that matter.  And Purpose will end up becoming a badge for campaigns that run the real risk of regulatory investigation and possible legal action.

We saw a lot of this in 2022:

These five examples of companies suffering significant reputational damage from overclaiming or making unsubstantiated sustainability claims are just a trailer for what’s to come.

According to the European Commission, 40% of the environmental claims made about products are “unsubstantiated” (Proposal for a Directive of the European Parliament and of the Council on green claims - as seen in January 2023). The amount of “G” heavy lifting ahead within the brand creative, sales and marketing world is going to be immense – and I’m not remotely convinced that brand marketing teams are geared up for it at all. So many creative comms campaigns put their company at legal risk without even realising it.

Your best bet to avoid this kind of scrutiny of ESG or Purpose claims is to focus on getting the ‘G’ right before you do anything else. My go-to advice for Boards and advisers is to familiarise yourself with ISO 37000 - the first ever international benchmark for good governance.

If you want to do ESG right, and you believe in Purpose as a north star by which to guide your company from ‘doing no harm’ to truly ‘doing good’, then you’ve got to start with the least fashionable of those letters.

G is for governance. G is for the glue that binds it all together. G is for getting it right.

Stuart Lambert