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The Importance of the “G” in ESG
This article is the second in a series that addresses the importance of Environmental, Social and Governance factors in an organization.
21 March, 2023

In the previous articles, we discussed how various businesses emphasised the importance of both the environmental and social aspects of ESG. Examples include tech-giant Microsoft which acquired 2.5 million tons of carbon removal from sources and converted it into saleable products. Similarly, The Bank of America financed renewable energy ventures through the firm’s Environmental Business Initiative. However, in this article, we will shift our focus to the G factor.

Considering the strong emphasis on the “E” – as seen with preventing greenwashing, and carbon backdating practices – what’s the point of “G”? After all, isn’t it most important that the “environmental” aspect is fulfilled? Despite its prevalence, it is argued that governance is as indispensable as its environmental counterpart. It strengthens the corporate structure and operations of a company but is equally susceptible to conflicts of interest with various stakeholders which can put the running and organizational structure of a business at peril.  

Governance considers the makeup of boards of directors, compensation, and oversight of top executives, conduct of these stakeholders and their impact on the organization alongside being transparent, accountable, and ethical in its practices and disclosures. The ideal governance structure is one that fosters integrity, aligning the interests of the company’s stakeholders, which include shareholders, customers, employees, and society at large. To achieve this, a robust board of directors is necessary to oversee the management of the company, ensuring that their obligations to stakeholders are fulfilled. The board must be competent, independent, and diverse to fulfil its role effectively in supervising management. Moreover, executives that receive bonuses based on ESG-related KPIs are more likely to prioritize the long-term sustainability of the business over short-term profits. 

Numerous policies are in place to ensure that companies adhere to ethical principles. These policies range from international standards to regulations enacted by individual countries. The United Nations Global Compact, for instance, encourages companies to adopt responsible policies in their operations, laying out ten principles that cover various aspects of corporate social responsibility, including human rights, labour, and environmental standards, it aims to mobilize a sustainable global movement by aligning companies’ strategies with Ten Principles and advancing societal goals through collaboration and innovation. The Global Reporting Initiative (GRI) standards are another framework that enables companies to disclose their environmental and social impacts, enhancing their perception as responsible. The Total Impact Measurement Framework provides a comprehensive understanding of a company’s value creation, including economic, social, and environmental impacts, enabling investors to make informed decisions. 

Despite these policies, some companies still fail to practice good governance, which can lead to reputational damage, financial losses, and legal action. For instance, Silicon Valley Bank (SVB), a climate-tech-friendly bank, recently collapsed due to governance risks that many ESG investors overlooked. The collapse exposed hundreds of funds registered as ESG funds, showing that some ESG investors may prioritize environmental objectives over governance concerns. Such incidents demonstrate the need for better policies to ensure that companies prioritize governance alongside environmental and social objectives.

In response to the risks posed by weak governance, BlackRock, the world’s largest asset manager, has implemented a “fast-exit” rule for companies breaching certain environmental, social, and governance-related standards. The rule ensures that such companies are removed from its iShares exchange-traded funds in a maximum of 45 days, promoting accountability and transparency. Alongside this the recent debacle surrounding Credit Suisse’s financial reporting and control frameworks has prompted a significant paradigm shift within the banking system. The bank’s internal control failures and material weaknesses have led to significant financial losses and client withdrawals, which in turn have raised concerns about the bank’s governance and management. The acquisition of Credit Suisse by UBS in an all-share transaction represents a critical turning point in banking history, highlighting the need for ethical governance and responsible leadership to maintain financial stability.

Another illustration of this is seen in the household-name coffee-chain Starbucks. Previously, less than 50% of outlet deliveries were arriving on time, resulting in drastically plummeting customer dissatisfaction. In addition to affecting customer perception, Starbucks’ supply chains were constantly impacted by poor outsourcing decisions, concerning, for instance, the source of beans, or packaging. However, in 2004, Starbucks launched the Coffee and Farmer Equity (C.A.F.E.) Practices program with Conservation International to promote transparent, profitable, and sustainable coffee growing practices. This program has more than 200 indicators measuring farms against economic, social, environmental, and quality criteria. It allowed Starbucks to gain insights into the challenges faced by farmers and supply chain operations in over 30 coffee-producing countries worldwide, alongside enabling them to take immediate action whenever notified of zero-tolerance violations, through investigations. This continuous improvement approach promoted positive change among suppliers and farms, ensuring a positive future for everyone involved in coffee. Starbucks’ governance changes have resulted in a lowered overall public relations risk profile and an enhanced brand image. It’s a strategic and sustainable move that benefits not only the company but also its customers, farmers, and the planet. Customers can now feel more confident about their coffee choices, knowing that Starbucks is committed to responsible sourcing practices.

In conclusion, the lack of proper governance can seriously derail the growth trajectories of established and emerging companies. While environmental and social considerations are undoubtedly crucial, governance serves as a vital stabilizing force to ensure that a company’s actions and practices are in line with its objectives and compliant with regulations. Therefore, effective governance is essential for the sustainable growth and success of any organisation in the long run.

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