Sustainability Takes on New Meaning

It’s tempting to imagine that the outcry about ESG, a now out-of-favor term for the environmental and human costs of business, will dissipate after the next presidential election, or when inflation returns to target norms, or if executives leave the social issues up to elected officials. But given the state of the economy and public confidence in our institutions, along with the drumbeat of news on the environment, and upheaval in supply chains—executives, boards, and those who advise them might want to brace for strengthening headwinds. 

How should directors respond? Shareholders are not likely to illuminate the path forward. Activism is on the rise, but investor preferences are all over the map. The same can be said for consumers—who have begun to divide into “red” and “blue” camps while still making buying decisions based on price and convenience. 

Meanwhile, the confusion of good intentions of actors continue to confound the investing public, from companies that claim to measure what matters most to a host of NGOs to rating entities calling for even greater transparency across a broad range of issues and priorities. 

When Elon Musk called out the S&P 500 ESG Index for scoring Philip Morris International twice as high as Tesla in June 2023, he exposed just how complicated—or perhaps inadequate—the metrics behind the rating of stocks can be. 

Is there a reason for the S&P index to be critical of Tesla? Sure. Musk is hardly a poster child for good management. When it comes to the “S” part of the ESG equation, he makes headlines for toxic workplace behavior and considers diversity commitments especially “woke.” On the “E” side, the costs of the manufacturing process, not just the product, matter. But to equate Tesla, a company that has brazenly and aggressively paved the way for moving away from fossil fuels, with one that is innovating around smoke-free products but still commands a significant share of revenues from the sale of cigarettes reveals just how unsatisfying the ratings and rankings can be. 

As Kenneth P. Pucker and Andrew King make clear in their seminal Harvard Business Review piece, “ESG Investing Isn’t Designed to Save the Planet,” the metrics behind this segment of the asset management market can have little to do with the questions that matter most in boardrooms and executive suites. Yet the keen interest of the investing public in aligning their values with their money isn’t going away. 

From addressing social turmoil and louder employee voices to decarbonization, heightened geopolitical tensions, and threats to democracy at home, directors are in for a wild ride, as public and employee expectations of companies change and grow. 

The bottom line? It’s the “G” of ESG that matters most. NACD has picked an opportune time to draw focus to its latest user manual for board members with ten guiding principles, The Future of the American Board report. 

To respond to this moment, boards have created special-purpose committees to illuminate and consider risks reflected in shareholder activism and employee engagement. Yet it’s hard to imagine confining to a subcommittee the strategic challenges of innovating around carbon emissions, de-risking the supply chain amid global tensions, or the changing norms in the employee contract.

Here’s a heretical thought: Over the course of the last year, in service to the Commission and in dozens of engagements from my perch at the Aspen Institute, I have come to experience the pushback against all things ESG as useful—as it invites executives and directors to become crystal clear about what matters most to the long-term health of the enterprise. Achieving this level of clarity cannot be confined to a special purpose committee; it requires fresh questions about corporate purpose, fiduciary duty, whether the business model is built for the future, and who are the company’s allies. We call it Agenda for the Prepared Board.

On the path to decarbonizing the economy, it’s all-hands-on-deck, a board imperative to prioritize investments that will only prove out in time. The motivations of committed executives run the gamut—from anticipating regulation and securing the supply chain to acknowledging employee fervor to realizing the potential for real upside—i.e., to take part in massive change rather than just brace for the consequences. 

The Agenda for the Prepared Board builds on the work of the Future of the American Board Commission. The last time NACD issued a set of principles about the role and responsibilities of boards was in 2011, when corporate leaders were still reckoning with the Global Financial Crisis. A new business ethic was growing, from B Corporations to conscious capitalism, but it was far from mainstream. The end game was still focused on the shareholder, aka the stock price—full stop. Boards loaded up CEOs with stock options and equivalents, “pay for performance” ringing in their ears.

But the rules are changing. A dynamic environment of social media, systemic risks, and deep uncertainty about the future underscores the need for a different brand of leader, new ways of governing, and standards for conducting business that speak to a wider set of concerns, to employees and critical partnerships.

The NACD Future of the American Board report poses important questions—especially for those who are new to the game. 

Boomer directors who stayed at their (Zoom) posts during the pandemic are now making more room for women, people of different races, and directors with varied experience. As the updated principles make clear, who serves, for how long, and for what purpose all will be reexamined.

Boards of tomorrow have a massive task: to understand—and it will not be addressed by the old way of doing things.

Here are my key takeaways from my time on the Commission and our own work with business leaders and directors:

To future-proof the corporation requires insight from new allies in the long game. Not all answers come from the C-suite. Committee charters are being revamped to assure a better flow of insight from employees, nongovernmental organizations, and subject matter experts aligning private initiative and investment with long-term sustainability. To maintain the health of a scarce resource or to replace a commodity at risk can require a radical redesign of a product or process, and innovation at massive scale. 

Trade associations that prioritize making all their members happy resist change and revert to lowest common denominator thinking. Today, the first movers in virtually any industry are engaged in complex partnerships that engage activists, scholars, business leaders, and their entire supply chain in common cause. Is the board equipped to take in signals from outsiders who may have the key to long-term stability and competitive advantage?

Corporate purpose as more than a slogan or mission statement. Boards with clarity about why the company exists are better able to focus on what is material to the enterprise and to align operations with their goals and intentions. 

Purpose reveals fiduciary duty. As the NACD principles and the Agenda for a Prepared Board make clear, the board’s work starts with clarity of purpose, and that means interrogating which inputs are critical for the company’s survival. In my own organization’s work to respond to the conservative pushback against ESG, we identify seven key considerations for boards to play offense, rather than defense, when it comes to social or environmental commitments. 

ESG standards emerged from filing shareholder proposals some 20 years ago. As the Tesla-Philip Morris example illuminates, ESG rankings and measures fail to capture the full complexity of the overhaul that’s needed at the board level. 

“Stakeholder theory” is hardly new. It may work in classrooms as an alternative to shareholder primacy, but it can’t be an organizing principle for managers without greater specificity about ends and means. Each business is unique and has its own road map. Smart executives have learned to eliminate ESG from their vocabularies in favor of language that is specific to the business. Replacing “stakeholder” with what and who matter most to the health of the enterprise is the next step. 

Incentives matter. One of the board’s awesome responsibilities is structuring CEO pay, but so is figuring out succession, how the CEO and direct reports function as a team, and whether the management team is clued into company culture, customers, and the supply chain. Restructuring the CEO’s pay to ensure teamwork and to prioritize what matters most is paramount. Fairness throughout the business matters.

Some boards have already taken the step by changing compensation committees into human resource committees. Watch this space—we are only at the starting block. Meanwhile, the disconnect between paying the CEO in stock while grandstanding about stakeholders is increasingly apparent.

Clarity of intention (purpose), a clear focus on the role of employees (much more than a stakeholder), and a willingness to engage at the systems level on problems that threaten the business model but can’t be addressed one company at a time—these domains require fresh questions and new ways of thinking and operating on boards. 

The system of democracy itself is at risk. Will boards stand up? What are the company and its executives called to do, especially when so many people question if “the system” is working on their behalf? 

Is the company fully aware and transparent about where and how its political capital is spent? Are the trade groups that speak on their behalf achieving the right balance of private protections and public benefit? Are executives adequately prepared to speak up on issues that rebound to the health of the enterprise—and the system on which we all depend? 

And critically, are employees receiving a fair share of the wealth they create—the baseline for trust in business and beyond? 

Boards are not bystanders in this game. NACD and its allies have set the stage for a critically important conversation about the future of boards. The old ways of operating are not serving us well. New questions emerge.

Who’s in? ■

This article is from the Directorship Special Issue 2024: The Future of the American Board.