The Board’s Role in Creating Value through Sustainability

As boards oversee how companies generate value for their shareholders, their view of strategy and risk management now encompasses sustainability, or environmental, social, and governance (ESG), issues.

But how should boards think about sustainability in the context of value creation and overarching strategy? Below are 10 recommendations with practical guidance for boards to incorporate sustainability into their thought and decision-making processes to support their organizations in the long term. 

1. Start with due diligence—ESG due diligence, that is. Boards that incorporate ESG due diligence into their merger and acquisition strategies bolster their due diligence practices beyond the usual financial considerations and operational factors.

ESG due diligence identifies stakeholders and isolates material ESG topics within an organization’s industry, geography, and its stakeholders’ dynamics. This exercise analyzes a company’s alignment with its stakeholders and any key risks that require the valuation model to be adjusted.

For instance, a company with limited environmental controls may open itself to increased penalties and reputational damage. Developing processes to address these risks can increase upfront and ongoing costs and can impact the valuation model accordingly.

Identifying and quantifying ESG-related red flags can help a company negotiate a better deal with the potential target or walk away from a deal that is not suited for its needs. Indeed, avoiding a wrong investment decision is often the most effective way a company and its board can add value for investors.

2. Identify and align with societal megatrends. Societal megatrends are broad, long-term trends that reflect societal objectives and guide government policy. In turn, they affect capital flows and investment decisions. 

Understanding megatrends and their business implications can help boards oversee a company’s strategy. Currently, some of the most prominent societal megatrends are: 

• climate change,
• biodiversity loss,
• environmental degradation,
• aging populations,
• government and corporate transparency, and
• technology and artificial intelligence.

For example, as governments look to address climate change, carbon pricing is one factor that affects business decisions. The carbon price in many European Union (EU) jurisdictions is well above $100 per ton, and the EU’s Carbon Border Adjustment Mechanism may impose this cost on companies that export to the EU.

3. Prepare for the regulatory environment. In the “third wave” of sustainability reporting, regulations are tightening globally to standardize ESG disclosures and address criticisms of greenwashing. For instance, the state of California has introduced climate disclosure requirements and we expect other states to follow suit. Meanwhile, the EU has expanded sustainability reporting requirements, including a requirement to validate supply chains in specific industries. The vast majority of global gross domestic product will be covered under some form of sustainability reporting regulations in the not-too-distant future based on countries that have adopted or plan to adopt a sustainability reporting framework.

Companies that take a global approach—leveraging the interoperability of regulatory frameworks—to addressing these requirements can support cost-effective compliance and avoid fines, penalties, and loss of business.

4. Take advantage of clean energy tax credits and incentives. The Inflation Reduction Act and other similar government programs dramatically expanded incentives linked to clean energy, energy efficiency, and decarbonization. Likewise, companies can utilize additional tax incentives, including state-level programs, to support decarbonization and energy efficiency efforts. These incentives can substantially lower the costs of clean energy projects and investments.

Boards should assess to what extent the companies they serve are leveraging incentives to support efficiency and decarbonization efforts. Companies that have made some form of decarbonization commitment, such as a net-zero goal or a science-based target, should seek cost-effective ways to achieve it.

5. Collaborate on resource efficiency. Boards are positioned to help companies view their value chains holistically through an ESG lens and identify the challenges they share with other actors. This can increase collaboration to strengthen resource efficiency and generate shared value. 

For example, adopting circular production methods can significantly reduce waste while improving resource efficiency. Additionally, collaborating with suppliers to address logistical challenges can improve productivity across the value chain and lower greenhouse gas emissions. 

6. Product differentiation. Consumers value sustainability now more than ever before. Maximizing this sustainability premium—often considered a proxy for quality—depends on multiple factors that companies should discern. This could include substantiating products’ sustainability performance and integrating them into marketing strategies, if warranted. Given greenwashing concerns, it is critical for the board to ensure that a company’s sustainability claims can withstand third-party scrutiny.

Differentiation can be particularly value-accretive in highly commoditized and competitive industries where it may be difficult to stand out. A company selling a commoditized product may be able to de-commoditize it with key customer groups and win market share.

7. Lower the cost of debt through sustainability financing. Sustainable companies are associated with better financial performance, especially over the long term. Not coincidentally, financial institutions are significant supporters of ESG integration and are increasingly investing with an ESG lens. In fact, Bloomberg estimates that the ESG market could surpass $40 trillion by 2030, anchoring the $140 trillion of projected assess under management globally.

Boards can play an important role in assessing sustainability-linked loans and other sustainable financing options and ensuring that the proverbial juice is worth the squeeze. These financing options can decrease borrowing costs and increase firm value, accordingly. They also commit the company to achieving certain sustainability goals, but they do come with compliance costs. 

8. Build and maintain a social license to operate. Corporate sustainability and ESG compels companies to view their company as an interconnected value chain that relies upon its stakeholders, including the communities in which they operate. Social risks can be difficult to ascertain but can substantially impact a company if they materialize; getting ahead of them is critical.

For example, companies in the mining, energy, and manufacturing industries often depend on community and local support to maintain operations. For a company that may not have a strong social license to operate, engaging local suppliers can be a powerful way to build community support for a company or project.

9. Improve an organization’s ESG rating. Better ESG ratings are associated with improved financial performance, particularly in the long run. Companies that embrace ESG throughout their operations are better protected from downside risk. For instance, putting plans in place to adapt to climate risk both from a physical and transition perspective can significantly lower a company’s overall downside risk due to climate change. 

While ESG ratings vary considerably in terms of their scale and methodology, they are heavily utilized by investors to integrate ESG factors into the investment decision-making process. Some of the more advanced ESG-rating organizations go well beyond simply assessing the presence of certain ESG policies: they evaluate whether there is evidence that the company is actually integrating ESG into its risk management practices.  

10. Enhance risk management. The World Economic Forum’s Global Risks Report 2024 suggests that environmental risks, such as extreme weather events, loss of biodiversity, and other changes to the planet’s natural systems, are the most significant global risks over the next 10 years. Accordingly, corporate sustainability initiatives are associated with improved risk management practices and send an important signal to investors.

Boards should encourage management to examine, quantify, and address how these risks could challenge their companies. Consider asking management questions such as:

• How is climate risk integrated into the company’s risk management practices?
• What process did the company take to identify material ESG or climate risks and opportunities?
• How does the company currently quantify the impact of ESG or climate risks, and what steps are taken to mitigate these risks?

Optimizing ESG Value

Boards have a vital role to play in how a company aligns sustainability efforts with value creation. This imperative is becoming more urgent as global governments and regulators continue to push for better ESG disclosures and the cost of inaction increases. Informed, action-minded boards that focus on value can make a positive difference in the future of their companies and the world.

RSM is a NACD partner, providing directors with critical and timely information, and perspectives. RSM is a financial supporter of the NACD.

Alex Kotsopoulos is a partner and leads RSM’s ESG Advisory Practice.