Discover more from Course Notes: Continuous Business Learning
Corporations exist with the societal approval. They can be regulated out of existence (or at least be split, think Facebook) if they misbehave. The trend in 2020 is that corporations are no longer immune from the societal inquiry into their activities.
Purpose is the reason for the company's existence (cliche, but...), and there's a looming question of what would happen if the company disappeared!
So the ESG is the response to a potential (even likely) mid-to-long term threat to the companies by the society at large. Investors recognize this and put extra pressures on companies to ensure their long-term survival in a PR minefield that awaits anyone careless enough to forget about the ESG section in their annual report.
Corporate purpose is thus needed to guide the company's activities, being alert about the increased standards while still managing to deliver value to shareholders. And asking the executives to deliver on this while juggling their business performance demands is not easy.
McKinsey thinks (I'm deliberately making it an arguing point) that corporate purpose is a serious factor in hiring staff and retaining customers. There's another school of thought (at least, in Eastern Europe) stating that while the purpose is important, the customer surplus (i.e. what you pay vs what you get) and the salary + benefits (you know, that amount of money that pays the bills) are equally important.
The Board's responsibilities
First and foremost, the Board must look into the company's long-term prospects, survival and value creation. Thus, anything that is a risk to their noble purpose is a risk factor that has to be managed.
To an outsider, ESG looks like more of a PR (internal and external) exercise, but in the past several years it has started occupying an ever larger portion of the companies' annual reports, and as such it can't (and shouldn't!) be ignored by neither Directors, nor executives, nor shareholders.
It may sound unnecessary, but the general consensus is that in 2020+ it's not possible anymore to shield the management (the Board's job) from the shareholders' demands for things that objectively will make the execs' jobs harder to perform.
The BOARD (oh how I love these reverse acronyms!) framework by McKinsey
Build an authentic purpose narrative with management. It's not the brand, has to be for real. Top management must understand all stakeholders' (MK: again, the key trend here is listening to ALL stakeholders, not just those who've put money into the business) positions on the company's SWOT and industry trends. There has to be a way to provide feedback (be it direct or indirect via sentiment analysis) to the Boards without creating PR disasters.
Own purpose in board practices. Following the purpose should be part of the Board's oversight. If the company claims to encourage diversity - it should be challenged on it, too.
Assess purpose commitments, ensuring management sets clear and measurable goals, actions, and accountability. Purpose means commitments, targets and action plans, but more importantly - the things the company won't or will stop doing to achieve it. Companies' actions lead to actions by their supply chain partners, and the ESG value lies in the second-order effects (i.e. how these partners treat their stakeholders), and it can be measured and reported.
Reinforce purpose lens in core board decisions. Strategic decisions and trade-offs requiring Board approval need to be looked at through a purpose lens, too, in addition to the usual NPV calculations.
Drive organizational accountability for purpose through management evaluations and reporting. Some companies have already started linking exec compensation to the ESG targets. Needless to say, this works better for the companies with excess cash and the shareholders eager to possibly forego some financial upside (ESG is not free) at the cost of doing what's right.