Taking A Closer Look at the “G” in ESG

Today, environmental, social, and governance (ESG) goes beyond analyzing the environmental toll of corporate operations. While shareholders are still concerned with a company’s greenhouse gas emissions and how ethically it’s operating (i.e., fair wages for workers, safe working conditions, etc.), the three pillars of ESG also focus on how it is being led (i.e., operational transparency, leadership accountability, etc.)—otherwise known as its governance policies. 

In fact, these policies are influencing the market: ESG investing soared to new heights during the COVID-19 pandemic, with many believing it would be a fleeting trend the following fiscal year. However, Bloomberg Terminal forecasts that ESG assets will generate $53 trillion in valuation by 2025, representing a third of AUM. For 2023 and beyond, ESG is part of the normal course of business discourse.

However, the ESG backlash left investors skeptical of whether companies are authentic in their claims. Now more than ever, C-Suite leaders are leaning into the “E” and “S” but neglecting the “G” of ESG. Why? We dive into the questions surrounding the lack of governance in corporate policies and how you can start implementing them in your operations.  

What is Governance in ESG? 

Governance encompasses a wide range of practices and principles that guide not only how a company is managed, but also how it interacts with its stakeholders (i.e., shareholders, employees, customers, suppliers, and the broader community). More importantly, it’s the one ESG pillar that stakeholders can gauge easily or assess without much research. 

Some of the key aspects of governance in ESG include:

• Board of Directors: The composition, independence, diversity, and expertise of a company’s board of directors are critical factors in good governance. ESG investors often look for boards with a balanced mix of skills and backgrounds to ensure effective oversight.
• Executive Compensation: Governance involves assessing how executive compensation is structured to align with the company’s long-term performance and sustainability goals. Excessive executive pay that is not tied to performance can be seen as a governance concern.
• Shareholder Rights: Governance practices should protect the rights of shareholders, including voting rights and access to information. Transparency in corporate decision-making is a fundamental aspect of good governance.
• Anti-Corruption and Ethics: Companies are expected to have strong anti-corruption policies and ethical guidelines in place to prevent unethical behavior, bribery, and corruption within the organization.
• Risk Management: Effective risk management practices are essential for good governance. Companies should identify, assess, and manage risks related to their operations, including ESG risks such as environmental and social issues.
• Sustainability Reporting: Transparency and disclosure of ESG-related information are critical. Companies are encouraged to publish ESG reports that provide stakeholders with insights into their environmental and social performance and governance practices.
• Stakeholder Engagement: Companies should engage with a broad range of stakeholders, including employees, customers, communities, and investors, to understand their concerns and incorporate their input into decision-making processes.
• Compliance and Legal Framework: Adherence to laws and regulations is a foundational element of governance. Companies must comply with all applicable laws and regulations and operate ethically within the legal framework.

Governance is seen as a key indicator of a company’s long-term sustainability and its ability to manage ESG risks and opportunities effectively. As investors become more conscious of the companies they invest in—companies committed to responsible and ethical business practices—it’s time to embrace the “G” in ESG. 

Overlooking Governance

Until recently, proposals related to the environment, worker rights, and social issues—those that focused on the “E” and “S” of ESG”—lacked support from the Big Three (BlackRock, Vanguard, and State Street) at conference calls and annual meetings. However, proposals related to corporate governance (“G”) remained popular among these investors, as the success of these “G” proposals had nothing to do with the environment, workers, or diversity. 

Instead, they aimed to prioritize the interests of stockholders by “making companies more open to the market for corporate control, by forcing changes in policy at the instance of a momentary stockholder majority, and by aligning company management’s pay to only one constituency — stockholders—by tying it tightly to total stock return,” wrote the Harvard Business Review. 

Eventually, investors became increasingly concerned with and aware of how companies used “ESG” labeling to their benefit, and these “manage-to-the-market”  tactics were not authentic or transparent—key characteristics of the ESG agenda.  Now corporate leaders and stockholders had to scramble to instill social and environmental initiatives so as not to lose investor faith.

“In the world of ESG initiatives, notifying your shareholders that you’ve eliminated the such-and-such amount of annual waste, or that you instituted an admirable initiative to reduce your carbon footprint is the easy part—the “ES.” It’s the “G” that likely needs more of your attention,” – Matthew Iak, Forbes article

Governance and the value reaped from integrating it within your business practices, is not so simple to embrace in today’s market. It involves enhancing operational transparency and integrating it seamlessly into a company’s culture to cultivate mutual trust and engagement, both internally and externally.

“And that, for us, in terms of when it comes to ESG, obviously starts with the G, a proper, clear and dedicated governance structure. That means that at all levels across Partners Group, across Board, executive, and management level, we ensure that sufficient governance is adhered to, so that our vision of building more, better, and sustainable businesses across their investment life cycle are adhered to, and all the way down into the different business units and our investment life cycle, we can realize sustainability at scale.”

– Princess Private Equity Holding Limited | Earnings Call Q2 2023

Further, it also centers on accountability, ensuring that every employee, regardless of their position from the CEO to an entry-level worker, comprehends their role, function, and significance in advancing the company’s collective success. 

As governance is intricately linked with operational structure, a thoughtfully designed program facilitates effective and efficient decision-making. These sound decisions, in turn, drive improved performance, fostering deliberate and consistent growth.

Best Metrics for Measuring the “G”

The intricacy and diversity of metrics pose a challenge for companies aiming to assess their governance performance. Corporate governance metrics encompass both qualitative and quantitative data, so to evaluate any facet of your company’s governance performance, it is imperative to first decide which aspects you intend to gauge. 

Below, we list the most common key performance indicators measured in relation to governance objectives or goals: 

• Board and Management Quality and Integrity: Assessing the company board’s competence, historical performance, and actions, all of which should reflect their capacity to offer strategic guidance and oversight.
• Board Structure: A soundboard structure should facilitate effective oversight, representation, and accountability to shareholders.
• Ownership and Shareholder Rights: Scrutinizing a company’s constitution and ownership setup, emphasizing the necessity to uphold the rights of external shareholders, mirroring those granted to the board, management, and major stakeholders.
• Remuneration: Evaluating a company’s policies and practices regarding salary or payment, ensuring they encourage management to create value.
• Auditing and Financial Reporting: Focusing on the reliability of a company’s financial reports and the requisite oversight they undergo.
• Stakeholder Governance: Examining whether a company’s decision-making aligns with the expectations and needs of all stakeholders, including customers, employees, suppliers, communities, and investors.

While the specific quantitative and qualitative data and key performance indicators used by each company will be customized to their unique business context, they will typically fall under these overarching categories.

Understanding the Market with AlphaSense

It’s not enough for corporations to simply publish ESG reports and set arbitrary sustainability goals. With greenhouse gas emissions, greenwashing, and stakeholder activism on the rise, corporate boards are being scrutinized more than ever with evolving global regulations and tightening reporting frameworks.\

The bottom line: you need to understand ESG through and through to be successful in today’s market. A tool like AlphaSense helps you cut through the noise and find the information you need in seconds—without any of the overwhelm.

Today it is challenging to research and benchmark performance due to the lack of standardization. Download our infosheet, The Top 4 Market Intelligence Sources for ESG Research, to discover which market intelligence sources you need to consult with to find reliable and timely ESG insights.

If you want to stay at the forefront of new developments in ESG investing, start your free trial with AlphaSense today.