The Board’s Role in Sustainability

ustainability has gone mainstream in the corporate world. Investors increasingly understand that a corporation’s performance on pertinent environmental, social, and governance (ESG) factors directly affects long-term profitability—a recognition that is transforming “sustainable investing” into, more simply, “investing.” Most CEOs also now recognize that ESG issues should inform their corporate strategy. But one important constituency remains a stubborn holdout in the sustainability revolution: corporate boards. It is an unfortunate truth that directors tasked with securing their company’s future are often holding the enterprise back with an outdated emphasis on short-term value maximization.

A 2019 PwC survey of more than 700 public-company directors found that 56% thought boards were spending too much time on sustainability. Some of the myopia can be traced to a lack of diversity on boards. Most directors are male, white, and from a similar background, and many are retired executives who came of age professionally at a time when the link between ESG factors and corporate performance was not clearly understood. But a large part of the problem is that until recently, boards didn’t have a mandate to grapple with sustainability; instead, their time was consumed by compliance tasks driven by the corporate secretary and by inside and outside counsel.

The concept of “corporate purpose” provides the impetus that boards need to increase their focus on ESG concerns and manage their firms for long-term success. A clear and compelling mission should be at the heart of every company’s efforts to enhance its positive impacts on the environment and society. Without such a purpose, a company cannot have a sustainable corporate strategy, and investors cannot earn sustainable returns. And the ultimate responsibility for defining that purpose must rest with the board, because it has a duty to take an intergenerational perspective that extends beyond the tenure of any management team.

Our research on injecting purpose into corporate governance draws on extensive conversations with board chairs, executives, and owners of more than 100 corporations operating across a wide range of industries in more than 20 countries. We’ve undertaken that research as part of the Enacting Purpose Initiative, a multigroup project led by the University of Oxford in conjunction with the University of California, Berkeley; the investment management firm Federated Hermes; the corporate law firm Wachtell, Lipton, Rosen & Katz; and the British Academy. The initiative brings together leaders from academia and practice in the United States and Europe to provide research and guidance on linking corporate purpose to strategy and performance.

A major output of this effort is a framework to help boards deliver on purpose. Called SCORE, it was initially devised by Rupert Younger, the director of the Oxford University Centre for Corporate Reputation and the chair of the Enacting Purpose Initiative. SCORE outlines five actions—simplify, connect, own, reward, and exemplify—that can help boards articulate and foster a firm’s durable value proposition and its drivers.

Simplify

Enacting purpose begins with knowing what it is. For that reason, purpose needs to be simple and clear—straightforward enough to be understood by the entire corporate workforce, the wider supply chain, and other stake-holders.

How should purpose be communicated? A good place for boards to start is with a statement of purpose signed and issued by all the directors. The board chair and the governance committee should take the lead in drafting it. The statement should define how the company aims to create value by fulfilling unmet needs in society. It should acknowledge the negative impacts the company must mitigate if it is to retain public support and its license to operate. And it should present a distinctive message—not something so generic that the name of any major competitor could be substituted. If those criteria are met, the statement can be a powerful tool for sharing a company’s vision for long-term value creation, even in industries with negative externalities.

EQT, a global private-equity firm, describes its purpose this way: “to future-proof companies and make a positive impact.” EQT defines future-proofing as anticipating what companies need to do to stay relevant amid increasing social and environmental pressures. Its one-page purpose statement, which was first published in its 2019 annual report, explains the firm’s commitment to “being more than capital.” EQT requires that any investment meet clear financial objectives but also contribute to the United Nations Sustainable Development Goals. The company’s founder, Conni Jonsson, told us that writing the statement was fairly easy and that publishing it unites executives, directors, and investors on the company’s priorities. “For us,” he said, “aligning on the statement of purpose was merely manifesting what has been our mindset since inception.”

Connect

Once corporate purpose has been articulated, it must be connected to strategy and capital allocation decisions. Strategy is about making certain choices and consciously rejecting others after serious deliberation. Capital allocation decisions naturally follow. Sometimes the process might lead a firm to sacrifice short-term profits by abandoning a lucrative but socially harmful product, such as when Dick’s Sporting Goods decided to stop selling assault weapons. Other times a company might undertake a project that will certainly lose money, such as when Medtronic publicly shared the design specifications for its ventilators early in the Covid-19 pandemic to speed up manufacturing of the lifesaving devices.

Connecting purpose to strategy gives a CEO the necessary foundation to prioritize long-term goals and resist pressure from activist investors and others who care only about short-term returns. “We have made some specific investments that we might not have made without our purpose being so clearly articulated,” Mark Preston, the executive trustee and group CEO of the property behemoth Grosvenor Estate, told us. “More importantly, there are probably some investments that we have not made, as a result of our purpose.”

Own

Ownership of purpose starts with the board, which must put in place appropriate structures, control systems, and processes for enacting purpose. This goes beyond delegation to the risk, compliance, and ethics committees. Senior management should take responsibility for ensuring that the company’s mission is embraced by everyone in the organization, right down to workers on the shop floor. It does this through its own actions, particularly when making tough trade-off decisions. Effective ownership requires that employees be fully consulted and engaged in delivering on the company’s stated purpose. Although management is responsible for direct communications with staffers, the board can create and oversee internal communication strategies to ensure that the company’s purpose is being effectively diffused throughout the organization.

At firms where a controlling family owns large blocks of shares or votes—as is the case in many of the largest companies around the world—the family’s representatives on the board can be especially forceful in helping the company find and execute its purpose. That has certainly been true at Ford Motor Company. “Our drive for environmental sustainability has come from our executive chairman, Bill Ford,” says Henry Ford III, a corporate strategist and the great-great-grandson of the company’s founder. “He was the one who really pushed us to do annual sustainability reports where we are transparent about the progress we are making in terms of reaching our environmental goals.”

Reward

Primarily through its compensation committee, the board is responsible for establishing the metrics that will be used to determine promotion and remuneration throughout the organization. Purpose, not simply profits, needs to be rewarded. Today compensation is largely based on short-term financial metrics. That has to change: A broader set of financial and nonfinancial metrics should be used to evaluate performance over longer time frames. And the place to start is with the board’s structuring of compensation for senior executives. For example, after British taxpayers bailed out Royal Bank of Scotland during the financial crisis of 2008, the bank’s board of directors linked 25% of executives’ variable pay to key performance indicators in the areas of “customer and stakeholder” and “people and culture.”

When choosing the right metrics to tie to rewards, performance should be evaluated in terms of both the company’s ESG activities and the external impact of its products and services. Materiality needs to be a cornerstone—the board and management must be aligned on which ESG issues are relevant to the company’s financial performance and should therefore be baked into executive compensation. For example, carbon emissions are not material for an insurance company, but for a coal-fired utility company they certainly are.

Ideally, the measures used to assess performance and drive rewards will eventually be based on a set of independent, rigorous global standards for evaluating ESG impacts, similar to the standards that have long been used to gauge financial performance. The foundation for this has already been laid by the work of the Global Reporting Initiative, the Impact Management Project (IMP), and the Sustainability Accounting Standards Board (SASB). (Disclosure: One of us, Eccles, was the founding chairman of SASB and is an unpaid adviser to the IMP.) When this work is complete, standardized ESG reporting will enable peer comparisons of how each company is positioned to handle the risks and opportunities presented by nonfinancial issues. Boards can then more easily link a company’s performance on these metrics to executive compensation.

Exemplify

Purpose and how it is being achieved must be exemplified in both quantitative and qualitative terms. Quantitatively, a company should integrate its reporting on financial performance with its reporting on sustainability performance, showing how results in the two areas are related. Qualitatively, it is important to have a consistent narrative that includes stories about what the company and its people are doing to fulfill its purpose.

Patagonia, the outdoor-clothing retailer, gets this better than most. Its stated purpose—“We’re in business to save our home planet”—drives all its activities. The company not only makes eco-friendly apparel but also engages aggressively in environmental advocacy and promotes an appreciation of sustainable practices and the natural world with beautifully crafted, visually appealing stories on its website and social media.

At the U.S. food manufacturer J.M. Smucker, purpose involves “feeding connections that help us thrive.” The firm aims to create “meaningful connections…for those we love and the communities in which we live,” and that’s exemplified in the way it treats its employees. As the executive chairman, Richard Smucker, told us, “You demonstrate your purpose when you take action. Sometimes you’re put in tough ethical situations and it’s about how you respond. For example, when closing plants, we have always given plenty of notice to make time for transition. You get respect because you’ve given respect.” He added, “To communicate our commitment, every year we print a small handbook for all employees with our purpose, our commitment to each other, and our strategy. You can carry in your pocket why we do things, how we do them, and what we do.”

A New Duty

When we promote the SCORE framework to directors, they often respond with a common fallacy: They cannot elevate corporate purpose because they have a fiduciary duty to put shareholders’ interests above all others. Setting aside the growing evidence that superior performance on material ESG issues leads to superior financial performance, it is simply not true that shareholders must come first. Shareholders are obviously important, but other stake-holders—such as employees, customers, and suppliers—are also crucial to a company’s long-term prospects.

To dispel directors’ misconceptions, we recently gathered legal memos on fiduciary duty from all G20 countries and 14 others. None offered an endorsement of shareholder primacy. This was true even in the United States. For example, a memo issued by Wachtell, Lipton, Rosen & Katz stated: “A corporation ignores environmental and social challenges at its own peril. Corporate boards are obligated to identify and address these risks as part of their essential fiduciary duty to protect the long-term value of the corporation itself.”

The key to putting the SCORE framework into practice is finding people and organizations willing to be among the first to act. A natural place to look for them is among the members of Business Roundtable (BRT), the lobbying group that declared in 2019 that the purpose of a corporation is to create value for all stake-holders. Nearly 200 CEOs, including the heads of some of the world’s largest companies, endorsed that idea. Each of those leaders’ boards should now walk the talk by publishing a firm-specific statement of purpose and implementing the SCORE framework. If the directors at the BRT companies fail to act, their behavior will not only breed cynicism but leave them vulnerable to ongoing attack by investors demanding more-concrete action on ESG issues.

If investors are to better identify a corporation’s role in society and its prospects for long-term financial returns, board members need to articulate and disclose their company’s durable value proposition and its drivers. The SCORE framework provides a tool to do that. We hope more boards will use it to promote long-term value creation and a more just and sustainable economy.