Corporate boards facing the pressure to direct their firms towards greater sustainability can feel conflicted when they see their fiduciary duty as mainly owed to shareholders. But boards cannot turn a blind eye to sustainability since all businesses operate in – and depend on – the environment. When trade-offs between sustainability and profitability arise, it’s their role to help executives strike the right balance and find ways to bring shareholders on board. 

This challenge was the focus of a dedicated programme at the last ChangeNOW summit in Paris, where business leaders and academics explored how boards can support sustainability without losing shareholder backing. 

Prioritising sustainability objectives

First, boards have to prioritise. There are 17 Sustainable Development Goals (SDGs) and it is almost impossible for one firm to make meaningful progress on all of them. This is especially true when goals conflict. For example, an automotive company may benefit the planet by electrifying its powertrain, but disadvantage blue-collar employees because fewer of them will be needed in assembly, maintenance and repair.

One way to prioritise is by focusing on those SDGs that are the most financially important (or financially “material”) for the firm in terms of current and future revenues, costs and risks. The industry-specific sustainability materiality map created by the Sustainability Accounting Standards Board or SASB, (now part of the IFRS Foundation) provides a framework, or starting point, for firms to approach this.

Firms like Engie, Novartis and many others have developed their own materiality maps tailored to their specific business model, product portfolio or supply chain. This is often done in collaboration with industry experts, major shareholders and non-governmental organisations (NGOs). 

Financial materiality frameworks can also help directors and executives identify hidden sustainability-related value drivers in their business to help them shift the focus from compliance to value creation and make the business case for sustainability investments to shareholders.

While the SASB materiality framework focuses on environmental or social impacts on the firm, the firm’s impact on the environment and society is also important. One way to identify those impacts is to conduct life-cycle assessments for its products with the goal of identifying the firm’s environmental and societal impacts across its value chain. 

Some companies, such as Kering Group among others, go one step further by estimating the financial costs of their products’ environmental impacts. This so-called “monetisation” of impacts on the environment and society can help companies put in perspective the profits generated by their products vis-à-vis their costs to society. To this end, PwC, the Value Balancing Alliance, and the International Foundation for Valuing Impacts have published detailed guides for the monetisation or valuation of corporate environmental and societal impacts.

While boards should of course delegate these impact assessments to the employees of their firms, they must be sufficiently sustainability-literate to understand the assessment and be able to challenge it.

Getting shareholder buy-in

Once the sustainability priorities are set, the next step for boards is to get shareholder buy-in. A bold move would be for firms to obtain Benefit Corporation status or similar designations to signal to shareholders that their purpose is not only shareholder value maximisation. However, few blue-chip companies have so far tried to obtain such designations.

More realistically, boards and executives must endeavour to communicate the business case for sustainability investments, based on their financial materiality assessment. Even if the business case is not clear, boards can elicit shareholder buy-in by providing them with cost estimates and other details of the sustainability initiatives and have them vote on these initiatives at annual general meetings (AGMs). 

Companies like Unilever, among dozens of others, are already raising their climate transition plans at AGMs, in what is commonly known as a “Say on Climate” (akin to “Say on Pay”). After all, asking for shareholder permission to invest in sustainability initiatives is better than asking for forgiveness later.

On the flip side, it would be risky for boards to make major sustainability investments without prior shareholder approval. An optimistic outcome could be a change in the ownership base of the company from purely profit-oriented shareholders to more socially minded ones, which would give the CEO and the board the mandate to pursue sustainability objectives. 

However, apart from a potential fall in the firm’s share price, there is always the risk that an activist shareholder buys into the stock and pushes for a profits-first approach, perhaps even replacing incumbent directors and CEOs in the process, as was the case at Danone and BP.

Companies and their boards could pre-empt such shareholder pressure by reintroducing (either at IPO or later if possible) governance tools that insulate boards from hostile shareholder activism, such as dual-class share structures, staggered board elections, poison pills, and other takeover defences, even though companies have tended to move away from in recent years. Of course, such defence mechanisms are unnecessary if the firm has a socially minded quasi-controlling shareholder, like the government or founders.

Monitoring performance

Once boards and executives have shareholder buy-in for their prioritised sustainability performance dimensions, it is time to execute. For instance, boards should decide whether and how sustainability should be routinely factored in capital allocation decisions. Chevron and InBev consider different carbon price scenarios in their net present value and internal rate of return calculations. Another example is the Belgian special chemicals company Solvay, which formally integrates its products’ environmental footprint in its product portfolio analysis, with the goal of generating more revenues from products with lower environmental impacts over time. 

Monetising a firm’s and its products’ impact on society also helps to integrate sustainability into strategic and operational decision-making because comparing and trading off profits with environmental costs in dollar value is easier than comparing monetary profits with tons of CO2 equivalents. Of course, monetisation requires judgement and assumptions, particularly when the financial costs of individual environmental and social impacts are even more uncertain than the financial impacts of CO2 emissions. The latter can be approximated using the social cost of carbon or the carbon price in cap-and-trade markets.

Another example of incorporating sustainability in decision-making is in the product design stage, where firms can use Resource Cleansheet solutions to compare product costs, customers’ willingness to pay and environmental impact across different design configurations and sourcing options.

Once the board understands how much the approved sustainability investments and initiatives can improve sustainability performance, it will be in a better position to set quantitative sustainability targets over the short, medium, and long-term horizons. Relying on frameworks like those developed by the Science-Based Targets initiative (SBTi) will lend credence to these targets. Once targets are set, boards should be furnished with the firm’s performance on a regular basis, in accordance with board reporting best practices, such that sustainability performance against targets becomes a regular component of board discussions, and targets can be adjusted when appropriate.

Hundreds of boards around the world now link executive compensation to ESG targets. What is important there is transparency about the weights on sustainability metrics vs. financial metrics, how targets for quantitative metrics were set and how the board scores executives on qualitative metrics.

Incentives for better sustainability performance can then be cascaded down the organisational hierarchy. For example, Microsoft uses internal carbon pricing to charge its business units based on how much carbon they emit, providing incentives to reduce business unit emissions. This raises the question: Are incentives best tied to impacts measured in standard units (e.g. tonnes of CO2 emitted and gallons of water used) or to monetised impacts? 

The latter makes it easier to evaluate a business unit’s total environmental impact (e.g., the societal costs of its CO2 emissions plus that of its water consumption in monetary terms). However, impact monetisation may feel like a black box process to the employees (e.g. business unit leaders) who are evaluated on them, obscuring how their sustainability performance is measured and how they can improve it, which can reduce their motivation. That said, these issues can be avoided if sustainability is ingrained into the firm’s corporate culture. In fact, formal sustainability performance incentives can backfire in this case.

The last word

Finally, while boards and firms may want to publicise their sustainability initiatives for public relations and marketing purposes, this should be done with caution. Greenwashing allegations can mar a firm’s reputation. One useful rule of thumb is that firms should not spend more on marketing a sustainability initiative than the amount they spent on the initiative itself.