Why Directors Must Own Sustainability

Maki Nakamura

Capitalism has always been good at seizing opportunities and driving innovation. Not too long ago, space travel was pretty much limited to professional astronauts, leaving the rest of us to just imagine boldly going where no one has gone before, as Star Trek fans like to say. But thanks to the billionaire space race, William Shatner, the 90-year-old actor who played Star Trek’s Captain Kirk, just returned from a trip to the Earth’s outer limits. That’s amazing, not to mention the start of an exciting new space tourism industry that has the backing of some of the world’s most successful entrepreneurs.

And yet, given our environmental challenges, more than a few critics point out that providing rocket joy rides to the ultra-privileged doesn’t sound like the most justifiable business model for this day and age. According to a report in The Guardian, officials at Richard Branson’s Virgin Galactic—which aims to launch full commercial services for so-called private astronauts next year—pushed back against environmental concerns by noting the venture can “get six people into space for an environmental effect less than a single business class ticket to New York.” But is that an appropriate comparison? You can justify adding a relatively small amount of cargo to a boat that’s already dangerously overloaded, but you still increase the risk of losing everything.

Keep in mind that COP21—the 2015 climate change “Conference of the Parties” who govern the United Nations Framework Convention on Climate Change (UNFCCC)—secured the crucial Paris Agreement to limit carbon emissions and hold global warming to less than 2°C on average around the world. But as COP26 gets underway in Glasgow this year, the world remains on track to miss its target, which is why anything that adds to the problem is part of the problem. As things stand, the World Meteorological Organization reports that concentrations of greenhouse gases in our planet’s atmosphere continued to climb last year, increasing faster than the annual average over the last 10 years—despite the pandemic.

Bitcoin is another good example of capitalist innovation. For years, naysayers insisted it would never work as a currency. But today it is legal tender in El Salvador, where consumers can now use the digital currency to buy everything from Big Macs to automobiles. Sure, this is the result of a questionable monetary experiment by a questionable Central American government, but bitcoin’s influence on the world is still pretty amazing even if it proves short-lived. But again, the environmental cost is being ignored.

Bitcoin miners reportedly use the same amount of energy as the entire nation of Sweden. As New Yorker contributor Elizabeth Kolbert recently put it: “A single bitcoin transaction uses the same amount of power that the average American household consumes in a month and is responsible for roughly a million times more carbon emissions than a single Visa transaction. At a time when the world desperately needs to cut carbon emissions, does it make sense to be devoting a Sweden’s worth of electricity to a virtual currency? The answer would seem, pretty clearly, to be no. And yet, here we are.”

Why are we here? That question has an easy answer. Sustainability, or at least true sustainability, isn’t yet a real priority for politicians or business leaders. The harder question to answer is, “Why not?” After all, without sustainability being a core preoccupation of most corporate executives and directors, it is generally accepted that the world as a collective won’t make meaningful progress against climate change, not to mention other urgent challenges like social equality.

Simply put, business leaders talk about sustainability as if it is a priority all the time. Business school case studies on the topic are piling up. Nevertheless, as a blog by the Ivey Business School’s Centre for Building Sustainable Value pointed out earlier this year, true business sustainability remains like the title character in Samuel Beckett’s Waiting for Godot, something that is much discussed but never quite arrives. And as we wait, the clock is ticking.

When it comes to the business community, part of the problem is that sustainability is still seen by corporate directors as a nice-to-have, so not enough pressure is put on the C-suite to make it a top priority, especially today, when everyone is preoccupied with surviving the pandemic. According to a survey conducted by the Institute of Corporate Directors last year, only 54 per cent of Canadian board members strongly feel “responsible for the social impact of their own organization’s activities.” This weak boardroom support for social responsibility stems, at least in part, from the lasting influence of American economist Milton Friedman, who gave capitalism a limited definition of corporate purpose that has been hard to shake despite growing support for so-called stakeholder capitalism. That’s a big problem because when it comes to driving sustainability, directors have a major role to play, one that goes beyond traditional governance.

As pointed out by Rahul Bhardwaj, CEO of the Institute of Corporate Directors, long-term sustainability is the primary responsibility of the CEO, but it should be reflected in corporate strategy, which supporters of evolving best practices in corporate governance say requires board input in addition to oversight. In a pre-pandemic Q&A on governance in the Age of Disruption, Bhardwaj noted that the traditional rule of thumb for directors is “use your nose to smell around but keep your fingers out of management’s business.” But many people question whether this rule of thumb is the best way to foster the innovation today’s world requires. “I am not hearing calls for intervention,” Bhardwaj said. “But increasing boldness in corporate decision-making might require a deeper collaboration between directors and executives, one with a more active board role. The foresight of a board stacked full of experience and relevant competencies can be an enormous value-add when it comes to strategy development.”

Strategy development has never been more important. As highlighted by a new Ivey research initiative aimed at helping corporations achieve real long-term sustainability, businesses that have committed to net-zero greenhouse gas (GHG) emissions by 2050 (or earlier) will need to take a deliberate approach that aims to shift strategies and business models to capitalize on opportunities. “If we are serious about net zero,” says Mazi Raz, Director of Learning Design & Strategy at the Ivey Academy and moderator of the upcoming Ivey Net-Zero Event Series, “then we are talking about the unprecedented transformation of how we do business. The industry leaders of tomorrow will likely be the firms that already, today, see the critical need to take a strategic approach to net-zero – business strategy, innovation, and value creation, carefully aligned with ambitious emissions reductions.”

“Because not enough boards are connecting long-term profits to sustainability, the rules of corporate governance and public expectations for a move to socially responsible capitalism have been at odds.”

Unfortunately, many corporate boards haven’t yet come to terms with what’s at stake and fail to consider sustainability as something they need to champion. This appears easy to justify because—despite calls for a significant paradigm shift—the role of directors as strictly defined by corporate law is to focus on company operations and profitability, not the well-being of society. In other words, because not enough boards are connecting long-term profits to sustainability, the rules of corporate governance and public expectations for a move to socially responsible capitalism have been at odds.

The good news is that change is somewhat unavoidable because, as the Centre for Building Sustainable Value noted last March, there are seven relatively monumental forces supporting a business shift towards real sustainability.

Recognition of sustainability as fundamental to business value: Major institutional investors and asset managers have realized that sustainability is fundamental to the long-term value of the assets they own. Believe it or not, even some players in the hedge fund crowd are pushing companies to take sustainability seriously. Earlier this year, for example, an activist investment firm named Engine No. 1 spent millions fighting a proxy battle against Exxon Mobil, aiming to shake up the board after Exxon refused to seriously commit to carbon neutrality. Despite owning a small stake in the nearly US$250 billion company, the activist firm was able to force the appointment of sustainability-minded directors to Exxon’s board after gaining the support of major shareholders, including BlackRock, the world’s largest asset manager. As pointed out in a commentary on the historic victory by Tima Bansal, Ivey professor of sustainability and strategy, and Mark DesJardine, assistant professor of sustainability and strategy at Penn State University, this was an “odd play” for the hedge fund sector, which is better known for forcing companies to serve the short-term interests of investors, often by cutting sustainability initiatives. “What we see as fundamentally different here,” the scholars wrote, “is the emphasis the hedge fund is putting on the connection between sustainability and long-term profits.” On one level, the shifting mindset of institutional investors stems from awareness of the systemic risks posed by a changing climate and failing ecosystems. But it is also driven by a recognition of the once-in-a-century opportunities that will be created as the world shifts towards a more sustainable future. In his 2020 letter to business leaders, BlackRock CEO Larry Fink noted climate change is now a “defining factor” when it comes to long-term corporate prospects, predicting this will lead to a significant reallocation capital “sooner than most anticipate.” Fink’s 2021 Letter doubled down on this position. BlackRock will now ask companies to disclose a plan for how their business models will be compatible with a net zero economy, and how this plan will be incorporated into their long-term strategy and reviewed by their boards. In Canada, the eight largest pension funds now consider sustainability factors as “an integral part” of their duty to contributors and beneficiaries. As major institutional shareholders continue to push sustainability, the impact on how companies are governed and managed will be profound.

Standardization of measurement and reporting: Sustainability-related reporting has been around for a long time, but a diverse array of voluntary reporting mechanisms has made it difficult to truly compare performance and make decisions in the way investors currently evaluate traditional financial statements. Driven by demand from institutional investors, this lack of comparability is likely to change quickly. In late 2020, the five leading sustainability reporting organizations—including the Sustainability Accounting Standards Board (SASB) and the Global Reporting Initiative (GRI)—announced that they plan to work together to develop a comprehensive global corporate reporting system. In addition, the International Financial Reporting Standards Foundation, whose financial reporting standards are followed in over 140 jurisdictions, has concluded a global consultation that supported the establishment of a Sustainability Standards Board to facilitate global standards. The potential impact of truly comparable data for markets cannot be underestimated, especially when the largest market players are now looking to make strategic choices based on this information. In essence, firms will be competing on their sustainability performance.

Ambitious policymaking: Business action on sustainability has, to a large extent, moved hand-in-hand with the policy and regulatory environment. And in general terms, policymaking on sustainability issues has evolved gradually with limited ambition, in part because politicians and policymakers have felt constrained by the actual or perceived resistance of businesses and citizens. These dynamics are rapidly dissolving. There is always going to be anti-change lobbying. But many of the biggest voices in business and finance now want ambitious, clearly articulated policy that provides a stable and predictable framework for investment in a sustainable, low-carbon future. Meanwhile, there have been major shifts in the perceptions and engagement of citizens. The Pew Research Center has tracked a major increase in the percentage of national populations seeing climate change as a major threat, with this group now being in the significant majority in most major economies. This is already translating into more ambitious policymaking. Two-thirds of global greenhouse gas emissions are now covered by some form of governmental net-zero commitment (including in Canada).

Equality, diversity, and inclusion (EDI): A fundamental reason that business often fails to deliver for society is that, as organizations, they still don’t reflect the communities in which they operate and aren’t welcoming places for all but a privileged minority. But the pressure for change is now overwhelming and it looks like many businesses are taking meaningful action to change. It is easy to be cynical about this, but the business case for change alone is compelling, since EDI improves creativity, productivity, and employee satisfaction.

Influence of leading companies: While the drivers of sustainability noted above predominantly describe external forces acting on firms, sustainability leaders are setting industry expectations for their peers. As a bellwether, the new membership criteria (listed below) of the World Business Council for Sustainable Development (WBCSD) are encouraging:

  • Set an ambition to reach net zero greenhouse gas (GHG) emissions, no later than 2050, and have a science-informed plan to achieve it.
  • Set ambitious, science-informed, short and mid-term environmental goals that contribute to nature/biodiversity recovery by 2050.
  • Declare support for the UN Guiding Principles on Business and Human Rights by having in place a policy to respect human rights and a human rights due diligence process.
  • Declare support for inclusion, equality, diversity, and the elimination of any form of discrimination.
  • Operate at the highest level of transparency by disclosing material sustainability information in line with the Task Force on Climate-related Financial Disclosures (TCFD) and align Enterprise Risk Management (ERM) with environmental, social, and governance-related (ESG) risks.

These are still long-term aspirations and not definitive actions. But they officially set the minimum sustainability standards for companies representing more than US$8.5 trillion in combined revenue and 19 million employees. That is noteworthy. Furthermore, as a CEO-led leadership group of 200 large multinationals—including 3M, BP, DuPont, Google, Philips, Toyota, and Walmart—the WBCSD has historically been a club for gradual change. And meeting these commitments—especially when “science informed”—will clearly require shifts in strategy and value creation models. In other words, they acknowledge that net zero means most organizations will need to operate quite differently.

Businesses are becoming agents of systemic change: Historically, most businesses have been keen to draw sharp boundaries around their societal impact. Companies, hesitant of risk and liability, only generally took responsibility for those things they could directly control. Witness how long it took many sectors to take responsibility for what happened in their supply chains. However, there is no such thing as a “stand-alone” sustainable business. Real sustainability must address the impact of a business’s operations and its relationships. As Ivey’s Bansal noted in a Forbes column on the increasing pressure being put on Big Oil to clean up its act, it took legal action by an alliance of non-governmental (NGO) environmental groups to force Royal Dutch Shell to adjust its emissions-reduction target to account for emissions released by end-users of its products. Nevertheless, leading companies are starting to consider their opportunities and impacts within much wider production and consumption systems. While this requires greater ambition and sophistication, it also substantially increases the scope for real positive impact through system-wide change. Ikea’s ambitious commitment to become fully circular by 2030, for example, will force change on a whole ecosystem of suppliers. Learning how to act in systems is a relatively new skillset for business, but it will rapidly strengthen the ability of business to be a force for positive impact.  A key point to note here: a systems approach works both ways; Embracing being part of a system makes you more likely to be receptive and open to the perspectives of others, which itself becomes a positive force for change in how companies operate.

Sustainable innovation and entrepreneurship: A massive wave of sustainable innovation and entrepreneurship is about to break that will accelerate the pace of change, creating new blockbuster businesses and disrupting old ones. While this may seem relatively predictable, there are several reasons to be really excited about the upside of the scale and impact of potential innovation. Firstly, a whole range of foundational technologies is advancing at an incredible pace: renewable energy production and storage, information technology, cloud computing, artificial intelligence, remote sensing, blockchain, and fintech. We haven’t scratched the surface of how these technologies can be integrated and deployed for sustainability, nor the opportunities to link them directly to the market power of motivated consumers. Secondly, the venture capital industry—a key component in the modern innovation ecosystem—has learned from past disappointments to take the more patient approach needed to bring clean tech innovation to market. Finally, the major forces we have already described are creating a general environment of flux and disruption that is ripe for new products, services, and business models. This is opening a period in which the potential opportunities and rewards for game-changing sustainability innovation and entrepreneurship become even greater.

There is no question that the transition of sustainability from a peripheral issue to the heart of the organization’s value creation model and strategy has remained elusive. And while several forces have the winds of change blowing harder than ever before, time is running out despite clear evidence that the business world needs to quickly change. The early movers stand to benefit from leading the charge and operating as firms that strive inherently to produce goods and services that maximize positive societal value while operating within the natural limits of the planet. Holdout companies not only threaten the stability of the planet—they risk going out of business when the rapid reallocation of capital described by Larry Fink arrives, which is why sustainability needs to be a priority for corporate directors and executives alike.

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