The environmental movement in the United States reached its zenith in the 1960s with the passage of comprehensive regulations, and ensuing market responses, to protect our land, air and water. Increasing challenges to federal regulations and enforcement, combined with worsening reports on climate change and natural resource losses, raise the question: How can we ensure further progress by other means?
The country’s most influential investors and private sector leaders may hold the key, and it will require going beyond solving their own footprint. We need them to deepen internal and external systems of accountability against the goals they’ve set. We also need the private sector to engage governments to create the policy and governance systems needed to truly solve the problems of climate change and biodiversity loss. They can help us achieve the progress we seek by furthering the track record they have built in recent decades. It will mean adopting goals, reporting and metrics to solve larger environmental problems, not just a company’s particular piece of the puzzle.
New rewards and accountability for progress made
In surveying practitioners and researching, we have identified three promising areas where investors, regulators or society can set stronger incentives for better reporting, metrics and accountability: risk disclosure; regular reporting on areas of materiality and board governance; and performance management.
Risk disclosure leading to action.
We have seen growing demand to require companies to disclose information relevant to environmental, social and governance (ESG) impact. Public letters from Yale’s chief investment officer David Swensen in 2014 and BlackRock’s CEO Larry Fink in 2018 heightened expectations regarding ESG performance in their portfolios.
In 2018, Bank of England’s governor Mark Carney signaled to banks in Britain to make longterm plans for the catastrophic risks of climate change. In the same year, support for the Task Force on Climate-related Financial Disclosures grew to 287 financial firms responsible for assets of nearly $100 trillion, also signaling a sectoral momentum demanding increased disclosure only 15 months after the task force was launched.
We see increasing shareholder votes by large asset managers, such as BlackRock, State Street, Fidelity and Vanguard, to demand more climate-related disclosure from companies in which they are invested.
Such disclosures reflect the imperative of the World Economic Forum’s 2019 Global Risk Report. Indeed, the Global Risk Report lists the top five risks to the global economy — four of which relate to the environment: “failure of climate change mitigation and adaptation” (No. 2); “extreme weather events” (No. 3); “water shortages” (No. 4); and “severe weather conditions” (No. 5). But disclosure of long-term risk does not equal action when companies focus on the short-term pressures of maximizing quarterly shareholder returns. The question is: How do we create stronger signals to encourage companies to act now to address long-term risks, particularly in the face of worsening climate change and resource loss around the world? Some point to the promise of regular reporting on areas of materiality related to sustainability.
New skills and improved reporting on progress in areas of materiality.
Responding to increasing disclosure pressures, we have seen a proliferation of ESG reporting frameworks driven by individual investors and institutional asset managers seeking more sustainable investment options. Rating tools such as the Morgan Stanley Capital International and Dow Jones Sustainability Index, and reporting guidelines such as the Global Reporting Initiative or Sustainability Accounting Standards Board, allow for more transparency in reporting progress on areas of materiality. While more effort is needed to consolidate various reporting frameworks, evidence suggests that “firms with good ratings on material sustainability issues significantly outperform firms with poor ratings on these same issues.”
Sector by sector reporting on materiality as it relates to sustainability will require new skills on the part of investors and their analysts to analyze these metrics as part of their quarterly reviews and to use them in developing their recommendations.
We need a new generation of analysts, fluent not just in finance but also in sustainability, to assess quarterly on areas of materiality, including sustainability, and to engage and track corporate progress on ESG metrics. Taking this one step further we are also seeing new activist investors, such as the firm ValueAct, engage the CEO and board to reach more ambitious financial and ESG goals.
If investors urge companies to properly disclose risk, and trained analysts regularly insist on sustainability data, we should expect greater momentum for company boards and leadership to respond.
Moving faster: from reporting to governance and execution.
We see increasing results from companies that create strong executive and boardlevel governance and management systems to act on the longterm risks to their business and to society. In companies such as McDonald’s and Nike, standing board sustainability committees or key board specialists regularly review progress and hold management accountable for progress on commitments and areas of risk. But only 62 percent of analyzed companies have some form of oversight for sustainability at the board level, and only 13 percent show truly active oversight practices with board mandates and regular reports on sustainability from management (PDF).
Likewise, in companies such as Alcoa, Danone, and Walmart, accomplishment of sustainability goals constitutes one key measure for assessing leadership and executive compensation. But only 2 percent of S&P 500 companies tie environmental metrics to executive compensation, according to a 2017 study by executive compensation and consulting firm Semler Brossy.
Investors, shareholders and the millions of individuals that invest in pension funds and sovereign wealth funds clearly play a role in signaling expectations to both executives and boards. How do we increase the percentage of boards that have stronger ESG structures? How do we motivate investors to look for board competence on sustainability — to ensure the internal metrics and incentives deliver on commitments that address risks and respond to the communities and society that they serve? In both cases, we believe investors and shareholders can productively pose basic questions when they meet with the leadership of companies, when they inquire about the credibility of systems put in place to deliver against targets, and when they ensure their analysts assess and act on relevant ESG information.
Future market leadership: signals and accountability to solve the larger problem
The latest IPCC reports document that the threat of climate change continues to exceed expectations, as do the trajectories of deforestation and ocean destruction in the world. And the reports in turn call for an unprecedented collaboration between private and public entities, the likes of which we have not seen since the Marshall Plan for economic aid to Europe after World War II.
Regulations still matter and play the most powerful role in driving progress on environmental issues, including climate change, natural resource destruction, species extinction and water pollution. But we also need to make better use of market mechanisms and signals to accelerate progress.
More regular disclosure and reporting on risks and materiality, raised expectations of action from investors and consumers, improved board governance and management incentives, and leadership in engaging both government and communities all promise greater speed and accountability in solving the problems we face.
This article is adapted from “A Better Planet: Forty Big Ideas for a Sustainable Future,” edited by Daniel C. Esty, new from Yale University Press. Reprinted by permission.