Boards and Sustainability: Three Best Practices

Jeremy C. Hanson and Sachi Vora

As global warming turns up the heat on the planet, investors are turning up the heat on boards. And investors are not only concerned about the climate but also about other environmental, social, and governance (ESG) issues: sustainability, diversity and inclusion, human rights, labor practices, executive compensation, employee relations, and board independence. No longer a question of corporate citizenship, these issues have become a matter of the board’s fiduciary responsibility.

That’s a far cry from the laissez-faire days of the 1970s and 1980s, when responding to such concerns was seen as unprofitable, or even from the transitional period that followed, when responding was viewed as the right thing to do, even if it wasn’t great for business. What changed? Beginning in the early part of this century and continuing to today, a mounting body of research has shown that investment strategies that consider ESG factors lead to better performance over the long term.1 And investors are putting their money—and their mouths—behind that proposition.

In early 2016, for example, Larry Fink, chairman of BlackRock, which currently manages more than $200 billion across sustainable investment strategies, wrote to CEOs of companies in which his firm invests on behalf of its clients. He asked each of them to lay out for shareholders a strategic framework for long-term value creation—“one that provides a perspective on the future, articulates the impact of the ecosystem on their strategy, explains how changes in that ecosystem might force the company to change course, and identifies metrics that support a framework for long-term sustainability.”2 And he asked them to affirm that such a framework for long-term value creation had been reviewed by their boards.

Large pension funds are also applying pressure by increasingly incorporating ESG analysis into their investment decisions. They see ESG lapses as red flags signaling trouble ahead—trouble that undermines the long-term value creation that the funds seek in order to secure the retirement plans of their members. Some $8.1 trillion in assets are now managed using ESG factors, a threefold increase since 2010. In the past five years, TIAA-CREF Social Choice Equity Fund has doubled in size, to a current $2.3 billion; a $2.4 billion Vanguard social index fund has quadrupled in size since 2011; and ESG index and research providers FTSE Russell, S&P Dow Jones Indices, and Sustainalytics have multiplied.3 This is to say nothing of the trillions of dollars in funds that aren’t held in specifically social funds but whose managers include ESG factors in their investment decisions.

For directors, issues other than ESG may have loomed larger in recent years—how to deal with activists, staying ahead of technology both commercially and as a matter of risk, and the continuing churn of M&A, spin-offs, and spin-outs. Nevertheless, the risk of inaction on ESG is rising. And so are the opportunities for companies to set themselves apart from the pack through reduced operational risk, lower cost of capital, reduced operating costs through improved natural resource management, increased market appeal to consumers and customers, and the ability to attract and retain top talent. Says Paul Polman, whose eight-year tenure as CEO of Unilever has been marked by an unwavering commitment to sustainability: “We are showing increasingly that . . . other stakeholders and shareholders benefit over the long term, with, for example, the market cap having more than doubled over this period. We also see brands with a strong purpose and social mission now growing twice as fast as our other brands, and more profitably. Increasingly, we are showing that a more purpose-driven model makes a lot of business sense.”4

Faced with these pressures, risks, and opportunities, many boards increasingly review sustainability strategy, operational and reputational risk, regulatory compliance, and the like. And many continue to adopt best practices in corporate governance, even as the bar gets higher from year to year. But they may overlook or undervalue one of the most critical factors in ESG performance: the leadership and talent factor. Specifically, there are three leadership and talent levers a board can pull to help ensure that the company it oversees is best equipped to address ESG concerns: create an ESG early-warning system on the board, gauge the readiness of the top team to manage ESG issues across disciplines, and assess the ability of the organization to accelerate ESG performance.

Establish an ESG early-warning system. A study of 1,200 leaders conducted by Wharton Executive Education found that 60% of senior executives admitted that their organizations had been blindsided by three or more high-impact events within a five-year period. Of those executives, 97% said that their organization lacked an adequate early-warning system, leading to unforeseen impacts on the core business or product lines.5 Unexpected, high-impact ESG-related events can be particularly damaging—ranging from a company-caused environmental disaster to dangerous product failures to corporate malfeasance and many more. Less spectacularly, insufficient attention to ESG can mean missed market opportunities, sluggish operations, diminished profits, loss of investor confidence, and a depressed stock price.

Boards should of course make sure that management is systematically tracking ESG performance, looking for ways to turn ESG into a competitive advantage, and regularly reporting to the board on the state of ESG in the company. But they can also consider the composition of the board and its ability to foresee threats and opportunities. If the board’s capability is weak, then it might want to consider ESG expertise as one of the attributes required of new appointees. If the need for such expertise is particularly pressing, the board can also temporarily expand to meet the need for someone who can fully appreciate the material implications of ESG issues.

A number of high-profile boards have in recent years appointed directors who fit that bill. In January of this year, Exxon Mobil elected climate scientist Susan Avery to its board. A physicist and former president and director of the Woods Hole Oceanographic Institution in Massachusetts, she has authored or coauthored more than 80 peer-reviewed articles on atmospheric dynamics and variability. In 2012 ConocoPhillips named Jody Freeman to its board. She is the Archibald Cox Professor of Law at Harvard Law School and founding director of the Harvard Law School Environmental Law and Policy Program. She formerly served as Counselor for Energy and Climate Change in the White House from 2009 to 2010 and as an independent consultant to the National Commission on the Deepwater Horizon Oil Spill and Offshore Drilling in 2010. The board of General Motors, in 2014, elected Joseph J. Ashton, who served for four years as a vice president of the International Union, United Automobile, Aerospace, and Agricultural Workers of America (UAW). In January of this year, Jørgen Vig Knudstorp, executive chairman of the LEGO Brand Group, was nominated by Starbucks to stand for election to the company’s board at the annual stockholders meeting in March. Though he was recruited for, among many other things, his global leadership and consumer experience, LEGO is well known for being environmentally conscious, and Knudstorp said that he found Starbucks fascinating and inspiring not least because of its “ambitious responsibility agenda.”6

Make sure the top team has the right capabilities for driving exemplary ESG performance. Companies that want to maintain public confidence and protect shareholder value—especially those in industries with high ESG risks—will need leaders who think strategically about the issues, communicate clearly and persuasively, and possess sound business knowledge and judgment. In addition to strategic and communication skills, the heightened importance of ESG calls for a number of interdisciplinary and cross-functional competencies, including:

• The ability to develop trusting relationships with a variety of company constituents before an issue becomes a problem


• A solid grounding in a wide range of environmental processes, procedures, and technologies; social issues; and governance requirements at the local, state, federal, regional, and international levels


• A knowledge of financial operations that extends beyond budgeting to an understanding of how finance intersects with ESG and the ability to make a business case for a new direction


• Familiarity with technological and process advances and an understanding of the trends in ESG and their influences on the company and the industry segment

All leaders in the C-suite—not just the chief sustainability officer, chief risk officer, or chief diversity officer—should be aware of today’s higher ESG stakes. Does the CFO incorporate ESG factors into financial analyses? Does the CMO understand the difference between greenwashing and demonstrable corporate commitment to environmental goals—and that greenwashing not only alienates consumers but also signals to investors that integrity may be a problem in other areas of the company’s operations? Is the CHRO able to sincerely incorporate the company’s ESG performance into the company’s employer brand, or would employees and potential employees respond skeptically? Does the executive team as a whole see ESG as an issue of long-term competitiveness?

Make sure the organization has the ability to accelerate ESG performance. In today’s new normal of constant disruption and fleeting competitive advantage, performance depends on the ability to accelerate—to mobilize around a set of strategic priorities, efficiently harness resources, experiment and innovate ahead of the market, spot opportunities and threats, and pivot at a faster pace than competitors. The ability to accelerate performance in ESG is particularly important because, when approached with a competitive mind-set, the issues are future oriented and fast moving, requiring rapid innovation in technology, operations, and business models. Instead of acting only as wise overseers of ESG, boards will also act as catalysts of speed, making sure that management has in place the ability to accelerate ESG performance as needed.

In our firm’s research, we have found that an organization’s capacity to accelerate performance depends on 13 drive factors (see figure) and their corresponding drag factors. These drive and drag factors can operate at all levels of the enterprise—in individuals, teams, and the organization as a whole. When systematically cultivated, the drive factors prepare the organization to accelerate performance. The corresponding drag factors, when ignored, materially slow and at times completely inhibit performance. Boards that insist that the company systematically assess and address these critical drive and drag factors will help ensure not only better ESG performance but also better performance overall.

Superior performance on ESG issues at all levels of senior leadership—the board, C-suite, and the top tiers of management—generates substantial benefits that can increase investor confidence. Those benefits include difficult-to-quantify but highly valuable factors such as an enhanced brand and increased attractiveness as an employer (especially among millennials, many of whom insist on working for purpose-driven companies). They also include immediate financial benefits: lower insurance payments, lower operational costs, and avoidance of fines. And, most important for investors and directors alike, exemplary ESG performance confers competitive advantage over the long term, helping ensure that the company not only survives but thrives.

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About the authors

Jeremy Hanson (jhanson@heidrick.com) is global managing partner of Heidrick & Struggles’ Financial Officers Practice and a member of the CEO & Board Practice; he is based in the Minneapolis office.

Sachi Vora (svora@heidrick.com) is a principal in the CEO & Board Practice; she is based in the New York office.

A version of this article article originally appeared in Governance Challenges 2017: Board Oversight of ESG, a report from the National Association of Corporate Directors.

References

1 See, for example, Deutsche Asset & Wealth Management, ESG & Corporate Financial Performance: Mapping the Global Landscape, December 2015.

2 Larry Fink, “To my fellow shareholders,” chairman’s letter to shareholders from BlackRock’s 2015 annual report, April 10, 2016.

3 Randall Smith, “Investors sharpen focus on social and environmental risks to stocks,” New York Times, December 14, 2016.

4 Alexandre Mars, “Doing well by doing good: An interview with Paul Polman, CEO of Unilever,” Huffington Post, May 9, 2016.

5 See Colin Price and Sharon Toye, Accelerating Performance: How to Mobilize, Execute, and Transform with Agility, Hoboken, NJ: John Wiley & Sons, 2017.

6 Starbucks, “Starbucks nominates three new board members,” news release, January 24, 2017.

VUCA, Meet META: the 2017 List of Superaccelerators

Colin Price

The VUCA acronym has been around for some time now, because we really do live in a volatile, uncertain, complex, and ambiguous world. As we near the one-year anniversary of the Brexit vote that is ushering the United Kingdom out of the European Union, any sort of VUCA index would have to be on the rise, given the fallout from Brexit, the surprise of the US presidential election, mixed signals about any number of international political and trade relations, and so on. The list of VUCA factors could be a long one.

But META can provide at least a modicum of reassurance. META is the acronym, based on extensive research into the four key aspects of corporate performance, that my colleagues at Heidrick & Struggles and I use to describe a detailed method for accelerating that performance: Mobilize, Execute, and Transform with Agility. And the good news is that the measurement we developed to identify the very best performers among the 500 largest companies in the world registered an improvement between our first list, in mid-2016, and the list we are now releasing for 2017.

VUCA may be taking the world in one direction, but META shows at least the top performers moving in the other.

The list of top performers, which we call “superaccelerators,” grew from 23 in 2016 to 25 this year. These companies are those that passed stringent tests that we developed for Accelerating Performance. Our research found that these four tests measure the kind of deep understanding of management that leads to sustained success. We call them the “rules of 20,” and we applied them to the top 500 companies in the world by market capitalization, as follows:

• The companies had to be in the top 20% in revenue growth in both the last three years and the last seven, meaning that they have been standouts both recently and over an extended period. We use revenues, rather than stock price, as the measure because it is the most direct test of how much customers value a company.
• The superaccelerators could generate no more than 20% of their increase in revenue inorganically (through acquisitions). Growth, alone, isn’t what matters. To be an indicator of success, that growth has to come from serving customers better or finding more of them.
• The companies couldn’t get more than 20% of their revenue from their home governments. Many state-owned companies are global powers, but that doesn’t mean they’re paragons of management.
• Finally, the model companies couldn’t have seen their profit margin drop by more than 20% over the seven years. We didn’t want to recognize companies that focused on revenue growth to the exclusion of everything else, because that sort of emphasis is rarely sustainable. (This rule of 20 addresses the question we get asked most frequently: “Why isn’t Amazon on the list?” Amazon is a great company, but its mantra that “your profits are our opportunity” has produced enough pressure on margins that it simply didn’t meet this fourth criterion.)

Those are stringent tests, so it’s encouraging that there are more superaccelerators this year than last. (For the 2016 list, see “What does it take to be a ‘superaccelerator’?”) These companies did not benefit just from being in one sector, such as technology, or in one particularly hot geography. While the United States dominated the list of superaccelerators again this year, with 16, China’s representation increased to 5, from 3. In all, Asia is represented by 9 superaccelerators; Europe has none. The companies come from a range of industries—healthcare/life sciences, consumer, financial services, real estate, professional services, and communications, as well as technology.

The spread of industries and geographies underscores one of the most interesting findings from our research: how a company is managed along our four dimensions—mobilizing, executing, transforming, and agility—mattered far more than being in an especially profitable industry or geography. A top-performing team, for instance, generates 23% more economic value than a poorly performing team handling the same function. Boards of superaccelerators show distinct characteristics—for instance, they are smaller than average, have less experience from outside the industry, and have fewer members over the age of 60.

The principles of META can be applied at organizations in any industry or geography, helping companies make sense of changes in their environment and react in a timely manner. They let companies play, in essence, offense and defense at the same time, sustaining the current source of competitive advantage while exploiting new sources of growth.

With capital becoming ever more global, liquid, and informed, creative ideas and agile execution can produce success in any combination of industries and markets.

Here is the full list of the companies that are this year’s best examples of how to take advantage of those opportunities (arranged in descending order of 2016 revenue):

Unless you know something I don’t, the world will stay in a VUCA state for the foreseeable future. Yet as these 25 companies demonstrate, when organizations find ways to mobilize, execute, and transform with agility, they can turn uncertainty into opportunity—now and for years to come.

The META Framework: Mobilizing, Executing, and Transforming with Agility

Colin Price and Sharon Toye

It’s widely accepted that businesses must greatly increase their performance pace just to stay in place—and they must go even faster if they want to keep up with customer expectations. But those statements gloss over some important distinctions.

For one, not all industries are changing at the same pace or at the same time. While the music industry was upended 15 years ago, for instance, insurance is just now seeing glimmers of innovation because the forces at work there play out over the longer term. Also, change isn’t always that quick, nor does it always enjoy a defined beginning and end. Thus it’s not enough just to mandate speed all the time, in every part of an organization and at every level.

The right pace—the one that will deliver the most return, most reliably—is found by increasing the metabolic rate of your organization through a process that accelerates certain functions, in certain ways, at certain times, designed for maximum effect. We call this process META, short for Mobilize, Execute, and Transform with Agility. Our book, Accelerating Performance, explores how we arrived at META and explains in detail how to implement it.

We think that META is an important framework because two of the mantras among executives today—the need to go faster and the need to look for disruptive business models—can take organizations into blind alleys. Businesses can land in an “acceleration trap,” where they aren’t discriminating enough about their search for speed and actually end up going slower. META is about working with what you have, taking threads, each not especially strong, and weaving them into a fabric of considerable strength. It isn’t about finding a single breakthrough.

Indeed, our research has found that there is more opportunity for improvement by becoming more effective in the markets where a company already operates than by taking a bolder approach and moving into different industries or new geographies. Many managers miss this point. They may spend so much time looking for the next big thing that they ignore the even bigger opportunities right in front of them. Thinking in terms of META helps managers explore these issues by parsing out the factors that can drag a company down or drive it forward. Let’s look at each META area in turn.

Mobilize

Mobilizing requires the ability to inspire aligned action based on a compelling ambition and purpose and a simple set of strategic priorities. An organization that is dragging here will feel overtaken by market disruptions and experience chronic service failures and high customer attrition. The company will see its key performance indicators in the red and suffer projects that are delayed or never finished. It may well have no clear purpose and a message so complicated that it deters people from even trying to understand it.

To turn this drag into drive, you need to focus and simplify: put the customer at the center of all decision making, and develop the ability to read changes in the external ecosystem through the lens of your customers. Your leadership must energize and gather the organization behind a purpose so powerful that everyone will feel that he or she owns it and wants to make it happen. Your organizational story must be easy to understand, told at every opportunity, and able to accelerate decision making to spur aligned and purposeful action.

Execute

Execution is about harnessing and streamlining resources to consistently deliver excellence in the core business. It is based on a shared understanding of the critical strategic capabilities required to improve performance, the extent to which those capabilities exist in the organization today, and the feasibility of closing the gaps. Managers must explicitly consider trade-offs and risks.

When your people and resources are stuck in complex, hierarchical structures, waiting for sign-offs; when there is little or no diversity of thought among decision makers; and when there is poor talent mapping and management, you are experiencing execution drag. You can tackle that drag and turn it into drive by reducing bureaucracy and creating a culture of meritocracy where leaders demonstrate accountability for how they perform and how they manage others. Such a culture-aware organizational chart will allow you to attract the best talent and release new energy to accelerate performance.

Transform

This is where companies experiment and innovate to create growth engines and to reinvent existing businesses ahead of the market; sometimes, transformation results from a dramatic breakthrough, while other times it comes from a steady, long-term effort through a process such as Six Sigma. More than the other areas of META, transformation implies a change in the way that people in the organization think and in the way that resources are allocated. It implies breaking with tradition and internal fiefdoms, rethinking the ways in which things are done, embracing change and innovation, and not tolerating mediocrity, even at the expense of personal relationships.

Agility

The key element of acceleration, agility implies being able to spot opportunities and threats and to adapt and pivot faster than peer organizations to create a competitive advantage. It also means preparing for, withstanding, and recovering from setbacks quickly.

An organization is dragging if it’s slow to adapt to market changes, suffers from analysis paralysis, keeps applying old solutions to new problems unsuccessfully, and has leaders who are slow to adopt new ideas. To turn this around, focus on nimbleness, decode signals indicating that change is coming, and act in a timely manner. Embrace change as an opportunity for continuous improvement, and look for leaders who are open-minded and can adjust to new internal or external conditions.

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When managers can increase their corporation’s metabolic rate, they greatly increase the chances of success. Speed matters—but not for its own sake. First, pick the race you want to run, and then run faster than your competitors. Doing so can lead to enormous opportunities to make your business more successful.

META and the drag and drive factors that underlie the framework must be addressed at four levels: strategy, the organization, teams, and individual leaders. I will explore each of these levels in subsequent posts.