How can effective governance unlock value from sustainability?

While the world has a collective responsibility to address sustainability, businesses play a central role in driving the urgent change needed.

“Companies that execute on their sustainability strategy (whether in operating model, products, support functions, or talent) do not just create more value for our planet and society,” says Julie Linn Teigland, EY EMEIA Area Managing Partner and EY Global Leader – Women. Fast forward. “They are also likely to capture more financial value for the company and its shareholders” — an approach EY calls “value-led sustainability.” In the EY Sustainable Value Survey, 69% of companies said they captured higher financial value than expected from their climate initiatives.

This latest research shows that effective sustainability governance is instrumental in driving those outcomes. Experts are not only more optimistic about revenue growth; they are also more satisfied with progress against climate targets.

Success, however, does depend on the ability to manage the continued tension between short-term priorities and long-term value. The need to drive the sustainability agenda has added a new layer of complexity when it comes to balancing short- and long-term business pressures.

This is particularly apparent when it comes to the critical dynamic between companies and shareholders. The survey found that 74% say their “company should address ESG issues relevant to their business, even if doing so reduces short-term financial performance and profitability.” This aligns with the views of investors — 78% of those surveyed in the EY Global Corporate Reporting and Institutional Investor Survey believe the companies they invest in should address sustainability issues relevant to their business, even if it reduces profits in the short term.

This tension does not recede for those who are governance Experts. In fact, 74% of Experts point to strong differences of opinion internally compared with 58% of Beginners. This suggests a meaningful opportunity for open debate and collaboration to shape approaches that balance these strategic trade-offs.

The majority of organizations (72%) have made explicit commitments to support the UN Sustainable Development Goals most relevant to their business. Material sustainability risks and opportunities range from diversity, equity, and inclusion to natural capital. We begin with climate change, given that it has been on the leadership agenda for longer and there are greater expectations around companies having a mature approach.

There is increasing disquiet among stakeholders that companies are not injecting enough urgency into addressing climate priorities: 55% say their employees don’t feel they’re moving quickly enough on climate issues. This growing impatience reflects concern that a company’s statements about its intentions are not translating into meaningful outcomes and do not provide an authentic picture of the challenges it faces.

As we saw earlier, the Experts are making greater progress in terms of their climate targets (52% vs. 13% for Beginners). However, while they are driving better outcomes, even the Experts recognize that they have further to go in refining critical elements of their governance around climate change topics. Take the role of the board as a critical example: Less than half of Experts (40%) feel the board is “extremely effective” when it comes to “challenging management on its climate plans,” and this drops to 17% for the Beginners.

Priority one: A systematic approach with better dynamics and greater knowledge

Companies have put in place a wide range of structures to integrate sustainability into the board’s decision-making, with no one approach dominating. For example, 28% assign oversight to a dedicated sustainability committee, while 23% assign it to an existing committee, such as risk or audit. However, while the structures for oversight may be in place, many still question whether sustainability is a systematic, intrinsic part of how the board operates:

• Only 7% of all respondents feel that sustainability issues are fully integrated into their board’s structures and decision-making processes.
• Over a quarter (27%) believe that significant change is still needed for it to be fully integrated.

While the right structure is important, effective governance also depends on having enough time to devote to sustainability, so that organizations can do more than just protect existing value, e.g., compliance requirements. Being effective also requires the ability to bring new perspectives to the debate:

• 83% of Experts are effective at “managing the board agenda to ensure long-term ESG risks and opportunities are always discussed, not just near-term business issues,” but this drops to 52% for Beginners.
• 86% of Experts are effective when it comes to “increasing boardroom diversity and ensuring new voices are given equitable speaking time to provide fresh perspectives on ESG topics,” but this drops to 36% for Beginners.

Effective oversight and decision-making also demand the right competence. An up-to-date awareness of the key trends, drivers and challenges of corporate sustainability is central to driving innovation; leaders must be agile enough to respond to a fast-changing sustainability landscape. But when the survey asked respondents what internal hurdles stood in the way of generating long-term value through a strong sustainability proposition, the chairperson and board members in the survey named lack of knowledge in key areas one of their top two challenges (selected by 38% of the board director cohort).

In summary, says EY EMEIA Public Policy Leader Andrew Hobbs, “quality time spent by willing boards who have experience and skills in ESG topics is more important to progressing against sustainability objectives than formal structures such as sustainability committees.”

Priority two: Accountability, with a bold approach to sustainability-linked remuneration

Defining “remuneration-grade” KPIs for sustainability objectives — which constitute a meaningful proportion of total reward and help to hold management teams accountable — is challenging. However, there is a compelling case to do so: Implementing effective variable remuneration schemes supports the delivery of outcomes and progress against sustainability objectives.

A robust approach will need to address several challenges:

• Multiyear time horizons: For survey respondents, the number one challenge is the difficulty of aligning the time horizon of annual salary and variable remuneration with sustainability goals that often have five- to 10-year targets (selected by 39% of respondents as one of their main obstacles).
• Unintended consequences: How do companies ensure that including stock options as part of sustainability-focused remuneration supports long-term value creation? If there is too much emphasis on stock, could that lead to the pursuit of short-term performance achievement to increase the share price?

There is also the question of “what matters?”. What topics do stakeholders think leaders should be assessed against? And, once materiality is assessed, it is important to determine priorities — or the weighting of incentive scheme metrics — to drive the right behaviors. Finally, companies also need to consider how metrics can be cascaded through the organization.

These complex issues do raise the risk of inertia or incrementalism. In fact, the research shows that less than half of organizations (47%) have made sustainability a significant element of remuneration today . However, the Experts are much more likely to have an advanced approach:

• Experts: 61% include ESG metrics as a significant element when setting the compensation of senior executives (with 34% as a limited element).
• Beginners: 29% make it a significant element (with 59% as a limited element).

Making real impact requires a shift in mindset. C-suites, boards and remuneration committees need to be pragmatic and agile when establishing ESG-based KPIs that continue to evolve. They can also benefit from being more open and transparent with their stakeholders — ensuring they engage with them fully on this critical topic and share details of their sustainability journey.

Priority three: An authentic approach based on material, trusted and credible disclosures

Authenticity in the context of reporting and disclosure is the willingness to not only share successes and targets, but also to confront the challenges and difficulties the organization faces on its journey. Stakeholders want to know where you are today, where you are going and how you plan to get there — they do not want greenwashing or greenwishing. They want a focused, authentic story, “warts and all,” about what really matters.

Leading companies have made more progress in embedding sustainability into their strategy, with KPIs in place for managing the business too. This makes it much clearer what is material to the business and therefore what needs to be measured. This clarity of purpose could explain why the sustainability-governance Experts are better prepared for the changing regulatory environment that will come into force with the EU’s Corporate Sustainability Reporting Directive (CSRD).

Looking forward

Because effective governance has always been a dynamic concept, the board’s work in that sense is never done. As we have also seen from our interviews, the sustainability agenda continues to evolve, with a range of topics demanding leadership attention and time. These include biodiversity, human rights in a company’s wider value chain, and workforce equity and inclusion.

Of course, this constantly moving agenda is a challenge for CEOs and board members. The risk is that a constantly changing and complex agenda causes some companies to become too reactive rather than strategic, or even to become “paralyzed” with uncertainty about what to focus on. With the right governance, however, companies can zero in on the sustainability topics that most matter to the creation of long-term value: securing the future of their organizations while also safeguarding the future of the planet and its people.