Better governance supports better outcomes
Effective governance is instrumental in driving value-led sustainability, but short- versus long-term tensions persist.
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.
This is a bar chart showing the percentage of respondents who are both optimistic about revenue growth prospects (76% for Experts, 45% for Beginners) and very satisfied with progress against climate targets (52% for Experts and 13% for Beginners).
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.
Companies that execute on their sustainability strategy do not just create more value for planet and society, they are also likely to capture more financial value for the company and its shareholders.
In other words, both “camps” are aligned on the need to make the difficult decisions and trade-offs needed to protect and grow long-term value. At the same time, however, 64% of the respondents to this survey say, “We face short-term earnings pressure from investors, which impedes our longer-term investments in sustainability.”
The quality of engagement between boards, management and investors is a critical factor in addressing this tension, particularly in terms of reporting. The Corporate Reporting Survey also found that 80% of investors feel “too many companies fail to properly articulate the rationale for long-term investments in sustainability.” This indicates a pressing governance need to improve corporate narratives and help leaders more effectively make the case for a company’s strategy for long-term value.
Of course, an effective external narrative depends on the organization itself being aligned on the balance between necessary short-term optimization and long-term value. The research finds that there has been a significant uptick in the number of company leaders who feel that there are differences of opinion within the leadership team on balancing short-term performance with longer-term sustainability plays.
This is a bar chart showing the percentage of respondents who feel there are differences of opinion within leadership teams on short- versus long-term decisions – 2022 research (55%) versus today (67%).
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.
Further sustainability governance refinements are needed
Leading companies drive better outcomes, but recognize that their sustainability governance journey has further to go.
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.
This is a bar chart showing the percentage of respondents who feel they are “very effective” when it comes to key areas of the board’s climate governance remit: “Exercising board oversight on execution and progress against climate pledge” had the highest results for both Beginners (33%) and Experts (57%).
Moving forward with sustainability governance
Focusing on board dynamics, remuneration and reporting can deliver a systematic, accountable and authentic approach.
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.
of respondents feel sustainability is integrated into board structures and decision making.
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.
Are effective at increasing boardroom diversity
Are effective at increasing boardroom diversity
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.”
Key questions for boards
- How confident are we that the board has access to all the skills it needs for good decision-making on development and execution of its sustainable strategy? If not, how can it access those skills?
- What gives us confidence that we have identified the sustainability objectives that are material to successful delivery of our long-term strategy?
- How have we integrated those sustainability objectives into the company strategy, governance and operations?
- How are we measuring progress toward these objectives?
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:
The risk of inertia47%
of organizations — less than half — have made sustainability a significant part of remuneration.
- 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.
Key questions for boards
- What sustainability impact or outcome does the organization aim to achieve with its executive compensation policy?
- What meaningful ESG metrics should be included in our executive compensation policy? How are we assessing their effectiveness regularly?
- How well do the variable pay performance metrics in place for executives (both short-term and long-term) reflect and align with our corporate values, purpose and sustainability priorities?
- How have we integrated and balanced financial and nonfinancial performance metrics across our executive scorecards and variable pay plans?
- How confident are we that we can avoid unintended consequences, e.g., focusing on ESG metrics at expense of other metrics?
- Do the ESG-based targets in the executive compensation policy align with our sustainability objectives and do they reflect meaningful stretch targets (e.g., achievement is not automatic or guaranteed each year)?
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).
This is a bar chart showing the percentage of respondents who feel they are either “prepared” or “completely prepared” for the EU's impending regulation on corporate sustainability reporting. Experts were most likely to say they had the technology and data analytics skills to deliver (83%), while Beginners were most likely to say they had accurate and verifiable data related to other ESG elements, e.g. biodiversity or human rights (62%).
Key questions for boards
- How is management organized to produce high-quality, reliable, and coherent financial and sustainability reporting? Do we have the right skills, experience, reporting lines and accountabilities in place to support this?
- What changes to the company’s risk management and internal controls systems are needed to produce high-quality, reliable and coherent reporting?
- What actions do we need to take in these areas between now and when CSRD takes effect?
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.
The constantly moving sustainability agenda is a challenge for European CEOs and board members. The risk is that a fluid and complex agenda causes some companies to become too reactive rather than strategic, or even to become paralyzed with uncertainty about where to focus their efforts. With the right governance, however, companies can zero in on the sustainability topics that matter most to the creation of long-term value: securing the future of their organizations while also safeguarding the future of the planet and its people.