Boards suffer an ‘identity crisis’ as ESG demands rise

Changes in expectations are broader still – making it harder for boards to define the new goal posts now that traditional financial metrics are often considered insufficient.

The influential US Business Roundtable even promotes a changed view on the purpose of a corporation. After decades arguing this was “principally to serve shareholders”, it declared in 2019 that a corporation should be for the benefit of all stakeholders, listing shareholders last after customers, employees, suppliers and communities.

According to the EY report, 98 per cent of investors now evaluate ‘non-financial disclosures’.

Now a new EY report on the “Board of the Future” describes “an identity crisis” around stakeholder priority and ESG in Australia following interviews with directors, chief executives and chief financial officers from 64 publicly listed and 29 private companies.

This adds to directors’ common complaints that a growing thicket of regulatory and risk compliance distracts boards from the strategic conversations that add real value. The report also argues Australian boards lag in digital literacy as well as “soft skills” and diversity.

But it’s the impact of ESG making for the most immediate change for boards. According to the report, 98 per cent of investors now evaluate “non-financial disclosures”.

“Boards are working out how best to meet public and investor expectations on sustainability and long-term value: and to square this with short-term demand for earnings,” it says. “The shift to more inclusive stakeholder capitalism has begun for some but by no means all.

“For many of those making the shift, it is an early and sometimes uncomfortable transition.”

Mark Barnaba is deputy chairman of Fortescue Metals as well as on the Reserve Bank board and chairman of UWA’s Business School.

He says many boards still operate in a mostly manual, paper-based model with enormous regulatory and legal demands, and information overload.

“It is a 20th century model that is still trying to evolve for a 21st century world,” he says. “Changes are happening in some boardrooms, but not as rapidly as community and social expectations and customer and shareholder demands are moving.

“ESG, and particularly green issues, are a good example of this.”

Fortescue clearly doesn’t consider itself among those not moving fast enough off the back of continued strong profits from iron ore. It has embraced “going green” in its operations, establishing Fortescue Future Industries for investments globally.

Most other public companies are more cautious but the rush to proclaim a commitment to “net zero emissions” by 2050 or earlier demonstrates the potency of the altered investor climate.

Cynical stunt

Most successful companies still reject the need to choose between the primacy of shareholders and a broader group of stakeholders – as measured by total shareholder returns over the long term.

Wesfarmers chair Michael Chaney, for example, dismisses the Business Roundtable statement as a cynical stunt designed to deter activists. There is no contradiction between delivering long-term shareholder value and a corporation’s role as a good corporate citizen, he says.

Always a believer in the power of hard numbers, he insists a company that loses sight of the single purpose of providing good returns to shareholders by doing the right thing is failing in its duty.

That leads to arguments over the use of non-financial metrics in highly sensitive areas like remuneration and short term incentive payments.

Yasmin Allen, director at ASX, Cochlear and Santos, argues key non-financial metrics actually become financial metrics by driving value for the company over the longer term.

“I think remuneration can be a really important tool to shape the direction of a company,” she says. “Everything you do in the short term delivers in the long term.”

But such assessments are usually harder to measure than traditional balance sheets.

“You can never satisfy everyone you have it right,” says another big corporate chair.

The intense focus on climate change also makes it harder – certainly in the short term – for companies that can’t easily promise to purchase enough offsets or decarbonise decades into the future.

Veteran director Graham Bradley chairs businesses ranging from neobank Volt to United Malt to Shine Lawers. But his chairmanship of Energy Australia involves satisfying greatly increased investor demands on ESG in order to “tick the boxes”.

“It’s gone beyond disclosure, it’s gone beyond risk analysis, it’s gone beyond investment in cost-effective abatement,” he says. “There’s now a requirement from even large institutional investors for investment beyond what is cost-effective in the short term.

“Boards are under strong pressure from investors not only to commit to a net zero target but to demonstrate a credible path to it through investments that in some cases will reduce near-term profits.”

Pressure that’s only going one way.