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Cgpro ESG Oct23

Are Boards Equipped To Deliver The ‘S’ In ESG?

Monday, 23 October 2023

By Fiona Hathorn, CEO of WB Directors. Fiona is also an advisory panel member for the FRC, advisor to Peel Hunt (mid-cap stockbroker) and Chair of Hanx's Nominations Committee (FMCG start-up). She is an expert in the areas of Governance, Regulation and Talent Management who has sat on both marketing and audit & finance committees (investment oversight expert).

Fiona Resized Fiona Hathorn CEO WB Directors

For decades it seems that the duty of company Boards was to protect financial wealth and maximise profit growth over and above everything else. In the last ten years or so, we have seen ‘governance’ take centre stage, where factors such as board composition, executive pay, good risk management and financial probity have crept up the agenda. More recently, ‘environment’ has dominated the corporate landscape generating huge investment and heavy regulation – and rightly so. The focus has been on a company’s use of natural resources and the effect of its operations on the environment, particularly when it comes to carbon emissions, both in its direct operations and across its supply chains.

However, as a combination of changing consumer preferences, employee attitudes and emerging regulation prompts firms to increase their focus on ‘social’ issues, more businesses are realising that the ‘S’ in ESG should be an integral component of their sustainability strategy. The historical lack of focus is partly due to the fact that environmental and governance issues are much more clearly defined and relatively easier to measure and quantify. Part of this issue is that the ‘S’ is extremely broad and covers everything from the Modern Slavery Act to health and safety, to supporting grassroots charitable initiatives.

So, what should the “S” in ESG be focussed on? According to the UN Global Compact, social sustainability involves identifying and managing a firm’s positive and negative impacts on a community. This includes ensuring that workers are treated fairly, providing equal opportunities to all, and working to address social disparities. Through this lens, it’s clear that the social elements of an effective ESG strategy go way beyond ‘charity of the year’ initiatives. This is about a fundamental shift in how companies are run, and more specifically the treatment of people and communities across their entire value chain.

In today’s dynamic business landscape, the integration of social aspects into business strategy is crucial. Calls for change are coming from the bottom up in our workforce. A new generation prefers businesses that are more ethical and environmentally friendly, demanding employers enshrine values and ethics into their business model, not just profit. The shift to hybrid and flexible working models has been seismic. The ‘great resignation’ and the ‘war for talent’ are not to be dismissed as trends or buzz phrases, because at their heart lies something serious - the dynamics between employer and employee are facing a historic shift. Successfully attracting a diverse workforce has never been more important for companies, and especially companies that hope to attract the best and brightest new workers. Studies show that Gen Z candidates consider a company’s commitment to diversity and inclusion important when choosing an employer and there is mounting evidence to support the fact that diverse teams are more innovative, likely to be more reflective of the customer base they’re trying to attract and can even impact a company’s bottom line. A McKinsey study revealed that companies with the most ethnically diverse executive teams were 33% more likely to outperform their peers.

Diversity Matters

In this context, diversity matters – diversity of thought, background, experience. The importance of diversity and inclusion, and more recently equity, are well established and work has been going on for years to improve it. However, it would be wrong to assume that this element of social sustainability is covered. While we have seen some progress on this front, it has been woefully slow and there is still much to do.

When it comes to gender diversity initiatives, three consecutive government-backed schemes have pushed the proportion of women holding boardroom roles across FTSE 350 companies from 9.5% in 2011 to 40.2% in 2023. Women on Boards has been measuring gender diversity in the FTSE All-Share firms below the top 350 listed companies and has seen numbers improve from 48% of firms not achieving a target of 33% women on boards in 2021 to 16% in 2023. [1]

While this is positive progress, it’s striking to note that the FTSE Women Leaders Review has set a goal for 40% female representation, supporting Women on Boards long-held campaign aim of 40:40:20 being truly representative. In addition they, and the Financial Conduct Authority, have outlined that one of the four most influential roles should be held by a woman - these roles are CEO, CFO, SID or Chair. 19% FTSE 100 do not meet these targets, rising to 36% FTSE 250, 41% FTSE All-Share ex350 and 73% among Alternative Investment Market (AIM) listed companies are yet to reach this goal.

The latest data from the government-backed Parker review, which was set up to improve ethnic diversity in Britain’s boardrooms, paints a similar picture. Nearly all the UK’s 100 largest listed companies now have at least one minority ethnic director on their boards. However, only seven people from ethnic minority backgrounds currently hold the role of chief executive of a FTSE 100 company, showing there has been slower progress in boosting diversity in executive roles.

When we consider the lack of diversity of UK executive teams, we have to question whether they are set up to deal with the broader ESG agenda, particularly when it comes to social aspects. Can we expect to see progress on diversity and inclusion when executive representation is still lagging behind?

Women on Boards UK in partnership with global consulting firm Protiviti, conducted new research into the mix of skills and expertise of executives at over 1,000 listed companies. The Hidden Talent: Diversity & Inclusion in the FTSE All-Share report highlights the lack of skills and diversity of expertise among FTSE All-Share executive board members – both male and female. We found that just 2.3% of executive board members hold positions other than CEO, CFO or Company Secretary across almost 4,800 executive board seats. Furthermore, within this small group of individuals, the report found a further concentration of expertise. The majority of these executives held positions focused on operational efficiency, with 68% either being Chief Operating Officer or Chief Technology Officer. The remainder of roles (less than 30 across almost 600 firms) include Employee Representative; General Counsel (senior legal adviser); Chief Information Officer; Chief Strategy Officer; Chief People Officer.

This data suggests that executive board member composition has not kept pace with the governance evolution of the past decade. The overwhelming predominance of the ‘traditional three’ roles of CEO, CFO and Company Secretary in composing the executive voice at board level reinforces what is now an out-dated exclusive board focus on compliance, financial probity and efficiency. These are important factors in any company’s success and it is entirely appropriate that these roles have a seat at the board table. However, boards need to consider the key challenges before them and how they work with the executives responsible for meeting them. People with similar expertise looking at similar information and facing similar circumstances are, unsurprisingly, likely to rely on similar assumptions and make similar decisions.  This type of groupthink can create excessive risks, not least heightened behaviour and culture risks. Indeed, low levels of diversity in key decision-making roles has led to many of the conduct scandals we have seen dominate headlines in recent months.

So where should companies start when incorporating the “S” within their broader ESG strategy?

Deloitte notes that People and Culture issues, particularly Equity, Diversity & Inclusion (ED&I), should be addressed as part of the social ‘S’ element. For many organisations People & Culture is also a key risk area. Even pre-Covid, McKinsey found CEOs identified ‘human capital’ as a top challenge, yet the same research subjects also rank HR as eighth or ninth most important function in the company. Our Hidden Talent research found that of the 81 executive board members across the FTSE All-Share who are not CEO, CFO or Company Secretary - just two executive board members across the FTSE All-Share have a human resources or a people and culture job title. While this skillset may be filled by non-executive directors the fact that this is one of the least prevalent executive skills at board-level is concerning in light of the fact that when we surveyed 400 of our board members, a strong majority (82%) stated that people and culture was a ‘top level’ area for their boards and a ‘significant’ issue.

They also agreed (82%) that ‘employees expect leadership from boards on people and culture’. Despite this, only 27% of board members surveyed said they draw on specialist HR expertise and 40% state that the quality of people and culture discussions were ‘weaker’ or ‘much weaker’ than other topics.

Expanding the executive voice on the board could be one clear route to enhancing the impact boards have on strategic People and Culture topics and in turn the CEOs ambition to fulfil their responsibilities under the ‘S’ in ESG. Elevating a formal seat to an organisation’s executive expert on People and Culture is certainly one route to go. Another way of achieving this is through the Remuneration Committee (RemCo). One of our board members changed the name of the RemCos she chaired to be ‘People, Culture and Remuneration’. This reframe was highly impactful and gave the committee authority to apply its expertise to a range of strategic topics. They analysed if the company ‘walks the talk’ on its rhetoric around culture and monitored pay gap data in a nuanced way to assess the impact of ED&I strategies.

Another innovative approach we are exploring with some of the companies we work with is setting up a ‘shadow board’ - a cohort of younger staff to work alongside the main board. When we consider that the average age of a NED is approximately 59.2 it is clear that boards need to seek new ways to engage a diverse range of voices to help them react to the changing social and business environment in which their companies operate.

RenewableUK has reported great success since it set up its shadow board in 2019. Amongst other topics the shadow board has been developed to help companies scale up even faster on renewables and accelerate the UK’s transition to a net zero future. Tapping into the drive, creativity and originality of this tech-savvy generation is proving invaluable to RenewableUK and its members. What’s more, with the right development and training plans in place, shadow boards have high potential for lasting benefits to those professionals' careers in the long-term, building a future-fit and savvy workforce. What helped to make the RenewableUK initiative a success is their partnership with WB Directors, Women on Boards corporate business, to ensure that shadow board members have the support and learning about how to engage effectively in a board environment as well as the skills to take back to their day jobs and help position themselves for the promotion opportunities they merit.

Meeting the business challenges of today requires boards to draw on a broader range of executive expertise. Whatever route you choose to explore, it all starts with redefining board-ready talent and elevating new skills and diversity of expertise into the boardroom. By focusing on this, boards should find themselves in a better position to guide their organisations to navigate the increasingly disruptive risk environment, seize transformational opportunities and ultimately deliver long-term value to a wide range of stakeholders.

It’s time to put the “S” in ESG in the spotlight.

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[1] All WB Directors data sourced from the report: Hidden Talent: Diversity & Inclusion in the FTSE All-Share