It’s been two years since 181 CEOs signed The Business Roundtable statement on corporate purpose, committing themselves to serving the interests of ‘all stakeholders’, especially communities, the environment and investors.
This pledge supercharged the ESG movement: companies began competing for high ESG ratings and inclusion in ESG-targeted investment funds, and selling products based on their corporate ESG commitment. Simply put, since August 19, 2019, almost every public company – and many a private company – has sought to fortify its reputation by making statements of commitment to environmental stewardship, social justice and responsible governance.
So why did a recent Willis Towers Watson survey of corporate leaders still find growing concern that ‘reputational risks could result in potentially crippling business outcomes’?
Perhaps it’s because many of these CEOs signed up to this pledge without consulting their board, let alone putting in place the operational and governance oversight systems necessary to achieve their stated goals. Harvard’s Professor Lucien Bebchuk is not alone in calling the pledge a ‘public relations move’ and pointing out ‘the failure to reflect the commitment to stakeholders in corporate governance guidelines’.
Perhaps it’s because many observers share the skepticism of an SEC commissioner who described the ESG trend as ‘labelling based on incomplete information, public shaming and shunning wrapped in moral rhetoric preached with cold-hearted, self-righteous oblivion to the consequences, which ultimately fall on real people’.
Perhaps it’s out of concern that by raising stakeholder expectations without the operational and governance reality to match, these aspiring companies may actually be increasing their reputational risk – which is defined as the degree to which expectations and performance fail to align.
That’s why investors and analysts are now scrutinizing this area more closely – out of obvious concern that corporate ESG statements may amount to no more than aspirational marketing, rather than operational priorities. BlackRock, for example, issued new proxy voting guidelines asking for details on how companies have considered the interests of diverse stakeholder groups in their decision-making – as well as whether they have appropriate due diligence and board oversight processes in place.
PwC has pointed out that ‘everything from carbon emissions and racial and gender balance to the sustainability of sourcing strategies is under the microscope’. And McKinsey has noted the increasingly prevalent sentiment that, while companies have traditionally thought of ESG as more of a marketing and communications issue, they are now ‘witnessing firsthand how non-financial risks can significantly affect corporate valuations’.
Even the bond raters care: Moody’s disclosed that ESG risks materially impacted 85 percent of its ratings in 2020, up from 32 percent in 2019.
Given the long-standing axiom that, with respect to investors, companies should under-promise and over-deliver, it is fairly stunning to consider how many companies are now over-promising in the ESG arena and ignoring the reputational risks associated with under-delivering. When stakeholders become disappointed and their anger is manifested in tangible financial and operational consequences – reduced revenue, reduced cash flow, reduced stock price relative to peers, increased cost of capital, difficulty attracting and retaining talent – they are finding support in courts of law.
The number of shareholder derivative litigations referring to reputational damage is skyrocketing, accusing boards of having failed to protect this mission-critical asset. While firms may once have felt safe hiding behind the defense that their statements were mere marketing ‘puffery’, they now have investors relying on their ESG and corporate citizenship statements and considering them material to their investment decisions.
Clearly, companies cannot continue addressing their ESG activities with what former BlackRock executive Tariq Fancy calls ‘marketing hype’ and ‘disingenuous promises’. They need to create new processes for understanding and managing the reputation risk associated with ESG and recognize it as an essential, enterprise-wide issue.
Building reputation resilience is a process no less sophisticated and enterprise-wide than building the financial controls that lead to better bond ratings. It’s all about enterprise reputation risk management, with a focus on stakeholder expectations. The chief legal officer should help the board oversee this mission-critical exercise.
An integrated enterprise-wide process would enable investor relations to advise on the risks associated with any failure by HR in its push for diversity; HR could weigh in on the impact regulatory scrutiny could have on hiring. The CFO could opine on the potential impact on credit ratings of failure to meet stated sustainability goals. Government relations could review marketing materials with an eye toward their defensibility in a political environment like a Congressional hearing; external relations would know the costs and risks of trying to satisfy environmentalists, and so on.
And the counsel’s office can then retain third parties, whether reputation insurance underwriters, consultants or outside counsel, to conduct an additional, objective process analysis that could be the basis for authenticated disclosures along the lines of those being requested by institutional investors such as BlackRock, State Street and Vanguard, and by skeptical regulators such as the SEC when requirements finally gel. This type of objective analysis and public validation is crucial to separating companies that deserve a ‘reputational premium’ from those that fall victim to the ‘liar’s discount’.
CEOs who signed the Business Roundtable pledge two years ago, and who are promoting their company’s ESG goals, have set expectations very high. That hype is now reputation risk. They need to make it real or walk it back. If they can’t keep their promises, and live up to expectations, their stakeholders will make them – and their board members – pay a high price.
Nir Kossovsky, author of Reputation, stock price and you: Why the market rewards some companies and punishes others, is CEO of Steel City Re.