The Greening of Insurance Asset Management
Beware the Sirens of Environmental, Social and Governance Investing
Boosting ESG without understanding and carefully considering who stakeholders are, what they expect and how their potential disappointment might be expressed is a tactical path to a reputational liability.
- Nir Kossovsky and Denise Williamee
- May 2021
It's been almost two years since nearly 200 CEOs signed a Business Roundtable pledge to balance the interests of investors with those of other stakeholders. Blame it on the lure of the sirens of environmental, social and governance-driven investing—and the expectations of reputational benefits and capital investments earned by outperforming peers' ESG rankings. It could be a story of capitalism at its best. Instead, it is a story of how captains of industry are potentially wrecking themselves and their boards on the rocks of reputational damage.
Corporate leadership has made these commitments in at least some cases without a clear plan to achieve them. This is a classic and enormous reputational risk. Leaders are setting expectations. If they don't meet them, stakeholders will become disappointed and angry, and their behavior will manifest in ways that have a direct and material impact. It is not a coincidence that between June 2019 and June 2020 there have been 39 federal lawsuits in which a board's duty to oversee reputation was cited—a nearly 60% increase over last year, and the third year of growth.
In many cases, companies may not have recognized who their stakeholders were or what they would do if their expectations were not met. Sen. Elizabeth Warren declared recently that the Business Roundtable pledge was “weak and meaningless,” and “just a publicity stunt.” For every company making pledges and setting goals without thinking through the potential reputational risks we have a news flash: Warren, backed by a more progressive Congress, is now a stakeholder. These companies stepped into Warren's wheelhouse.
Too many companies are treating these ESG pledges as mere marketing statements, but when financial setbacks occur plaintiffs' lawyers are seizing on boards' failures of their duties to oversee mission critical functions such as corporate reputation. While the Caremark International litigation that set the legal standard for board liability made allowances for “puffery,” it also made it clear that boards have a duty to protect operational viability.
ESG pledges can't be empty promises when they speak to operations that investors value. And they can't only focus on the environmental and social parts of the equation. E and S won't amount to much if they aren't backed by better governance. That means when companies make pledges and set stakeholder expectations those pledges will come to fruition; directors need to make sure executives build across the entire enterprise, operations and culture the consequences of those promises.
ESG pledges can’t be empty promises. And they can’t only focus on the environmental and social parts of the equation. E and S won’t amount to much if they aren’t backed by better governance.
Consider two iconic businesses whose values are bound to their reputations for ethics and safety. Goldman Sachs and Boeing each spent upward of $1.5 billion on ESG initiatives that may have boosted ESG metrics but provided no protection when processes most important to their shareholders failed.
Or consider Signet Jewelers, reaching a $240 million shareholder settlement related to pledges over gender ethics. Or Wells Fargo, settling with a world record price tag in a derivative suit over reputational damage.
Boosting ESG without understanding and carefully considering who stakeholders are, what they expect and how they might express their disappointment is a tactical path to reputational liability.
While ESG investment done correctly is commendable, the ESG sirens of the investment community are trapping companies and their leaders in a blinding fog of metrics. ESG investment is touted loudest by the firms that will profit from the ecosystem: conformance consultants, performance auditors and investment advisers.
There is no end in sight as companies exhaust themselves competing for the highest ESG marks to please the investment community, but at the potential cost of ultimately disappointing the very stakeholders they are hoping to appease. The culmination of that disappointment could be evisceration in the courts of law and public opinion.
Managing the risk of disappointed stakeholders expecting ESG triumphs seems prudent. Better still, it is actually a path to better ESG metrics. ESG rating firms are taking into consideration the risk that companies will fail to meet their objectives. Effective January 2021, institutional investors exemplified by BlackRock have started voting their proxies on the strategies firms use to meet their ESG objectives. These stakeholder groups need to hear a clear and convincing narrative describing how these hazardous reputational seas are being navigated and how those risks are being mitigated throughout the organization. Best of all, we have observed over the years that equity markets—reflecting the mindset of ESG raters, bond raters and institutional investors—have rewarded companies disclosing verifiable reputational risk management efforts with equity boosts ranging from 7% to 30%. Apollo Global Management's 11.5%, $1.15 billion increase over a span of two weeks in January is exemplary.
To reliably avoid destruction at the hands of ESG sirens, corporate leadership must take a lesson from Odysseus and lash itself to the ship's mast of reputational risk management and wisely pursue maximum shareholder returns by charting a course that minimizes stakeholder disappointments. Companies need an expansive reputational risk management process staffed by a team that can gather intelligence from throughout the enterprise—defining who the sea of stakeholders includes, what they expect, and whether there are gaps between expectations and actual performance. They need to highlight third-party validations, whether in the form of a legal review or insurance cover.
Engagement in that process, support by third parties who can validate the soundness of governance and operations, and insurance that shows someone is standing behind the company's systems and protocols, will build into a story that marketers and investment relations professionals will love to tell. It's a story that matters to all stakeholder groups—including the political players who can damage a company's reputation with a press release or a tweet.