Sustainability governance is integrated governance

The logic behind integrated reports — the merging of sustainability and business disclosures — is straightforward.

Academic research, Wall Street reports, even company financial performance all show that sustainability is good for business. Investors and other stakeholders are looking for evidence that companies are combining their sustainability and business strategies.

Integrated reports, the idea goes, will drive integrated performance.

But by focusing on integrated reporting as the end, rather than a means to an end, companies are missing the point. In fact, they’re putting the cart before the horse.

Companies need to focus on integrating sustainability across their business, then demonstrate this integration in action through their reporting. Integrated reports aren’t important in themselves. It’s what they’re meant to show — that companies are truly making sustainability disclosure, strategies and systems part of how they operate, innovate and drive growth — that’s key.

Nowhere is this integration more important than at the board level. Sitting at the top of the organizational structure, boards are responsible for steering their companies towards sustainable and resilient business performance.

So, if governance is the linchpin, just how many boards are actually set up to focus on integrating sustainability into business in a way that’s effective, that drives the goals that improve performance?

To answer that, Ceres analyzed board governance practices of 475 of the world’s largest publicly traded companies. Our new report “Systems Rule: How board governance can drive sustainability performance” examined whether these companies integrate sustainability priorities such as climate change into board mandates, director expertise and executive compensation, and how these board systems affected their performance on sustainability issues.

Here’s what we found:

• Most large companies say that their boards oversee sustainability, but when we dug into the details, the systems appear largely rudimentary or piecemeal. Only 13 percent have adopted a formal board mandate for sustainability and disclose board-management discussions on sustainability. Just 17 percent demonstrate that they have directors with expertise in sustainability. Merely 6 percent disclose details of the connections between executive compensation and sustainability targets.
• Companies that have robust systems for board sustainability oversight are likely to have established sustainability-related goals and, as a result, better performance. A business that establishes a formal mandate for sustainability issues at the board level is 2.1 times more likely to have stronger sustainability commitments. A company that has a board of directors with backgrounds in sustainability is 2.7 times more likely to have stronger sustainability commitments. Organizations that create strong links between executive compensation and sustainability are 2.1 times more likely to have stronger sustainability commitments.  
• The best-performing companies integrated the three main systems of board governance that we examined, rather than taking a piecemeal approach to board sustainability governance. To be most effective, board systems must reinforce one another.

Given this background, what can boards do to create strong governance systems for integrated sustainability and business performance?

Be holistic

Board governance systems should be integrated and reinforce each other. Formal mandates for sustainability oversight should be supported by the recruitment of directors with the right expertise, who in turn should incent management by linking executive compensation with sustainability.

At Nestle, the board of directors is responsible for overseeing sustainability. Key directors, including the chairman of the board, have skills and expertise in relevant sustainability issues, such as water security and child health, and the annual variable remuneration of executives is linked to sustainability goals. 

Focus on materiality and results

Board directors should move to a results-oriented approach to sustainability oversight. They must create governance systems that drive performance and that are tied to considerations of material risk. Systems for systems’ sake do not produce results.

L’Oreal links the compensation of its chairman and CEO to progress made on the organization’s sustainability targets, including carbon emissions, water consumption and waste generation.

Assess and act

Not every sustainability issue is material to every company, but there is enough evidence about the potential for materiality, especially in the long term, that should prompt boards to investigate. Boards should get management to assess whether issues such as climate change are in fact material to the companies that they oversee. When an issue is found to be material, boards have a responsibility to act. 

Insurer Aviva’s board risk committee has identified climate change as an emerging risk, ensuring that the issue is regularly reviewed, and the potential long-term impacts evaluated for the business.

Be more open

More detailed disclosure, including details on the material issues that the board prioritizes and high-level details on how it addresses those priorities, can spur more sustainability commitments and improvements. Disclosing more also will go a long way in demonstrating to stakeholders that board systems exist in more than name only.

The bottom line is it pays for companies and boards to champion the adoption of strong board governance. A systems-level approach drives sustainability commitments and performance. Given the sustainability risks and opportunities companies face, true integration, then followed by integrated reporting, has to be the name of the game.