Transforming companies
  • Elias George, Partner |

From the origins of the concept of the Joint Stock Company in the middle ages, firms have been primarily focusing on two fundamental objectives: maximizing value-creation for their shareholders, and consequently empowering their workforce for generating best value. The depredations of some of these companies – and the East India Company springs to mind as an exemplar here – on nations, communities and the larger landscape, are all a consequence of this traditionally limited focus. The economist Milton Friedman famously said, “There is one and only one social responsibility of business – to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.”

However, the times they are a – changing. The last few years have seen intensifying external influences playing on firms to transform their objectives, operating models, and culture, towards not just ‘doing no evil’, but also for ensuring benign impacts on their entire ecosystem, including their physical setting, their employees, and society at large.

The evolution of companies along this trajectory towards being good and doing good, needs to be oriented along three axes: Environmental impact, Social consequences, and Governance (ESG). In terms of environmental impact, firms need to be mindful about minimizing their footprint on the soil, on water, and on air, along their entire value chain; including their subcontractors and ancillaries who contribute to the creation of their products and services. The enormous impact of firms on the social ecosystem has recently been vividly demonstrated by the global conversations happening around some of the social media companies, whose actions have sometimes evoked visceral reactions from affected governments and communities. Likewise, the quality of internal governance is becoming increasingly critical, as well as a source of competitive advantage, especially in these times where talent is such a key determinant of a firm’s output. Millennials and the younger ‘Generation Z’ presently constitute around 52 percent of the world’s workforce, and these generations are much more sensitive to the quality of internal governance in firms, particularly relating to fairness and inclusion. Given these compulsions, the impact of the ESG troika has never been more consequential in determining the fortunes of firms.

Three primary trends have been at play in effecting a transformation towards ESG-driven thinking – the latest, and most powerful being the rude awakening that COVID-19 has brought to all of humanity in its wake. The pandemic has brought home vividly the realization that ignoring our physical setting and relationships with the natural world can pose existential risks for organizations, and that individual well-being cannot be separated from community welfare. The global conversation is now replete with new coinages like ‘The New Normal’ and ‘The Great Reset’; and once this pandemic washes over us, firms will have to be much more mindful of their impacts on the environment as well as on all stakeholders, be it their employees or neighbouring communities, for their operations to be sustainable in the long run.

The second factor is stakeholder and investor pressure. Even before the onset of the pandemic, sensitivities to the environmental and social impact of firms had become acute. In a study conducted by KPMG in 2018, more than a third of the top managements surveyed indicated that investor pressure had increased their company’s focus on ESG aspects. Given the enormous power of the internet and the social media to foster instantaneous global conversations, we have seen cases where questionable practices by firms – be it in terms of environmental degradation, unfair behaviours vis-à-vis their own employees or affected communities – have led to tidal waves of protest, impacting their brand equity and valuations. The set of key stakeholders of a firm has effectively expanded beyond the traditional model of investors, shareholders and employees; and now encompasses a larger cohort, like communities, the media, and civil society organizations. Klaus Schwab, Founder and Executive Chairman of the World Economic Forum (WEF) explains this as a transition from ‘shareholder-oriented capitalism’ to ‘stakeholder-oriented capitalism.

The third factor that is compelling firms to make this transition towards ‘goodness’ has been the recent intensification of regulatory pressures. Governments across the world have started issuing regulations for inducing ESG compliance. Several stock exchanges have adopted listing rules on ESG disclosures, and around 97 stock exchanges including India’s National Stock Exchange and BSE India Ltd. have become partners of the Sustainable Stock Exchanges Initiative, a United Nations initiative to promote responsible investment in sustainable development and to advance corporate performance on ESG issues. The UN Global Compact’s three-year strategic plan announced in January 2021 aims to hasten the adoption of corporate sustainability and principled business practices. 

One of the challenges that regulators face is the wide diversity of ESG measurement metrics, and there is a pressing need to evolve ESG measures that hold good globally, and are acceptable to all stakeholders. In India, the Securities and Exchange Board of India (SEBI), had mandated Business Responsibility Reporting (BRRs) for the top 1000 listed companies. In August 2020, the Ministry of Corporate Affairs (MCA) released the report of a committee on BRR, focusing on key themes like value chain, labour welfare, gender equity and other fairness indices. The regulatory landscape is tightening; with new focus on aspects like and naming and shaming companies, as well as on providing public access to key information; informed by the thinking that “Sunlight is the best disinfectant”, to quote the great Justice Louis Brandeis of the U.S. Supreme Court.

In sum, the actions of companies in the realm of environmental and social impact, as well as on internal good governance, have become existential issues, which no firm can henceforth afford to ignore. The time has come for companies to conclude ESG Compacts that hold them accountable for how they treat the environment they operate in, how they address their stakeholders’ concerns, and how they treat their employees, without which their survival and flourishing will justly be called into question.

 

(A version of the article was published in The Times of India Online on 15 March 2021)