Insights

Governance and ESG

The term “ESG” (Environmental, Social and Governance) has gained significant attention in recent years, much to the delight or dismay of interested parties. ESG represents a shift towards incorporating sustainability and ethical consideration into corporate decision making processes. Governance, on the other hand, is likened to the invisible hand that keeps the ship sailing smoothly, ensuring that everyone onboard plays by the rules and steers in the right direction.

The Marriage between ESG and Governance – How did it occur?

The convergence of ESG factors with governance has evolved organically over the years. Whereas historically ESG-related issues were considered as being separate and distinct from the business of generating revenue and profits, companies have recently began responding to stakeholder expectations, investor demands, regulatory requirements, and the recognition of the materiality of ESG factors.

Nowadays, the demand for corporate social responsibility is on the rise, with growing expectations for companies to actively engage in addressing social and environmental issues. On the one hand there is a growing demand for companies to be socially responsible and to prioritize their impact on people and the planet, and on the other hand businesses are expected to make a profit which is ultimately essential for their survival and growth.

Was it well received?

In a similar vein to other developments, the assimilation of ESG principles into governance has prompted diverse reactions within the financial sector, albeit in a distinct manner. While some stakeholders have embraced this convergence, others have expressed scepticism about whether this intersection will yield long-term profits, both then and now.

The Pursuit of Profit vs. Purpose- Driven Businesses

Discourse surrounding profit versus purpose within the realm of ESG practices and governance have become a central issue in recent business discussions. Historically, enterprises predominantly pursued profit maximization as their primary goal. Stakeholders began to question whether the balance of power tilted towards shareholders to the detriment of the common good and whether the primary focus of businesses was the maximising of profits.

However, in recent times there has been a noticeable shift in the way businesses operate. Companies driven by purpose, prioritizing social and environmental responsibility have garnered considerable momentum.

As a result, this trend has led to the emergence of the ‘profit-purpose paradox,’ highlighting a potential clash between a company’s financial viability and its larger mission. Such conflict occurs when a company’s pursuit of profitability contradicts its social obligations.

Balancing Priorities: Treading a Fine Line between two Seemingly Conflicting Goals

Striking a balance between profit and purpose involves a thoughtful approach that considers both financial viability and social impact. Navigating the ‘profit-purpose’ paradox requires companies to adopt a comprehensive approach to their business model, potentially reevaluating it entirely.

This entails carrying out a thorough assessment of the social and environmental consequences of their actions and integrating these assessments into their comprehensive strategy. It inter alia involves:

• Defining your purpose and Maintaining Transparency: Embracing a purpose-driven ethos necessitates transparency and accountability. Companies must be open about their ethical standards, environmental footprint, and societal contributions. This helps stakeholders, including investors, employees, customers, and communities, understand how the company creates value beyond just financial returns.
• Prioritizing Stakeholder Interests: The increasing pressure on businesses to showcase dedication to ESG principles stems from a variety of sources, including investor preferences, consumer choices, employee demands, and regulatory mandates.
• Strong Governance: The composition of a company’s board plays a pivotal role in shaping its values and direction. The backgrounds, cultures, and characteristics of board members are influential factors. A board that encompasses diversity enhances the organization’s dynamics by introducing varied perspectives, which can streamline problem-solving and foster the generation of innovative ideas and solutions.
• Short-Term vs. Long-Term Initiatives: Assessing the impact of short-term decisions on long-term sustainability and striving to achieve a healthy balance that supports both immediate financial objectives and long-term purpose-driven initiatives.

So how is this balance beneficial? And what are the impacts of losing stability?

Aligning profit goals with a broader purpose yields numerous advantages for businesses. It fosters a stronger brand reputation, boosts competitiveness, enhances employee engagement, stimulates innovation, strengthens risk management practices, improves access to capital, promotes long-term sustainability, and generates a positive impact on society and the environment.

When stability is compromised, both aspects inevitably suffer. Decisions that undermine purpose raise the likelihood of profit being adversely affected as well. These detrimental effects may manifest as: (i) decreased work quality (ii) eroded client trust (iii) cultural degradation, and (iv) damage to reputation.

Conclusion

More and more, companies are acknowledging that profit and purpose are not conflicting goals, but rather complementary components of enduring business prosperity. By incorporating Environmental, Social, and Governance (ESG) considerations into their corporate strategies, companies can uncover synergies. These synergies demonstrate that initiatives benefiting society and the environment can concurrently enhance financial performance.

This article forms part of a series of publications focusing on cross-sectoral matters relating to governance, risk, and compliance. This series aims to offer legal and practical insights, a valuable resource for understanding and navigating the dynamic landscape of GRC in Malta.

This publication was first published in the Times of Malta on 3rd March 2024.