How to make non-financial reporting your company's north star

It's good practice to align your company's strategy with environmental, social and good governance targets or 'ESG' for short. After all, who doesn't want to operate sustainably for the benefit of all stakeholders, above all for society as the top stakeholder?

ESG has been under increasing pressure lately. The Financial Times describes sees the future of ESG as “at a crossroads”. The Economist sees “a broken system (that) needs urgent repairs”. Some greenwashing and woke-washing scandals have done the rest. Critics might argue that the world has more pressing matters right now, with the war in Ukraine causing energy, food and potentially refugee crises for many countries.

The question is: can ESG be saved? And if so, how?

ESG doesn’t need saving. It remains a clear ambition but it needs transparency. In an increasingly fragmented and volatile world, it is more important than ever for companies to have a clear compass. Having a “true north” is a prerequisite for sustainable management and for creating value for all stakeholders – and thus, for inclusive capitalism. Clearly defined and clearly communicated ESG goals can be this north star.

I am convinced that ESG is not a short-term trend, but is here to stay. But only if we are talking about real, transparent, honest and measurable ESG. ESG must not only serve an ideology or further bureaucracy; it must balance the desirable with the feasible. Then there will be acceptance – and impact and results.

1. ESG is a leadership issue. It should be anchored at the top of the company and build the basis for the corporate business strategy. Management must have a clear idea of the short, medium and long-term development of the company and define the goals accordingly. It is not good enough to simply set one goal in the distant future – such as net zero by 20XX – but not define any intermediate steps for how to achieve sustainable business operations. This has nothing to do with visionary corporate management but a great deal to do with handing over responsibility to future generations.

2. ESG is a standing high-priority topic for the supervisory board. It is, of course, up to management to define and execute a company’s strategy and drive ESG. However, supervisory boards need to endorse it, should set the frame and provide fundamental orientation. Supervisory boards should set up compensation systems that include achieving the most relevant ESG targets. Through individual targets for board members, supervisory boards incentivize meaningful progress in the short term.

Talent pipelines, for example, that encourage inclusion and diversity can be set up in a timely fashion. But meeting ESG goals is less a sprint and more of a marathon: creating a sustainable transition toward climate neutrality requires long-term incentives also tied to investors’ monetary interest. In addition, all these efforts are typically well-received by investors at an AGM vote.

3. ESG should go beyond “E” and not solely focus on environmental targets, such as reducing greenhouse gas emissions. It is just as much about “S” and “G” as it is about the environment. That includes, for example, diversity goals, good governance, zero harm, creating jobs and more. Companies need to define clear goals in all three areas – E, S and G – in order to get better. All three are interconnected, anyhow.

4. There is no use if only top management knows about ESG goals. An ESG strategy must be fully integrated into a company's corporate business strategy and must become a critical part of the corporate culture – because culture eats strategy for lunch – and also has an impact on the actions of customers, suppliers and partners. It's about creating an ESG system for a company. The top-down actions need to meet the bottom-up desire. This is also the best remedy against greenwashing or woke dreaming.

5. ESG can become a power booster in hiring the right resources. Top talent is hard to find, the war for talent is over – the talents have won. So, how to get the best people? High compensation? Maybe, but not special or sustainable. High tech? Well, maybe – but could be short-lived. What excites the best in class? In my experience, it has often been the right answer to a simple question: why should I work for you? The answer is having a purpose, serving society and being relevant to the greater good of the world.

Relative performance (in comparison to peers) is also a must. Don't jump into issues like purpose and ESG promotion if your operational performance lags behind the industry and your competitors. CEOs also risk their jobs if they run their companies in line with ambitious ESG goals but fail to deliver sufficient financial and operational performance. Competitive and sustainable profitability is a crucial duty. It creates the necessary freedom and independence for ESG to be seen as a “must have” rather than a “nice to have".

In the capital market, ESG-led companies compete with others from the “old world”. Market competition has increased now the era of low-interest rates is over. If the expected return is not met, most investors will look elsewhere or force management/board changes. Every child knows that you need to kill the dragon first before you conquer the princess – CEOs should know this, too: big rocks out of the way first. If your performance trails your competitors: keep your head down and work harder. Don’t get distracted by things which are above your levels – yet.

Getting ESG right is of crucial importance – not just as a prerequisite for the long-term success of companies. The right approach can bring about a new kind of inclusive capitalism. Companies today are exposed to higher expectations above just delivering profits – as we see through global climate activism, the Me Too or Black Lives Matter movements. What’s relevant today is that business serves society. By redefining capitalism, we can build a more just and sustainable world.

However, the commitment of management and employees to ESG is not enough; political and regulatory frameworks must also be supportive. ESG requires a uniform, globally applicable set of rules so that companies can be credibly and correctly compared to each other and audited independently. The Accounting Standards Boards in America and Europe determine the rules of international accounting and should also set up the criteria for ESG internationally, according to which companies can then formulate their goals. These goals should be science and rules-based and verified by global auditors. The mantra “substance over form” applies: the quality of the content is decisive. I hope we make significant progress here, for ESG has come to stay.