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  • Prashant Mara

Arguing for a broader understanding of profitability and a narrower definition of ESG

Prashant Mara and Pratik Bakshi


Boards, analysts, shareholders, civil society, regulators, and PR agencies are in a tizzy. ESG is the new buzz word, and the in-thing to do is to splash it around in annual reports. Everyone seems to want to get on to the bandwagon – which is great – but the elephant in the room is the cost of achieving the amorphous, evolving objectives that form part of the ESG canvas and how real is actual ESG implementation (ESG actualization – for lack of better term).


This article argues that while profitability and ESG 'actualization’, at first blush, look like they are pulling corporations in opposite directions, the utopia is when they are no longer doing so. This article further argues that the path to this utopian status is also less radical than what most PR spins on ESG will have us believe. While packaging ESG into something that is a serendipitous epiphany, which turtle necked CEOs of corporations have suddenly experienced is all very good for corporate packaging, the substance of ESG actualization is much more mundane and has been around for many years. Equally, the concept of profitability with a purpose to benefit stakeholders (defined widely) has been around for decades now.


A broader understanding of profitability


An article by US law firm, Wachtell, Lipton, Rosen & Katz summarizes the position on profitability very well. We draw your attention to the concept of “long-term sustainable value”, which the authors of this article speak about. Generally speaking, this should already be at the core of any well-run organization. But recent examples of FTX, Theranos, Stayzilla and several other posterchildren of new age VC funded companies clearly are not. Contrast this with the likes of IBM and Tata, who have traditionally adopted environmental best practices, are socially conscious and governance driven (all suspiciously similar to the new age principles of ESG) and are still at the top of their respective sectors. These are long standing examples that demonstrate that adopting a broader understanding of profitability in the long term has worked well for corporations.


A rationalized definition of ESG


To deliver long term sustainable value to its stakeholder, a corporation needs to be, well, well run. This means that it needs to conduct its business in a way that builds value for generations, beyond the immediate shareholders in its register and for stakeholders, beyond the immediate shareholders. ESG implementation is forcing more corporations to recognize that all people around the world are potentially stakeholders. While this may sound mind boggling – it should not be.


ESG is not a ‘zero to one’ concept but has its predecessors in the form of emission controls, sustainable sourcing, environmental impact assessments, Environment, Health and Safety (EHS), and Corporate Social Responsibility (CSR). Therefore, the Lego blocks are already there – regulations, codes of conduct, vision/mission statements of corporations, environmental standards, technology tools etc. Guidance in the form of Caremark doctrine, Public Trust doctrine, and Polluter Pays principle exist to set standards for risk assessment and mitigation.


These “older” frameworks or Lego blocks, however, took more of an altruistic approach, implying that management teams should be good Samaritans, because it’s the right thing to do. What’s unique about ESG, and perhaps the reason for its growing acceptance (apart from the urgency) is the business risk and opportunity metrics being applied, which tends to resonate more with the business community. If corporations are using these Lego blocks, as some of them are, they are already achieving the fundamentals of ESG objectives.


So, what’s missing?


What is missing is “real” reporting, accountability, and consequences (for non-compliance) with bite. This is not going to be achieved with awards, annual reports, or conferences. A serious effort needs to be made to map existing compliance, regulatory and risk mitigation standards to what a corporation is implementing and fix the delta (if any). Again – this is not new, but perhaps the focus on ESG will drive real compliance in larger numbers of corporations? Regulations world over (especially in Europe) are now talking about real consequences for non-compliance. Whether this will drive compliance in substance or will revert to a check box exercise, remains to be seen.


Similarly, risk assessment and mitigation by the boards, auditors, general counsel will need to consider ESG “fall outs” and that may temper the memos and decisions based on those memos. While ESG compliance (repackaged existing regulation) has found its way into new laws, risk assessment and mitigation are harder to transpose into laws that are prescriptive. Unless management in corporations adopt these as an integral part of their decision-making process (based on standards already available), this is going to be harder to pin down and has consistently been the one that has let down compliance and now possibly, ESG actualization.


Utopia


We believe that most of what are making the rounds lately as ESG principles are not new. What is new is that corporations are increasingly being judged on this, not just by regulators and the courts, but by the larger stakeholder community. There is a risk that the implementation becomes a PR spin without metrics, measurements and real consequences. When corporations and stakeholders recognize ESG for what it really is – carrying through the principles of good governance (most who have been available for decades now) as part of their corporate DNA (as some already have for ages now) and when markets attribute a premium in value for those corporations (or a discount for the lack thereof) based on tangible metrics, that’s when there is real convergence in the seemingly opposing forces of ESG actualization and profitability.

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