Recent months have seen the term ‘woke’ generate few positive headlines. McDonalds rolled back its DEI program, Meta said it it would no longer use fact-checking on posts, and right-wing media celebrated the supposed death of the ‘woke agenda’ globally. This shift comes as climate pledge commitments turn into ‘forward-looking guidance’ on corporate performance. The reason? Many wish to avoid potential reputational issues associated with guidance revisions, disappointing shareholders, or facing legal challenges under heightened regulatory scrutiny by the incoming US administration
In light of these headlines, it’s worth examining what critics mean by ‘woke’ and whether the associated policies and processes have truly been discarded.
Fiduciary Responsibility and ESG
Fiduciary responsibility is a fundamental and legal duty for corporate investors. Critics argue that ESG considerations distract from this duty and should be ignored. However, proponents of ESG assert that there are clear links between ESG factors and positive financial performance, ROI, and ROIC. In other words, ‘woke’ works.
A recent ruling by a US Federal Court in Northern Texas considered the issue, with the court finding that American Airlines had failed its employees by selecting BlackRock to manage part of its pension scheme, citing “ESG activism” as a breach of fiduciary duty. The court emphasised that while it is permissible to consider ESG risks through a strictly financial lens, ESG cannot stand on its own.
The Business Context
When investing, often a few key financial metrics are the focus, e.g. accelerated revenue growth, high ROIC, positive Free Cash Flow (FCF) margin, political stability and a net cash position. Understanding how the business can achieve asymmetric financial upside is critical, and this facilitates a deeper comprehension of how ESG and sustainability fit within an organisation and whether external or internal factors drive issues which are material to business performance. For example, using the Mutually Exclusive Collectively Exhaustive (MECE) profitability framework, we can drill down into these factors, creating clear linkages between financial performance and ESG variables.
Productivity, Business Performance, and ESG – case study
Productivity measures the efficiency of converting inputs into useful outputs, typically quantified as a ratio over a given period. Inputs often include labour, capital, materials, and energy.
Labour is a universal input for producing goods and services. From a social perspective, the ‘S’ in ESG is essential for a productive workforce to achieve business growth and performance. Breaking down the ‘Social’ component, we examine internal and external factors impacting productivity. This involves identifying the capabilities required to meet customer demands. This article focuses on the ‘People’ element, which includes experience, domain expertise, and motivation.
Companies aim to cultivate a high-performing culture and workforce to achieve their business targets. Critical components include effective hiring, clear goals, continuous training, employee engagement, performance management, incentive programs, accountability, and team collaboration., We categorise these under three key pillars: recruit & retain, learning & development and ethical conduct.
Example ROI – Retention
To illustrate, consider staff retention and the identified levers available for the business, noting potential externalities such as a tight labour market, and how these link to financial performance.
Problem Statement: Key employees in a region of the business (service-based) are leaving to join competitors. How do we stop this and retain our staff?
Analysis:
- Identify which employees are leaving (function, role, seniority, geography) and the short-term impact on the business.
- Assess costs, including sales impact, key relationships, skills, and the cost to hire replacements.
- Engage in exit interviews and workforce engagement to identify whether the issue is acute or systemic.
- Assign proxy for the future potential of employee – this allows you to measure the impact of the employee forecasting forwards.
Proposed Initiatives:
This can include flexible work arrangements, competitive pay and benefits, work-life balance, training and development, inclusive culture, wellness programmes, employee engagement, recognition and rewards, team-building activities and supportive leadership.
Example Calculation:
- A Director of Sales (£110k) with key customer relationships is leaving, responsible for £500k sales annually.
- Cost to business over two years includes gardening leave, loss of revenue, and recruitment costs.
- Root cause: pay and work-life balance.
- Proposed initiatives: compensation uplift, additional support staff, recruitment fee, and work-life balance benefits.
- ROI after two years is measured across two scenarios: ‘doing something’ vs. ‘doing nothing’.
Conclusion
This example illustrates the strategic integration of ESG components with business performance, establishing a transparent and compelling business case. Effective communication of these initiatives, both internally and externally, is crucial. This approach not only justifies ESG decisions but also embeds them into the corporate strategy to achieve targeted business outcomes. Given the recent scrutiny surrounding ESG, it is imperative to develop robust communication campaigns and strategies to navigate and address these challenges effectively. Ensuring the right ESG initiatives are proposed, targeted, and implemented is essential to fulfilling fiduciary duties amidst increasing contention.
The author is Sustainability Director at London-based consultancy Oury Clark
