The time has come for leaders to collaborate with stakeholders to identify, manage and report material ESG risks — and incorporate them into their business models and operations
In the current environment, ESG risks pose one of the greatest threats to public companies’ abilities to deliver predictable results. A recent Bank of America study calculated that 24 ESG incidents in the period 2014–2019 cost U.S. public companies over $500 billion in market value.
Given the threat posed by ESG risks, some argue that superior risk management is a leading indicator of future financial performance, while many lenders and institutional investors view the firm’s ability to successfully navigate ESG risks as a proxy for management quality. And there is growing evidence that companies judged by investors to effectively manage ESG risks are rewarded with lower costs of capital and higher valuations.
ESG risks are potential environmental, social or governance hazards that can keep companies from achieving their stated objectives. Enterprise risk management (ERM) is a process whereby executives, under the board’s oversight, identify, quantify, mitigate and monitor the firm’s material risks. With increasing demands for transparency and more regulations, environmental risks such as climate change, loss of biodiversity and single-use plastics; social risks such as those arising from concerns about equity, diversity, and inclusion; and governance risks associated with corruption, cybersecurity and tax transparency present new challenges for directors.
One of the most prominent ESG risks facing companies today is, of course, climate change, which poses systemic risk to companies across sectors and geographies. Research by the Sustainability Accounting Standards Board (SASB) found that 89 per cent of industries may be materially affected by climate change risks, including physical and regulatory risks. Given the ubiquity of climate change risk, investors and lenders cannot diversify away from its expected negative effects. Rather, investors and lenders must encourage all companies in their portfolios to manage it.
Unfortunately, few corporate boards have experience addressing climate change and other ESG risks. One study of 1,188 Fortune 100 company board members found that only 29 per cent of their directors had relevant ESG experience, which is an improvement over an earlier study reporting that only 17 per cent of boards had at least one director with ESG experience. A 2022 paper by the National Association of Corporate Directors (NACD) found that although 47 per cent of directors see climate change as an issue, only nine per cent see it as a top priority discussed at all levels of the company.
[This article has been reprinted, with permission, from Rotman Management, the magazine of the University of Toronto's Rotman School of Management]