The ESG execution gap: What investors think of companies’ sustainability efforts

Investors told us that the top priority for business should be the development of innovative products, services and ways of operating (83%). Ranked second is the need to maintain profitable financial performance (69%). And environmental, social and governance (ESG) outcomes also appear among investors’ priorities for business: data security and privacy ranks third (51%), effective corporate governance is fourth (49%), and reducing greenhouse gas emissions (44%) rounds out the top five (see figure below).

What’s more, investors believe that the business terrain is shifting. Although inflation and the macroeconomic environment are today’s towering risk factors, investors see them abating over the next five years. The threat of climate risks is expected to increase over that time frame, along with threats related to cybersecurity. Innovation—investors’ number one priority—could help companies temper both cyber and climate risks, and even open up new market opportunities for fast movers.

The investors who took our survey reported some noteworthy shortfalls in business’s effectiveness on two fronts: delivering outcomes that matter to investors and reporting on those efforts. For three of the top five outcomes that investors want companies to deliver, investors say that the effectiveness of business action matches the outcome’s level of priority: seeking profitable financial performance, ensuring effective corporate governance, and ensuring data security and privacy.

But investors see an effectiveness gap in other priority areas. They think companies are less effective at being innovative and reducing greenhouse gas emissions, relative to those outcomes’ respective priority levels. Since being innovative is investors’ top priority for companies, that area arguably warrants more attention from management teams. And if business’s response to climate change rises as an investor priority in the coming years, as our survey findings on threats suggests it will, then companies will need to raise their game there, too.

Of course, investors’ perceptions of overall business effectiveness on priority outcomes are shaped in part by corporate reporting, which is one of many sources of information they use to assess a company’s activities and performance. Our survey responses show that investors see a stark effectiveness gap in corporate reporting. Whereas reporting on financial performance and corporate governance is perceived as effective relative to their respective priority levels, reported information on innovation, data security and greenhouse gas emissions is far less so (see figure below). Given investors’ emphasis on innovation and a likely increase in both climate pressures and data complexity, companies would do well to step up their disclosures on how they’re addressing these topics.

For reporting to be effective, it must be relevant and reliable. Yet, we found a gaping trust deficit: the vast majority (87%) of investors surveyed perceive that company reporting on sustainability performance contains greenwashing. One of our US-based interviewees referred to it as ‘some fluff in the corporate ESG dialogue.’ Another interviewee, based in Japan, said, ‘I wonder whether companies are just drawing pictures about the UN’s Sustainable Development Goals to make it look good or they are sincerely taking actions toward them.’ Below, we’ll explore in more detail what could make reporting more trustworthy.

Despite that trust gap, investors believe they are generally effective at allocating capital to support businesses in achieving their priority outcomes. Longer term, however, investor sentiment about effectiveness will be important, particularly if capital allocation is tied to perceptions of overall management performance and reporting quality.

Investors largely think that companies should take steps to address risks and opportunities associated with climate change—but they also want to know the business rationale and financial implications of such actions (see figure below). Seven in ten agree that businesses should have initiatives to reduce emissions and should develop products and processes that are climate-friendly. Similar numbers of investors say it’s important for companies to report the relevance of sustainability to the company’s business model (69%) and the costs of meeting sustainability commitments (73%). As one of our European-based interviewees said, ‘Companies need to focus on the big picture. The sustainability risks of the company should be considered in the light of all the risks of a company, including the financial.’

There’s a parallel desire that progress not dampen investment returns, for investors have a fiduciary duty to maximise returns for their clients. Four out of five respondents (81%) say they would accept only a one percentage point or less reduction in overall returns for companies in their portfolios that take sustainability actions. Those include both activities that have a beneficial impact on society or the environment and sustainability activities that are relevant to the business’s performance and prospects.

As part of the push for financial discipline, investors seek greater transparency on the economic impact of companies’ sustainability agendas. Two-thirds of investors say they would want companies to disclose the monetary value of the effects their actions have on the environment and society, although no agreed-upon methodology exists for doing so. Although valuable to investors, such disclosures could also give leaders a better basis for the direction, funding and execution of sustainability strategies over the long term.

Investors place lesser value on company sustainability disclosures relative to other information available to them. This indicates a more pervasive lack of trust in what companies report on sustainability goals and progress. Our interviewees pointed to assurance as a way to build their confidence.

Three-quarters of respondents say their confidence in sustainability reporting would receive the biggest boost if it were assured at the same level as companies’ financial statements (i.e., reasonable assurance). One of our UK-based interviewees stated, ‘If there is assurance on sustainability reporting, I think the purpose should be the same as the audit of the financial statements so that the reader can be comfortable that what’s reported is reasonably accurate and relevant.’ Investors are less likely to have confidence in limited assurance opinions, which are largely what companies seek for elements of their sustainability reporting today. Ultimately, investors expect assurance work to be undertaken by regulated firms that employ independent experts with high levels of sustainability knowledge and expertise in applying professional scepticism (see figures below).

Our interviewees also highlight other fundamental issues that need to be addressed. Among them are building the requisite knowledge of investors, companies and auditors; building capabilities for assessing forward-looking estimates; ensuring that reporting is complete; and communicating ‘key (or critical) sustainability assurance matters’ in sustainability-related audit reports, similar to what investors get with today’s audits of financial reporting.

Looking forward, companies will need to be ready with more reliable reporting. Investors know this will take time. They report that they would be unlikely to take abrupt actions such as divesting their stakes in companies that have received a qualified audit or assurance opinion on their sustainability reporting. In the first instance, investors say they would see a qualified opinion as a way of understanding the maturity of a company’s reporting processes and oversight. Beyond that, they might also seek more information from the company’s audit committee (or equivalent). Companies should be ready to explain and engage.

Given today’s business environment and its multiple cross-currents, companies may reason that sustainability goals, with their attendant rigorous organisational efforts and investment requirements, might need to be pushed further out. Investors, as our survey indicates, believe that action, and more transparent reporting of it, are required. Drawing on these findings, along with earlier research and our ongoing work helping companies with tough business decisions on climate, we offer actions in three areas to guide executives’ immediate initiatives and help meet investor demands.

Integrate sustainability factors with core business strategy and decision-making. As our survey suggests, sustainability outcomes have become too important to investors for companies to treat them as mere add-ons. Instead, sustainability should be embedded into business strategy and processes for making decisions about capital allocation, investment, and other activities involved in strategic execution. In our experience, these integration efforts are most successful when companies start with a set of sustainability goals. From there, they can seek new ways to compete, assess what organisational capabilities will be needed and define bold actions across time horizons. One global chemical company we know provides an example of how this works. The company modified many of its products and processes after the realisation that its carbon-intensive offerings could end up being outlawed or shunned by customers. It undertook a far-reaching product portfolio review to gauge the environmental impact, understand what needed to change and determine which products could be re-engineered to add the most value. We find that when leaders show investors how they connect sustainability with their strategy—as this company did—it better signals how they’re gearing their companies to long-term value. As one of our European-based interviewees aptly said, ‘The whole house needs to move. Employee remuneration and operational and financial targets need to be aligned with the company’s sustainability goals.’

Measure the value of today’s climate risks. The threats to operations, infrastructure and supply chains from climate disruptions are growing. That’s also true of risks arising from social changes that reshape demand and energy systems. So, it’s not surprising that investors want companies to demonstrate how their strategies mitigate risk and how they protect, and even enhance, enterprise value. To this end, leading companies are refining how they identify and measure climate risk and related environmental issues. They start by focusing on risk exposures, segregating them into discrete classes. These include transition risks (such as the impact on company valuation, future insurance premiums, compliance costs to meet evolving regulations, and taxes imposed on companies with higher carbon footprints) and physical risks (including damage to assets by severe weather and potential disruption in resource availability). There are opportunities as well, including lower costs from more effective resource use, burgeoning demand for climate-friendly products, and subsidies and incentive payments. Some companies are using modelling tools to hone their estimates of threats and opportunities. They apply the findings across business units to create a comprehensive risk portrait.

Track and report sustainability performance with the same rigour and data quality as financial performance. Investors want to trust company sustainability reporting. However, such reporting is often cluttered with operational measures that lack financial or strategic context, so it’s not surprising—as we have shown above—that most investors believe some greenwashing exists. Companies should focus their reporting on what matters most to their stakeholders about efforts to embed sustainability in their strategy and operations. New sustainability reporting standards are in development that could increase clarity, consistency and comparability. Companies should get started today to bring sustainability and finance teams together to review data sources. This can make sustainability reporting more meaningful by placing it in a financial context, while breaking down data silos across the organisation. Companies should also strive to reduce the risk of greenwashing. They can do this by incorporating effective systems, controls and oversight into their reporting process to make it accurate, reliable and trustworthy. Obtaining assurance from independent practitioners who are experts in applying professional scepticism can also raise the trust quotient.

Looking ahead, investors will only step up the pressure on companies to meet climate goals with more effective action—and higher levels of transparency to assess progress. It’s up to organisations and their leaders to push ESG to the forefront of strategy.