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Keeping Governance Front and Centre: Don’t Put the Cart Before the Horse in Considering ESG


Expert insights from Dr Margaret Cullen, Founder and Principal, Think Governance Ltd. and Board Assessor, IoD Ireland. This blog has been written exclusively for IoD Ireland members.

The concept of the invisible hand introduced by Adam Smith (1)  is a metaphor for the way the market spontaneously regulates and transmutes voluntary conduct motivated by individual self-interest into the long term collective best interests of society. Climate impact and socio-economic divides within and across countries, however, tells us that the invisible hand is not sufficient to promote and ensure the prosperity and well-being of society, so the State intervenes through regulation. Striking the appropriate balance between the invisible hand and regulation becomes a central policy question. Reforming free market capitalism also requires market actors to behave ethically and recognise the social impact of business decisions. Corporate Social Responsibility (CSR) looks beyond the invisible hand of the market regulated by the State to the visible hand of management as an adjunct mechanism for regulating the interaction between corporations and society (Kirwan, McBride and O’Riordan, 2018 ) (2).

It is impossible for companies to ignore the tsunami-like emphasis on Environmental Social and Governance (ESG) issues in recent years. This emphasis has a range of catalysts including, but not limited to, environmental concerns and related government and regulatory policy (EU Action Plans on Climate, Sustainable Finance), evolving best practice in the area of stewardship (e.g. FRC’s Stewardship Code, 2018), investor expectations on responsible investing, and consumer and society sentiment. Each catalyst is ratcheting up pressure on companies to enhance their ESG framework. The level of capital flowing into funds that incorporate ESG criteria have grown considerably so what was once an issue on the fringes of investment is becoming part of the material financial analysis of a company’s value. A key question for listed company boards is whether the criteria used by institutional investors reflects the governance reality of their business as well as the criteria and timelines that the board have determined appropriate. Benchmark owners, regulators and asset managers are not yet fully aligned to the metrics and measures that matter. Unquestionably “S” as a criterion is underdeveloped and far too narrowly defined. It is not a criterion that can be easily integrated into an investment decision. There is much more to do here, a discussion of which is beyond the scope of this article. As we move further towards a more harmonized understanding of ESG, company (public and listed) boards must reflect on the strategic trajectory of their businesses in the context of the mixed ESG expectations of key stakeholders. 

The Importance of ‘G’ in ESG

For many years I have included CSR within my teaching on corporate governance, reflecting a company’s social responsibility as an intrinsic part of the system of corporate governance. ESG is essentially the new or expanded CSR and proponents put governance (G) as the third of three criteria to assess companies. In this author’s view, ‘G’ should be the overriding system which influences ‘E’ and ‘S’. I have publicly challenged the approach of including “Governance” as part of the acronym as for me, the ‘G’ is the starting point from which everything else flows, including a board’s perspective on its responsibility towards the environment and its role in society. If, as I suspect, its position within the acronym persists, its relevance must be understood well and characterised by more than just a few easy to compute metrics. 

I am often surprised at how narrowly the ‘G’ continues to be defined. In interpreting ‘G’ there is a strong tendency to focus on governance form as proxies for governance effectiveness: e.g. independent non-executive director (INED) majority on the board; ‘appropriate’ gender and cultural diversity on the board; separation of the roles of chair and CEO; and remuneration structures that demonstrate alignment between executive pay and shareholder value creation. These are all important governance elements, but following a set of guidance on governance structure is probably the most straightforward aspect of governance. Corporate governance is so much broader than this. It is a dynamic system by which companies are directed and controlled.  In broad terms, the objective is to create safe, sustainable companies that operate within the legal and or regulatory environment to which they belong. Doing so benefits economy and society. Through this dynamic system, boards must determine and execute strategy which should include, among other things, a clear understanding of the nature and extent of the company’s social responsibility, including to the environment. It is this understanding that must influence a company’s approach to “E” and “S”. In other words, a full appreciation of governance recognises that it has to be the ‘G’ that influences the E and the S. The risk is that the bigger governance picture is missed by those seeking to respond rapidly to stakeholder expectation or, indeed, by those influencing this expectation. The governance of public and private institutions plays a fundamental role in ensuring the inclusion of social and environmental considerations in the decision-making process. Companies run the risk of adopting an environmental or societal blueprint (i) without considering the adoption of this blueprint in the context of the practical realities of the business and sector within which they operate and the board’s strategic objectives and (ii) absent a very clear view at board level of the company’s purpose, role and responsibilities when it comes to the environment and society.  

Boards of directors direct by knowing first and foremost what the purpose of the organisation is. Debate within the CSR perspective centres on the extent to which various stakeholder concerns should be made integral to corporate strategic goals, and on the basis for resolving trade-offs among competing and conflicting stakeholder interests. This debate has persisted in academic circles for many years. The renowned Milton Friedman, in his book, Capitalism and Freedom (1962), argued that ‘there is one and only one social responsibility of business – to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud’. Notably Friedman also argued that in making profits for shareholders, companies must conform to the basic rules of society, both those embodied in law and those embodied in ethical custom.

The Role of the Stakeholder

Stakeholder advocates argue that companies owe a duty to all those affected by their behaviour and should be responsible and accountable to all those affected by companies’ decisions, including customers, employees and managers, partners in the supply chain, bankers, shareholders, the local community, broader societal interests, and the state. Donaldson and Preston (1995) argue that stakeholder theory “is intended both to explain and to guide the structure and operation of the established corporation. Toward that end it views the corporation as an organisational entity through which numerous and diverse participants accomplish multiple, and not always entirely congruent, purposes ”(3). The basis of stakeholder theory is a rejection of the notion that ethics and economics can be neatly and sharply separated and an assertion that a shareholder centric approach does not reflect the complexity of human activity within a company and/or the sector it operates within (Freeman, Wicks and Parmar (2004) (4). 

Refuters of stakeholder theory have argued that the task of establishing core values such as what a company stands for, and doing this in a manner that takes into account concerns across and within heterogenous stakeholder groups, imposes an unrealistic expectation on managers (Sundaram and Inkpen, 2004 ) (5). I would argue that it is not unrealistic, but it is the governance challenge.  Access to capital is pivotal for any company and the shareholder is an important master of the board, albeit not the only one. Modern day boards must be capable of managing multiple masters and proving that value and values are not mutually exclusive. 

A Clear Company Purpose

As mentioned earlier, the board must be clear on company purpose. It must define the company’s product and/or service value proposition and integrate its key stakeholders into its strategic thought process. So before getting caught up in the “G”ES tsunami, take a step back as a board and ask yourselves some critical questions. 

  • Does  the board believe it has a responsibility to be proactive when it comes to its environmental footprint beyond the regulatory imposed minimum?
  • Does it believe that companies have a responsibility to protect society from gross economic inequalities or is this the job of the state? 
  • Does the board consider the implications of its business strategy on society and/or the local community? 
  • Does the board see the company’s workforce as a cost or a valuable asset to be protected, trained and nurtured? 
  • Does the board care about working conditions in factories overseas to which it has outsourced production? 
  • Does it view its customers as transient, agile buyers of its product or as committed consumers whose allegiance to is products is brand enhancing and pivotal to company sustainability? 
  • Does it view the sustainability of its supply chain as critical to company success and recognise its role in safeguarding this sustainability?

These questions are not exhaustive but are a critical starting point to integrate “E” and “S” into the strategic, risk and cultural planning of any business, in short the “G”. 

In a later article for the New York Times (6) Friedman makes an important observation that the objectives of a manager (in terms of social responsibilities) may be different to the business owners’ and asserts: “Insofar as his actions in accord with his ‘social responsibility’ reduce returns to stockholders, he is spending their money. Insofar as his actions raise the price to customers, he is spending the customers' money. Insofar as his actions lower the wages of some employees, he is spending their money. The stockholders or the customers or the employees could separately spend their own money   on the particular action if they wished to do so”. This observation is central to the ESG discussion and evolution because it throws light on the fact that all stakeholders within the free-market capital eco-system have a key role to play in promoting stakeholder capitalism. 

The ESG Journey

For years CSR/ESG issues were a secondary concern for investors. Today institutional investors and pension funds have grown too large to diversify away from systemic risks, so they must consider the environmental and social impact of their portfolio (Eccles and Klimenko, 2019 ) (7). Clients are also demanding products with ESG related objectives.

Institutional investors must walk the talk and acknowledge that while value and values are not mutually exclusive, there may be medium term return tradeoffs and cost/revenue implications of systemic risk reduction.  In addition, investors must give companies the time needed to implement changes. This timeframe and the accountability around it must reflect industry and company context, company commitment, the practical realities of organisational, cultural and behavioural change and the long term objectives of the company. Imposing a one size fits all blueprint on investee companies may not be the answer. In addition, ignoring a company’s commitment to an ESG journey and using voting rights to penalise boards and companies that don’t meet investor-imposed criteria within investor-imposed timeframes could have unintended consequences. For environmental matters, time is certainly of the essence, but getting it right must be prioritised. 

The critical role of the consumer and the public at large in the success of stakeholder capitalism is pretty much overlooked. Consumers and the public, champion environmental change and the narrowing of the socio-economic divide that is so blatantly present in our world. Through their purchasing habits, however, they can indirectly endorse the strategy of companies and their related philosophy towards the environment and wider society. Consumers should not ignore the origins of the product they consume or the disruptive force of the product producer/distributor. For stakeholder capitalism to thrive, consumers and the public must play their part. 

The stakeholder framework does not rely on a single overriding management objective for all decisions. Rather, stakeholder management is an iterative task of balancing and integrating multiple relationships and multiple objectives. Companies that clearly define their role in society beyond shareholder value maximisation give a message to investors and customers to which these stakeholders need to respond. This must be driven from the boardroom. Let us keep the G front and centre. 


  1.  Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, 1776 and The Theory of Moral Sentiments, 1759
  2.   Kirwan, McBride and O’Riodan, 2018, Cases in Corporate Governance and Business Ethics
  3.   Donaldson, T. and Preston, L, 1995, The Stakeholder Theory of the Corporation: Concepts, Evidence, and Implications, The Academy of Management Review
  4.   Freeman, Wicks and Parmar, 2004, Stakeholder Theory and “The Corporate Objective Revisited”, Organisation Science
  5.   Sundaram and Inkpen, 2004, The Corporate Objective Revisited, Organisation Science
  6.   Milton Friedman, 13th September 1970, New York Times, “The Social Responsibly of Business is to Increase its Profits”
  7.   Eccles and Klimenko, 2019, Sustainability: The Investor Revolution, Investors are getting serious about sustainability