ESG disclosure won’t save us without a deeper shift in corporate accountability

“What gets measured, gets managed...” or so they say. This cliché is repeated so often with respect to environmental, social and governance (ESG) disclosure that no-one really stops to think about its implications. This worn-out adage implies that if we simply focus on collecting ESG data, the rest will take care of itself. The result is a growing mountain of data which fosters a tick-box compliance mentality, diverting attention and resources away from the activity needed to actually deliver sustainable outcomes, and instead, creating the illusion of progress.  

It is now well documented that this line is, in fact, a misquote, and the intended meaning was closer to the following:  

“What gets measured gets managed — even when it’s pointless to measure and manage it, and even if it harms the purpose of the organisation to do so”. - Simon Caulkin, Columnist 

Recent developments in ESG disclosure are necessary and encouraging. Yet on their own, they fail to represent a genuine shift in the purpose of business, toward being a driver of long-term prosperity and wellbeing for people and planet, without a deeper transition in corporate accountability.  

Towards future-fit ESG disclosure frameworks 

The landscape of corporate disclosure frameworks is evolving rapidly, and the quality of information being shared has made significant progress in recent years. It started with a focus on backward facing data on performance to date measured against a baseline, to now providing forward facing data on progress towards future-facing scenarios. We are starting to see new legislation, such as the such the UK’s Transition Plan Taskforce Disclosure Framework which launched in September 2023 and the EU’s Corporate Sustainability Reporting Directive, that require companies to disclose their most significant inside-out impacts on society and the environment, known as ‘double materiality’. This contrasts starkly with the International Sustainability Standard Board (ISSB) framework, which only requires companies to disclose the outside-in impacts of society and the environment on their financial performance, known as ‘single materiality’. As Adrienne Buller points out in her book The Value of a Whale, the single materiality approach asks “not what you can do for the climate crisis, but what the climate crisis will do to your portfolio?” The double materiality approach asks both. The development towards double materiality disclosures will therefore broaden the relevance of corporate disclosure and enable a much wider range of stakeholders to hold companies to account.  

Most significantly, we are beginning to see the introduction of context-based accounting against widely recognised norms and thresholds. These thresholds represent the minimum impact a company must deliver to meet the scale of our sustainability challenges, beyond which they are contributing to the restoration of the stocks of social and environmental capital on which they and the rest of the economy depend.  

This is best represented by the introduction of science-based climate targets and disclosure, which indicate how a company is performing against an independently verified transition pathway consistent with the normative threshold of maintaining within 1.5°C warming above pre-industrial levels. We are starting to see companies report whether they are helping to replenish groundwater faster than the minimum recharge rate - the threshold necessary to keep aquifers stable or growing over time. On the social end, we are beginning to see companies report the proportion of workers in their supply chains being paid a ‘living income’, the threshold above which people can afford a decent standard of living for all members of their household. This concept of sustainability thresholds underpins the design of the Future Fit Business Benchmark and the Science Based Targets for Nature, but is lacking from many of the mainstream disclosure frameworks.  

Sadly, too many companies treat science-based targets as a ceiling, rather than a floor to their ambition. However, the point these metrics highlight is that being ‘net-positive’ or ‘giving back more than we take’ is no longer enough. They help companies and their stakeholders understand what it would take to cross the thresholds that enable the social and environmental systems on which we depend to thrive and crucially, how far we still have to go to reach that point. 

A new consensus: from shareholder primacy to stakeholder capitalism 

But in our rush to improve the quality of ESG disclosure, we need to stop and ask ourselves what this information is for? The question of who should be able to hold businesses to account, for what and what information they need to do so - gets to the very heart of the purpose of business in society. Each business is locked in a web of transactional relationships with a variety of stakeholders: from shareholders to customers, employees, suppliers and communities, and ultimately to nature and society. Yet for the past five decades, this question has had only one answer: businesses should be accountable to their shareholders for maximising corporate profits, and thereby shareholder wealth.  

This answer has rested on a number of well-trodden yet shaky justifications. First, that shareholders are ultimately owners of corporations because they represent the residual claims on the corporation’s assets. And second, that it’s in the interests of society for all individuals, including shareholders, to maximise their self-interest, subject to the rules governments put in place to fix “market-failures” such as externalities. These justifications are beginning to break down in the face of existential environmental and social crises that undermine all our interests, and which this system of corporate accountability has not only failed to prevent, but contributed towards.  

In recent years there has been an apparent shift in the consensus surrounding corporate accountability, away from ‘shareholder primacy’ and towards ‘stakeholder capitalism’, which attempts to reconcile the competing interests of stakeholders in the name of ‘long-term financial value creation’. The World Business Council for Sustainable Development states that “our work in this area is designed to help companies succeed by making stakeholder capitalism real and rewarding for business”. While Larry Fink, CEO of Blackrock Asset Management asserted that “in today’s globally interconnected world, a company must create value for and be valued by its full range of stakeholders in order to deliver long-term value for its shareholders.” 

The question is whether this really represents a meaningful change from shareholder primacy? The definition of fiduciary duty (the legal mechanism which maintains shareholder primacy) in most jurisdictions already explicitly authorises directors to consider the interests of other stakeholders and ESG factors, in so far as these affect long-term or ‘enlightened’ shareholder value. However, in practice, directors rarely give these interests equal weight, and studies show the decisions that result from this model are indistinguishable from those made under the traditional shareholder primacy model.  

Current strategies for shifting corporate accountability 

There are two strategies currently being employed to try and shift corporate accountability. The first is to build evidence of the links between decisions that contribute towards the immediate systemic crises we face that erode long-term shareholder value. This is what the proponents of single-materiality ESG disclosures are trying to achieve, and is precisely the reasoning behind ClientEarth’s lawsuit against the directors of Shell for neglecting to address the risk of climate change to the company, to the detriment to its shareholders. The case was recently dismissed on the basis of insufficient evidence to meet the exceptionally high bar set to justify court rulings on corporate decisions, a sign of how difficult this strategy might be to achieve in practice. 

The second approach is to empower other stakeholders to hold a business accountable in ways that meaningfully affect its bottom line. The discourse around ESG disclosure tends to assume this data is only relevant to investors and financiers as they decide where to allocate capital. However, other stakeholders are also involved in transactional relationships with corporations, and the flows between them can also be used as levers with which to influence corporate behaviour. To name just two examples, insurance companies decide what price to set premiums to reflect risk and incentivise certain behaviours, in return for guaranteeing claims against uncertain events. Employees decide which company to offer their labour to in return for a salary, based on a number of characteristics such as location or reputation. All of these transactions can affect a company’s bottom line. Therefore, we need to think of double-materiality ESG information as also being relevant to these stakeholders, so they too can make informed decisions about the transactional relationships they enter into with businesses. This will require making this information accessible in new ways. For example, how often do we see a company's ESG performance listed alongside the salary or location on a job listing, or as a search filter on recruitment platforms such as Indeed or LinkedIn? 

However, both of these strategies, while useful, ultimately reinforce the idea that directors should continue to maximise long-term profit and share prices as the key indicator of their success, because they encourage stakeholders to leverage ESG information in ways that affect the company’s bottom line. Neither of them, therefore, represent a genuine shift in the purpose of business away from profit maximisation as an end-in-itself, and towards profit as a means to creating long-term social and environmental value. 

Goodhart’s Law: Toward comprehensive corporate accountability and disclosure  

There is a concept in economics known as Goodhart’s Law which challenges the management cliché I quote at the beginning of this article. It states that “when a measure becomes a target, it ceases to be a good measure.” This is because the incentives created to game the target undermine its original intention. The classic example is known as the ‘Cobra Effect’, in which the British Government in India tried to reduce the cobra population by offering a financial reward for cobra tails. This simply created a perverse incentive to breed more cobras in captivity. The relevance of ‘Goodhart's Law’ is that not only has the sole focus on profit and share price neglected and exacerbated social and environmental concerns, it has also created perverse incentives to manipulate share prices via excessive buybacks, dividends, financial engineering and low levels of investment. This is also the same mechanism behind ESG greenwashing. If we incentivise good ESG performance with higher share prices or return on investment, this will lead some companies to identify accounting tricks which appear to boost their ESG score while ignoring issues created by their fundamental business model. 

The frustrating implication of Goodhart’s law is that the world is too complex to reduce the purpose of business down to advancing to a single metric or the narrow interests of a single stakeholder. True leadership in this world of increasing uncertainty requires directors to shift their mindset from maximising profit, to satisfying a variety of financial and non-financial goals while balancing a variety of interests in the face of unavoidable immediate trade-offs. This balancing act needs to be guided by a sense of fundamental purpose. Shareholders, as fellow citizens, friends, family members and colleagues, are also too complex to possess only financial interests. The most audacious strategy, signifying a genuine shift in the purpose of business, would involve expanding the definition of directors' and shareholders' “interests” to include non-financial objectives.  

A good example of this in practice is Cafédirect, a UK-based publicly traded company, whose fundamental purpose is locked into their governance structure through their articles of association and via a Guardian Share Company that controls veto rights to protect the company’s mission from hostile shareholders. Meanwhile, they have appointed coffee producers to their board of directors to represent a variety of stakeholder interests in their governance structure. This is the sign of a company whose purpose is maximise social and environmental value while remaining profitable. The effect is to signal to current and potential shareholders the core values of the business and appeal to their non-financial interests. Narrow-minded or short-sighted investors who can’t see the value (in the broadest sense of the term) in this way of doing business are free to put their money elsewhere. Those who are prepared to stick around should engage their other portfolio investments to follow Cafédirect’s lead.  

Ultimately, effective ESG disclosure proves necessary yet insufficient, given the potential for manipulation within any external or transactional reward structure. Effective ESG disclosure must follow a deeper imperative: aligning a business's governance and accountability with its fundamental social purpose.  

If you would like to work with Forum for the Future to create a future-fit corporate disclosure and accountability mechanism, one that creates an enabling context for shifting the purpose of business, please contact Charlie Thorneycroft.