Futuristic buildings with vines hanging down

Three-part series: ESG and employment law – what it means for your organisation: Part 3 – Governance

Part 3: The G

In parts 1 and 2 of the series, we looked at the ‘environmental’ and ‘social’ aspect of ESG and its relationship with employment law. This article focuses on the ‘governance’ element.

Governance is concerned with how a company is led and managed. It looks at its decision-making structure, how it distributes responsibilities internally, and also the systems, rules and practices it has in place. Governance reflects how the social and environmental aspects are monitored and managed and oversight of ESG matters lies with the board of directors.

Governance also focuses on the wider regulatory aspects – such as legislation and sector specific regulations. Many regulators across a range of sectors (such as financial and advertising standards) are holding companies to account and the Competition and Markets Authority is so concerned with greenwashing that it’s produced a Green Claims Code and has announced investigations into companies alleged to have made misleading sustainability claims. Various pieces of legislation – from reporting on the gender pay gap to publishing modern slavery and human trafficking statements – have been introduced to ensure minimum standards are met.

As we discussed in Parts 1 and 2, the ‘E’ and ‘S’ are becoming increasingly regulated areas and therefore businesses ought to to ensure compliance with requirements set externally by central government and regulators, as well as ensuring they have effective internal governance in place. Internal governance isn’t just about setting objectives and an ESG agenda: it’s also about measuring performance against agreed benchmarks to track progress and remain accountable.

Organisational and leadership structure and make-up is key here. Executives and senior leaders have pivotal roles to play in setting and implementing the ESG agenda. Indeed, under section 172(1) Companies Act 2006, directors must have regard to the impact of a company’s operations on their community and environment. The board of directors is accountable for the long-term success of a company and it’s crucial for good governance that a focus on environmental issues, sustainability and social aims is embedded into long-term decisions. That being said, from an employment perspective, a company’s HR department is also likely to be very influential in helping shape the company’s approach to ESG.

Many businesses have HR representation in the boardroom, which can influence strategy and culture. Some companies have dedicated sustainability directors or committees which have executive responsibility for delivering ESG objectives and improving sustainability in the organisation – members of the board who are tasked with ESG issues will be familiar with the requirement to exercise reasonable care and skill (section 174 Companies Act 2006) based on the knowledge, skill and experience a director actually has, and would be expected to have, which will be highly relevant to those leading on ESG matters. As well as ensuring the board has appropriate ESG knowledge and expertise, ensuring representation in terms of gender, race, neurodiversity (to name a few) is also important. Having a diverse board helps ensure that a range of opinions and experiences from people with different backgrounds are involved in strategic decision making, which leads to more robust, well-rounded decisions.

Parts 1 and 2 in this series of articles covered some of the key considerations when looking at how to enhance a company’s social and environmental credentials. As flagged previously, these are issues which need to be driven from the top of an organisation and filtered down. Some of the key governance issues to think about are:

  • Strategy – ESG is firmly on the agenda for most businesses, and ensuring the board has a mission statement, and a strategy to get there, is the first step in ensuring ESG is a meaningful and integral part of the company’s success, rather than just paying lip service to it.
  • Collecting data and reporting – the work does not stop once a strategy has been developed. A key aspect of good governance is ensuring data is collected and reported back to the board, so that progress can be measured. For some companies with a very strong ESG agenda, ESG-related information and data will be given equal importance as financial information. There are a number of areas where data can be collected and reviewed, for example:
    • Gender and ethnicity pay gap reporting – it’s a legal requirement for businesses with a headcount of 250 or more employees to report on their gender pay gap statistics. There is no legal duty in relation to ethnicity pay gap reporting, however a number of businesses are reporting voluntarily in the interests of transparency. Reporting on pay gaps helps an organisation to identify the areas they need to address. It also allows external stakeholders such as job applicants and clients to assess whether they want a relationship with the organisation.
    • Collecting diversity data – collecting diversity data allows businesses to measure their performance in terms of diversity, inclusivity and equity. If employees or job applicants are willing to disclose their data, it can help an organisation to identify issues and inform future strategy and targets. Once future targets are set, progress should be monitored on an ongoing basis.
  • Policies – see our previous articles for some suggestions of the types of policies a business will want to consider implementing to bolster its ESG agenda. Policies should also be periodically reviewed to ensure they remain current and fit for purpose. Linked to this, it is not sufficient for policies to simply exist: staff should receive training on key policies (such as whistleblowing, anti-discrimination and harassment) so they can effectively deal with any issues that arise.
  • Remuneration – executive pay levels have come under scrutiny recently, as discussed in Part 2 of this series. Shareholders are increasingly willing to challenge executive pay awards and the disparity between the average employee’s pay and CEO pay can say a lot about an organisation’s values, and indeed, governance. It’s also worth noting that more than half of FTSE 100 companies include ESG measures as part of their executive incentive plans. Ensuring the key ESG aspects are linked to remuneration helps incentivise sustainable decision-making and moves away from the (arguably unsustainable) focus on short-term financial performance.

As the final strand of ‘ESG’, good governance is a necessity for businesses to succeed and it should firmly be on the agenda for both HR and the board of directors. Employers who fully embed their ESG agenda into the organisation will benefit from a competitive advantage, with evidence pointing to improved profitability and reputation.

To discuss any of the issues raised in this series of articles, or for any other employment related queries, please do not hesitate to contact Bethan Jones.