Realistic and Unrealistic Expectations for CEOs and Boards
There's a problem of expectations in corporate boardrooms and at shareholder meetings. A growing plurality of shareholder resolutions relate not to executive function but to the issues of carbon, climate and sustainability. This is a problem because even though these issues are seen more than ever as a sign of corporate health (see this piece from Forbes) the subjects may not be native to the day to day of running an established business. Still, there's an expectation that the most senior people in an organization are paying attention to sustainability if not climate change broadly. While this is a generally positive trend it's important to talk about when this places unrealistic expectation on executives. There needs to be a logic behind our expectations. Specifically, expectations need to be divided between situations where executive skill is wasted on carbon and climate, when a CEO's attention and skill should be expected, and when fluency (not mere attention) is critical, indeed fundamental. That is what this post will attempt to do for organizations at three different stages.
The Basic Problem
CEOs get hired for their managerial skills, networks and ability to create organizational results. Board Directors are picked for their ability to open doors, their capacity to mentor great executives, and for their deep knowledge in subjects germane to the business. Investors and boards should reflect on the practical effect of this selection process. These criteria select away from candidates with the knowledge and skills to connect a company's strategy and tactics to the ROI of climate planning and sustainability. To be fair, sustainability and climate planning aren't the only disciplines with a common boardroom skills gap. The CEO will rarely be the best salesperson, best marketer, best strategist, chief legal head or toughest negotiator at the firm (although it's likely s/he is at least one of those) , yet with these disciplines there are obvious and well defined roles which plug knowledge gaps. Roles which fit neatly under the CEO, CFO, or COO. In that way climate and sustainability really are outlier disciplines.
Confronted with a pointed question on climate related risks many CEOs find themselves lacking expertise anywhere in the org chart. As a result any actions to resolve pressure from ESG-minded investors often lack context and narrative enough to satisfy underlying concerns. Worse, CEOs and Boards in search of that narrative often blindly stumble to the first (or most commonly available) answer because they don't know the value of the project.
This leaves us with a simple question: When is it desirable to start looking for climate and sustainability expertise at the executive level? At what point need a search committee start asking questions about a potential CEO's fluency with climate risks? or sustainability? or carbon liability?
The advice that follows is constructed from help I've supplied to companies both large and small across a variety of industries spanning non-profits, manufacturing, entertainment, tech and others. There's no bright line when it comes to sustainability. Some CEOs will have climate planning incorporated into their strategy at the outset, others may not consider the issue until they are well into the mid-market. The answer is one of context but what follows should serve 90% of readers 90% of the time. (Author's Note: It's worth mentioning that 'Sustainability' has broader social and societal impacts, but for our purposes we're going to dodge those in this post. When you see 'Sustainability' written here it's intended to reflect itself in the context of climate change.)
Start up to about $100MM - You have other things to do.
Start by asking what kind of job your CEO has been hired to do. For small companies where the CEO is the company's best salesman and chief window-washer questions like these shouldn't even be on your radar. This describes niche shops, early stage companies, entrepreneurial ventures and family companies lacking professional leadership.
This advice ruffles the feathers of many activists concerned with climate change. They're right to be frustrated. In aggregate SMEs are a massive part of the economy but we're not talking about the aggregate. We're talking about what should be expected of a specific CEO. It's not reasonable for businesses in this space to make economic policy, risk management or external supply chain operations a daily focus of their strategy and that's what this can entail.
Getting the basics to run smoothly in the SME space is hard enough. CEOs and Boards in this space have other fish to fry. Will these organizations be impacted by extreme weather? Of course they will. That doesn't make it a central concern. Activists interested in this space should be looking to government to supply rules for the marketplace and leave these companies to the hard work of making a dent in the world.
+/-$100MM to +/-$500MM - Where you should be managing your risks
These CEOs have a different and more expansive mandate. They get hired to make plans for long term sustained growth, to execute a new strategic vision, or to prep the company for a founder exit/IPO. At this point it's appropriate to put climate change and sustainability on the radar. Companies of this size require professional risk management even if that isn't part of day-to-day operations. The diversifying and hedging of suppliers, detailed insurance reviews, and the tracking of industry-altering trends are all critical needs that you want a practiced hand administering. Climate and carbon planning are on that list too.
What does that mean, tactically, for the CEO of a quarter billion dollar company as opposed to her $50M or $5B counterpart? At a minimum an executive should include climate based risk assessments in whatever periodic review of liabilities s/he conducts normally. So for example, companies in this space may already have contingent plans in case:
- oil prices spike or plummet,
- a chief competitor goes out of business / gets an influx of cash / takes on new senior management,
- the company losses/gains a strategic account
- new regulation comes down from SEC/EPA/DEA/FDA/Etc.
To account for climate, carbon and sustainability it's good to think about them in terms of things you can define. Even things that are out of your control aren't beyond a level of prediction so they're useful to consider. Although any list will be different from one organization to the next consider a few of these as potential adds to the pile of concerns to make plans for:
- if operations experience prolonged drought (as in California)
- climate related material shortages (think plant and animal products like grapes, leather, dyes, cotton, fragrances)
- the cost of OPEX for heating and cooling as average temperatures and longer/hotter heatwaves arrive
- security of the built environment around facilities during extreme weather (building access, risk of flooding, age of critical local infrastructure)
- relative costs and break even points for facility security (on some of the above concerns) ranked against their cost of insurance
- municipal commitment to climate security
- exposure of the company to additional costs from carbon when priced by regulation (2-3 scenarios are helpful)
- resource and time requirements for innovation projects tied to any above concern
These points are just a sample of those that deal with scenarios whose likelihood and whose scope of impact are both knowable within a band of uncertainty. This fact places them squarely within the portfolio of possible futures corporate executive should be concerned about. It's unrealistic to expect companies of this size have the skills on staff to address the many and varied ways that climate will impact its operations and strategies. It's perfectly reasonable, however, to expect companies of this size to be retaining outside expertise who can identify exposures, prioritize actions in response, and craft the narrative that places company values at the heart of those actions. It then falls to internal resources to achieve buy in from all stakeholders, both internal and external.
In addition to actions and strategies that a company can take internally, someone with executive authority should be staying abreast of movements in the marketplace (and their sector specifically) that trade groups are involved in relative to climate. Some sectors will be more active than others. For example, shipping and technology firms, with their massive costs for infrastructure and energy, have greater clarity of the risks of rising sea levels and carbon regulation.
Finally, it's the job of the CEO in this space to talk openly and honestly about where s/he sees climate risks. Clearly there's a value for that conversation internally but it's even more important to talk with local media and policy makers. A company of this size will likely have an out-sized influence on local issues and it's important to local and regional agencies and media know what your concerns are.
$500MM+ - Where your concerns include "Vulnerabilities"
Moving to scale CEOs find an entirely different set of concerns. Their concerns revolve around an unexpected condition that emerges from climate-related risk management. Risk management relies on the basic ability to plot the likelihood of an event happening against the potential impact of that event. For example, what are the chances that a particular component of a manufactured good experiences failure and what happens if it fails? If this is a high probability event with low impact it may mean you should prep with additional customer service support. The same event with a high impact may mean a product recall. Climate breaks that mold. It breaks that mold because "likelihood" is a function of time. Although our approximations for impacts are improving, there's still too big a variable on when some impacts will happen and if they will arrive in a linear way or all on once.
To be clear, what we're talking about here isn't extreme weather events like hurricanes. Those are their own concern to model against. We're talking about the basic conditions of climate change. Questions like, "When will sea level rise impact our operations forcing us to relocate or make substantial investment?" This is a real question if you're in leisure, transport, extraction or agriculture. It's also a serious concern for any industry upstream from coastal/tidal areas or for whom water as a resource plays an outsized role. As a serious matter, but here's the problem: Once you scope possible impacts it's still maddeningly difficult to place them on a timeline. Our question about sea level for instance may conclude that there's a 70% chance that by 2050 there will be a six inch rise expected to the average height of sea level in the bay near our facility. How then to make accurate decisions about big capital projects if impacts can't be scoped with clarity. Said another way, how do you build a model for prudent investment and a reasonable ROI if timetables, impacts and rate of change are all probabilistic?
This gets back to the core of our boardroom conundrum. What do we expect of CEOs in this space? The answer, again, is in the job that they've been hired to do. CEOs for billion dollar enterprises have the daily task of integrating the efforts of many different parts of the machine. Their skill is in organizing others. They don't need to be masterful with climate but they do need to know how the subject interacts with the different parts of their company. Here's a list of six items that scope out the broad reach of climate as a factor in corporate life. A CEO dedicated to managing climate risks and creating a sustainable company should be thinking in these terms. S/he should be able to talk about climate at the level of strategy and tactics as it relates to the whole company:
- GET CLEAR ON WHAT'S A RISK Vs. VULNERABILITY - CEOs of multi-billion dollar enterprises are inherently working with organizations of such a size that they're exposed to risks that fall outside quantitative risk-management yet still deserve time and attention. For our purposes we're going to call any scenario with reasonable good information (or reasonable reliable bands of uncertainty) a Risk. Risks can be managed with established techniques. For scenarios where we depart from good information (as we do from 'likelihood' in the above example) yet where we retain well-founded anxiety we call the scenario a Vulnerability. CEOs and Boards should be active in crafting the narrative that informs how an organization addresses risks and should communicate down the threat that vulnerabilities pose even though there may not be enough information to address them. The first activity creates an opportunity to reinforce organizational norms and second an opportunity to discourage lazy thinking and encourage innovative solutions.
Example: A fashion company identifies that sourcing cotton is more challenging than in years past because of drought conditions in Egypt. They hedge this risk by diversifying suppliers and securing longer term contracts in more stable growing regions. The same business however determines that key clothing lines in South and Central America may require radical reevaluation if those markets experience an additional 30+days of 90 degree heat every year. Climate massively impacts fashion but lacking good data for when heat itself may alter tastes makes this a vulnerability. The company decides to communicate this concern down through marketing and starts looking for indicators in other industries that can be helpful.
- USE REPORTING AS A STRATEGIC OPPORTUNITY - CDP and GRI reports on carbon exposure have become a mainstream reporting mechanism in big business. Their value is that they create public accountability to drive numbers down. Large companies, and public companies especially, have reporting obligations beyond these. Internally the finance, compliance and marketing teams should be producing effective strategic communications on climate that can be published in annual reporting. It's been an obligation for some years now that public companies report on their exposure to climate liabilities in their 10-K filings. This is an SEC rule that's more honored in the breach than it is in compliance. This is a mistake. Companies can use this space to define the norms of their sector and communicate the value of their long-term planning in a way that makes the sense to the exact target audience that would care, investors. Up till now this obscure rule has been reviewed more for the sake of energy companies than core goods and services (see the great reporting HERE) but a wise grocery executive could easily frame electricity cost projections for their stores (run on solar power) against a competitive chain's (in a carbon-intensive market) as a massive competitive advantage in future earnings. It's a projection that's profoundly simple to model out mathematically and one that would play well on investor calls.
- OPERATIONALIZE AND MONETIZE YOUR WORK - Take this literally. Whomever a CEO charges with responsibility for climate and sustainability issues should be accountable to operations and finance. It will be up to the CEO to decide the right line of accountability here so depending on culture you could be looking at the COO, CFO, or both (as in a matrix org.). The point person for these concerns should have the relative authority and responsibilities of a trusted inside legal council. With legal council the inside person would be responsible for seeing that all the internal processes are getting executed in the right manner and making sure that cross departmental concerns have a logic and continuity that remains consistent. At the same time, inside council would know when to stop and bring in the big guns from an outside firm. VP of Sustainability would have the same level of importance and discretion. S/he delivers projects and initiatives that align with finance KPIs, integrate with operations KPIs and serves as the face of the company at industry events and government functions where carbon and climate are germane. Above all s/he serves as the chief translator and communicator which binds the greater mission of the company to smart practices. CEOs of large companies empower someone with this responsibility and then set KPIs that treat the work as vital.
- PROMOTE FOR SUSTAINABILITY SMARTS - We don't yet have good long term data on the value add that a Chief Sustainability Officer, VP of Sustainability or Sustainability Manager brings to the organization however what is clear is that organizations that hire for those positions are sending a clear signal to the rest of the firm and to investors about the place that the discipline holds culturally. (Just take a look at this article from MIT's Sloan Management Review for more there) What's important here is that the need for serious thinking about climate is communicated by including it in hiring practices. Managers and mid-level executives should be getting the same level of education in climate risks and sustainability that they get in lean processes or regulatory issues. A baby food company whose CMO understands that climate change encourages infectious diseases may be better prepared for the downturn in business when the next Zika virus breaks out. Climate conscious VPs of Sales may know before their clients what hotter working conditions and more frequent heat waves mean for their clients' needs and can adjust sales forecasts in advance. As you bring people up through the organization their knowledge of carbon, climate and sustainability should be one of the many things that they get education on because it's a strong market force.
- GET OUTSIDE HELP - You won't be good at everything no matter whom you hire. Bring on outside talent for the big stuff. Thorough risk and vulnerability analyses can be done to prepare you for serious concerns. Even complicated liabilities are not beyond the grasp of analysis if done with care. The right qualitative measures can prioritize your vulnerabilities and build value for shareholders and security for executives.
- PUT PRESSURE ON YOUR PARTNERS - Very few of us have the leverage of Wal-Mart, but everyone can exert some level of pressure on their supply chain and partners. The larger you are the more dangerous it is to not understand the inner workings of those you rely upon. Large companies have the power to insist that partners up and down the value chain start adopting more climate-conscious thinking. Audits of partner facilities can and should include audits of major climate hazards and questions about planning for climate risks. This is especially true in a post-Paris summit world. Supply chains are spread out across the world and established systems for analysis of where to source from will need to be adjusted as more and more nations create different policies to lower their carbon emissions. China, as one example, may not have have the same competitive advantage it used to if border adjustments seek to normalize the differences in carbon intensity of some products. This process can be compounded with layers of corporate structure that place a company under many jurisdictions at once. Holistic analysis of carbon exposures will be critical moving forward.
The state of the marketplace in 2016 is not what it was even a few years ago. Technology and globalization have pushed us into a place of long term slow growth. In this new climate incremental gains can be significant and modest missteps can be fatal. This business environment has grown investor concerns for the role that climate change and sustainability play in operations, market assessments and many other facets of corporate health. CEOs and Boards of Directors are not always filled by people with good knowledge on these topics and the fact that the issues aren't native disciplines in those circles creates a strategic weakness. There's a reasonable expectation that once a company gets to a certain size its leadership should be looking at climate change as a substantial unknown when modeling the future.
Mid-market companies need to assess climate risks to all the facets of its operations and should bring in outside help if the executive doesn't have native knowledge of the issue. Although there are a variety of issues that could pose a concern, mid-markets leadership should limit itself to risk-management of issues where good data can be extracted and scale up its appetite for analysis as it grows. This advice isn't an excuse to ignore potential hazards but a statement of time and bandwidth.
Large institutions are responsible for looking at risks and vulnerabilities caused by climate change. These can take a wide variety of forms, may defy easy quantitative assessments and will likely require outside experts to model and prepare for. Large institutions also have the internal capacity to keep someone in a sustainability focused role. While the spread of impact between an excellent VP of Sustainability and a mediocre one is not yet certain, there's a major message sent to investors by the naming of such a person. Equally important to the role is that s/he be placed in the leadership structure under operations or finance instead of marketing, as has been done by some, because that sends the most powerful message of all.
A variety of tools are available to the wise CEO and s/he should be looking for ways to use both voluntary and required reporting, hiring and advancement criteria, innovation, and KPIs to send the message to all levels of the organization that climate is a concern, sustainability is critical and that the boardroom is focused on these issues and will be watching.
I hope you enjoyed this (somewhat lengthy) post. Please share it with someone if it makes sense to. Email me if I can give you more information. Brian@ClimateMoneyPolicy.com