Companies don’t win over investors just by issuing sustainability reports and engaging in other standard ESG practices. What they need to do, says Harvard Business School’s George Serafeim, is integrate ESG efforts into strategy and operations. He makes five recommendations: Identify the material issues in your industry and develop initiatives that set your firm apart from rivals; create accountability mechanisms to ensure the board’s commitment; infuse the whole organization with a sense of purpose and enthusiasm for sustainability and good governance; decentralize ESG activities throughout your operations; and communicate regularly and transparently with investors about ESG matters.

The Board’s Role in Sustainability

To build long-term profitability, boards of directors must pay more attention to ESG concerns—and a compelling corporate purpose should underpin their efforts. That’s the contention of the authors, who offer a research-based framework called SCORE to guide boards’ actions: Simplify—define and communicate your purpose clearly; Connect—link your purpose to strategy and capital allocation decisions; Own—ensure that all employees embrace the firm’s mission and have the means to deliver on it; Reward—tie executive compensation to metrics that include ESG performance; Exemplify—use data and narrative accounts to show stakeholders how you’re achieving your purpose and improving sustainability.

The Challenge of Rating ESG Performance

Over the past decade, more and more institutional investors have taken an interest in companies’ records on environmental sustainability, social responsibility, and governance. In this article the head of ESG research at Sustainalytics, which gathers information on tens of thousands of companies worldwide, explains why this data matters and how his firm arrives at its performance ratings. The process involves identifying the risks a company faces, assessing how well it’s managing them, and engaging in follow-up dialogue to ensure accurate analysis. MacMahon also discusses why certain companies’ ratings have improved or worsened and how to put your best foot forward.

Until the mid-2010s few investors paid attention to environmental, social, and governance (ESG) data—information about companies’ carbon footprints, labor policies, board makeup, and so forth. Today the data is widely used by investors. Some screen out poor ESG performers, assuming that the factors that cause companies to receive low ESG ratings will result in weak financial results. Some seek out high ESG performers, expecting exemplary ESG behaviors to drive superior financial results, or wishing, for ethical reasons, to invest only in “green funds.” Other investors incorporate ESG data into fundamental analysis. And some use the data as activists, investing and then urging companies to clean up their acts.

It’s an open question whether ESG issues will remain as salient to investors during a global pandemic and the associated economic downturn—but my bet is that they will. That’s because companies are likely to be more resilient in the face of unexpected shocks and hardships if they are managed for the long term and in line with societal megatrends, such as inclusion and climate change. Indeed, in the opening weeks of global bear markets following the spread of Covid-19, most ESG funds outperformed their benchmarks. And when colleagues and I looked at data for more than 3,000 firms between late February and late March 2020—when global financial markets were collapsing—we found that the ones the public perceived as behaving more responsibly had less-negative stock returns than their competitors. I believe that longer term, the crisis is likely to increase awareness that companies must consider societal needs, not just short-term profits. The recent prominence of the Black Lives Matter movement, too, is creating a groundswell of support for strong diversity policies and fair employment practices. It seems clear that companies will be under growing pressure to improve their performance on ESG dimensions in the future.