ESG & Cognitive bias inside the boardroom: ESG is here to stay and will continue to disrupt business models

February 16, 2021 6:16 AM

The board’s role is to develop a strategy for the enterprise’s long-term success; ESG is the critical element to long-term success

Environmental, social and corporate governance (ESG), too, is being interpreted in many ways. For the sake of this piece, let’s take up three biases that commonly abound in the boardroom. (Representative image)

By Santhosh Jayaram

Recently I was invited to share my thoughts at a conference in Africa. The topic assigned to me was quite interesting: ESG—The Elephant inside the Board Room. It reminded me of the popular fable ‘The Elephant in the Dark’, wherein a group of blindfolded men are trying to conceptualise what the elephant is like by touching it.

The first person feels the trunk and proclaims it is like a snake. The one who feels the ear says it is like a fan. The next touches the legs and summarises that it’s a pillar, and the fourth one who feels the tail announces it’s like a rope. The parable illustrates that one’s subjective experience can be real, yet it could be very different from the objective reality.

Environmental, social and corporate governance (ESG), too, is being interpreted in many ways. For the sake of this piece, let’s take up three biases that commonly abound in the boardroom.

The first is confirmation bias, which seeks information that confirms the initial judgment of the individual.

It is possible that due to the collective wisdom of the past, the board would like to see evidence that confirms a postulate. Can anybody have evidence to show the future? There must be deliberate discussions on potential scenarios and hedging across potential futures.

The ‘inconvenient truth’ of climate change is already precipitating. The other inconveniences include diversity, executive pay, polluted air, polluted water, human rights, hazardous waste and plastics, among others. No resulting impact will be black swan events; these are grey rhinos marching at us.

The second is selection bias, which results in unintended decision outcomes because of a lack of representation in a sample. Of late, we are witnessing more and more companies requesting benchmark studies around ESG. These requests come most often with a sample list of organisations in the same sector and possibly in the same geography. There is a selection bias to this approach, which closely ties with the herd mentality. Many business models are impacted not by somebody in the same sector. With technology proving to be an ultimate leveller, trying to study similar industries can be a critical mistake.

The third one is hyperbolic discounting bias, where the focus is short-term gains rather than longer term. For long, this bias in many boardrooms has managed to keep out the discussion on ESG, but any longer will be drastic.

In most boards’ remit, it is very clearly mentioned that the board’s role is to develop a strategy for the enterprise’s long-term success. ESG is the critical element to long-term success, and that has been proven with data over some time.

To be fair, it requires a high level of conscious effort to overcome these biases and chart a meaningful strategy encompassing ESG. One of the proxies for the diversity of thought and reducing these biases is demographic and skill diversity on the board. ‘Great minds need not think alike’ should be the motto inside the boardroom. There should be voices inside the boardroom representing stakeholders who are impacted. It should include employees, customers, vendors, suppliers, the environment, and even the future generation.

The updating of influential groups like the WEF and Business Roundtable in favour of stakeholder capitalism signals the end of Milton Friedman’s doctrine. Today, boards need to be organised to include this change. There have to be clear responsibilities and evaluation metrics for the boards’ performances on ESG, and this also needs to be transmitted to the executive level.

ESG is here to stay and will continue to disrupt business models; and the boards that lead and direct companies with the right approach by overcoming such biases will ensure the success of companies into the future.

The author is partner & head, Climate Change, Sustainability and CSR Advisory, KPMG in India

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