How to Navigate State ESG Battles

Larry Walsh

The concept of Environmental, Social and Governance (ESG) has received much attention over the last few years, with many companies taking public positions on the issue, and in several notable cases, being roundly criticized for doing so.

At its core, ESG is an organization-wide approach to improving a company’s environmental, social and governance practices as a path to earning customer loyalty, reducing costs and boosting business value. An article in the Harvard Business Review last year characterized ESG as “a function of strategic risk analysis that helps companies better prepare for an evolving operating environment.”

Companies have come under attack from the left for not moving fast enough on ESG goals, while a growing number of conservative state and local markets are pushing back against ESG. Legislative proposals in roughly a dozen states this year would penalize companies for considering environmental, social and governance factors—such as climate change or diversity issues—over financial returns.

Executives in some states have begun to object to anti-ESG restrictions. Lawmakers in North Dakota recently defeated proposals to prohibit the state government from doing business with financial institutions that have adopted ESG goals and policies. The American Property Casualty Insurance Association (APCIA) recently opposed a South Dakota bill that would bar financial companies and insurers from using ESG standards. Others have estimated that legislation and state policies banning ESG investing end up costing taxpayers and pensioners more.

Which raises the question, what’s all the fuss?

One answer: The controversy over ESG reporting is an outgrowth of the long-running fight over how companies are—or are not—dealing with global warming and the environmental impacts of their operations. And like many issues today, it has become highly political, tied up in red/blue bickering that reflects politics more than sound strategic planning. Individual companies and the broader investment community understand the many nuances of ESG, but for many it is now becoming a political litmus test.

CEOs have clearly recognized the problem. In a 2022 Fortune 500 survey, only 28 percent of CEOs felt their company had an obligation to speak out on important social and political issues. That is down from 50 percent just a year earlier. Similarly, a 2022 Harris poll found brands are being damaged by “political drama” and that staying close to customers and communities was preferable.

By most estimates, a significant portion of the Fortune 1000 have adopted or are considering some form of ESG reporting, presumably following a careful assessment of the best long-term interests of their company, its employees, customers and shareholders. So, having made the decision, how does a company prepare for the potential for criticism that may come from critics from the left or the right?

As McKinsey points out, the principles behind ESG support a company’s strategy and advance its business model. There are multiple external factors that influence corporations—from climate change and emissions, water, wastewater and the management of hazardous materials, to labor practices and the health and safety of employees, to business ethics, capital allocations and supply chain management. To produce a car, auto manufacturers have to begin to identify and source the components five to ten years before that car hits the market. They have to consider safety and emissions standards. They have to understand the consumer preferences that will determine design. Multinational corporations cannot wait to see what type of regulations will emerge; they have a fiduciary responsibility to anticipate them and work to shape their development.

Here are a few guidelines for executives grappling with state ESG pressure:

• Identify the risks to your organization. Companies that listen regularly to their constituents have a clearer sense of their concerns and can identify local issues that could become problems. Now is the time to use research to identify the issues, people, political and economic trends via polling and focus groups. This knowledge will be critical in guiding communications strategy and targeting messaging to a company’s key constituents. Ask, do we have a team in place who can address the long-term challenges this company is facing? Establish a crisis protocol that draws on experts across disciplines to help you assess risks and make decisions quickly.

• Build the business case for the policies you’re adopting. In articulating long-term risks and what must be done to address them, corporate leaders can build knowledge and understanding of their efforts in the communities they serve. They can say what they’re doing to reduce waste, reduce unnecessary costs, prepare for future environmental regulations and adopt governance policies that ensure the business is run responsibly. They can say, “We choose to provide good benefits and an inclusive workplace because we want a committed employee base, and we want to be able to recruit the best and the brightest Our policies and programs are evolving in response to events because they allow us to fulfill our obligation to stakeholders.”

• Stay away from fads, public debates and one-off efforts that risk being out of line with your mission. The less a company is aware of its constituents’ needs and concerns, the more pressure it may feel to make public statements that are inconsistent with its values and goals.

• Go overboard to educate and persuade those who matter to your business. Many of the issues that are critical to business leaders are not of particular interest to the public. It’s up to executives to define the issues in ways that are relevant to their most important audiences—whether that’s customers, residents, community leaders or policymakers. If a business has 50,000 employees in 12 states, it has an impact in those communities as employees and as residents. Business leaders can articulate that impact, educate policymakers and build communities of support. An in-depth knowledge of the concerns and interests of their key constituents can guide how companies choose to engage grassroots or GrassTops advocates, the most effective media and digital outreach, and whether to build third party support or coalitions.

• Build local alliances before a crisis occurs. Building support is even more important in state and local communities, where the players know each other, and local opposition can be generated by prominent individuals. An early assessment of a community’s people, politics and history can help guide early outreach and drive the debate. Without this analysis, a company risks being in the weaker position of reacting to it. Knowing where political support exists for ESG-related legislation—whether from state or national influencers—can help a company identify advocates and decide whether to build grass-roots support or reach out directly to decision makers. The more a business builds local knowledge of its efforts, the more inclined that community will be to support it when its efforts are questioned.

• If pressed, forcefully defend your decisions, drawing on the business case you have made. Although he took flak for it, Vanguard CEO Tim Buckley’s decision to withdraw from the Net Zero Asset Managers Initiative put the responsibility for management decisions on the executives of the businesses in which Vanguard invests.

Putting a label on any activity effectively shuts down discussion. Business leaders have an obligation to open it up and leverage local relationships to offer perspective. Even businesses in highly regulated industries can confront negative public opinion and regulatory or legislative issues that threaten their brand, market share or growth potential.

Of course, no matter what course a company adopts, it may still find itself in the middle of a firestorm. Having strong relationships with state and local constituents—and a well-honed crisis plan—will help give business leaders the support they need to weather any upheaval and stay focused on their long-term goals.

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Larry Walsh is vice chairman of the Hawthorn Group, and a senior consultant on crisis planning and response to Marsh, the world’s leading risk advisor. He is the author of several benchmarking studies, a former managing director at Hill and Knowlton, and worked on more than 30 races for the U.S. House and Senate, on presidential races in the U.S. and Latin America and he served as Special Assistant to the President during the Carter Administration.