How Private Equity-Backed Companies Can Move the Needle on Sustainability
Sustainable LeadershipPortfolio Company LeadershipPrivate CapitalSustainability
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September 22, 2021
Sustainable LeadershipPortfolio Company LeadershipPrivate CapitalSustainability
Executive Summary
PE-backed portfolio companies are struggling to make progress on sustainability goals. Here's how to drive change.
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Excerpt from the article originally published by the Harvard Law School Forum on Corporate Governance

Harvard Law School Forum on Corporate Governance published a byline by Russell Reynolds Associates' Mark Adams, Joy Tan and Emily Taylor on driving sustainability in the private equity space.

 

Sustainability commitments at the private equity firm level are not translating into portfolio company businesses 

Private equity firms are making highly visible commitments to address the challenge of sustainability. Market-leading firms, such as The Carlyle Group, EQT, and TPG Capital, now produce sustainability reports and have dedicated executives overseeing sustainability initiatives and embedding sustainability throughout the deal cycle. Other firms are even making debt funding contingent on hitting certain ESG targets. This comes in response to pressure from society at large, but also from fund investors—88% of limited partners use ESG performance indicators when making investment decisions, according to recent research by Bain & Company.

Despite these public commitments, PE-backed portfolio companies do not appear to be making consistent progress toward sustainability goals. According to the Russell Reynolds Associates 2021 Global Leadership Monitor (GLM), which surveyed nearly 200 portfolio company CEOs, C-suite leaders and next-generation executives, only 44% believe that their executive leadership teams are effectively embracing opportunities for ESG, compared to 67% of public company executives. This suggests that good intentions are not yet translating into action for portfolio companies. 

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Private equity-backed portfolio companies are not prioritizing sustainability in key operational decisions 

A first step to integrating sustainability into a business is often redesigning business models, core processes, and/or products to embed ESG and corporate social responsibility considerations. Done well, this feeds a strategic transformation that can impact customer loyalty and employee satisfaction, leading to better brand reputation and increase in market share, and eventually to higher value creation and higher deal multiples. However, GLM data suggests few portfolio company leaders are actively engaged in such activities. Only about 25% have been involved in redesigning processes, products or services with the explicit objective of improving environmental or social outcomes over the past two years. Even fewer—about 20% – are currently involved in internal efforts to examine the organization’s environmental or social impact. 

One reason few portfolio company leaders are championing sustainability may be the lack of financial incentives. Organizations communicate their priorities, such as profit and revenue, client service, and market expansion, by including them in bonus targets. Compensation strategies that encompass ESG goals are nearly non-existent at portfolio companies, with only 5% of portfolio executives reporting that they are a consideration. (To be fair, they are also nascent at public companies; just 12% of public company executives have their compensation linked to sustainability goals with compensation.) 

An additional issue is the need to embed sustainability competencies into talent considerations. Sustainability initiatives and dedicated funds cannot truly advance if leaders are not genuinely committed to the cause. This is still a rare practice at portfolio companies, with just 9% of executives reporting that sustainability experience is considered a core hiring criterion. 

To read the full article, click here.