Family Business: ESG strategy in family businesses: Compliance or transformational goal?

This article first appeared in Wealth, The Edge Malaysia Weekly, on December 27, 2021 - January 09, 2022.
Family Business: ESG strategy in family businesses: Compliance or transformational goal?
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A piece of news on Nov 25, 2021, took the internet by storm and was widely shared on social media. In the spotlight was ATA IMS Bhd, an electronic manufacturing firm based in Johor that received a notice of termination from its main customer — Dyson Ltd — over allegations of forced labour practices. The news not only shocked the investors, but the termination could also mean a huge blow to Malaysia, as the country is a major electronics hub in the region. 

Some may ask, “Is the alleged forced labour practice a big issue?” The answer is, “Yes, it is”. This is because such a practice does not comply with environmental, social and governance (ESG) policies.

What is ESG? According to Investopedia, ESG criteria are a set of standards for a company’s operations that socially conscious investors use to screen potential investments. Environmental criteria consider how a company performs as a steward of nature. Social criteria examine how a company manages its relationships with employees, suppliers, customers and the communities where it operates. Governance deals with a company’s leadership, executive pay, audits, internal controls and shareholder rights.

In fact, ATA IMS is not the only company caught up in ESG concerns. You may recall seeing in the news that several plantation and rubber glove companies have faced increasing scrutiny in recent years due to reports of destruction of tropical jungles and labour abuses. United States Customs and Border Protection found abuses by some of them and barred their products from entering the US market. 

ESG issues have also been gaining more attention in the context of corporate finance. Based on an interview conducted by the OECD Secretariat in 2020, most banks incorporate sustainability considerations into their corporate lending activities owing to investor demand, civil society pressure and a growing understanding of the material impact of ESG on the financial performance of corporates. 

This recent news shows how organisations are under pressure from regulators, investors and the public to take responsible and sustainable actions. With this in mind, embedding ESG into business strategy to build long-term resilience and well-being is critical.

Role of family businesses in ESG

With the trend of a global transition to ESG compliance, should family businesses lead by example?

Family businesses are the economic powerhouses that drive local, national and global economic development. They not only contribute to global gross domestic product but also provide a large number of employment opportunities. For instance, as reported by the 2021 EY and University of St Gallen Family Business Index, the largest 500 family businesses in the 2021 Index generated a total of US$7.28 trillion in revenue, employed 24.1 million people worldwide and were distributed in 45 jurisdictions. 

Family businesses are often value-oriented and have long-term investment goals. One of the main reasons is because they are not affected by the pressure of the quarterly reporting cycle like listed companies. Family businesses think long term, as their main goal is to continue the legacy for future generations. 

With their dominance in the economy and the labour market, family businesses can change the world by increasing their impact across sectors and geographies by making ESG issues their priority.

AIR model to help family businesses fulfil ESG commitments

The call for ESG commitment and the importance of compliance is evident, but we have seen little effort or enthusiasm from family businesses thus far. According to a new global survey conducted by PwC network with 2,801 family business owners across 87 territories, although more than half (55%) of the respondents believe their company has the potential to lead on sustainability, only 37% have a defined strategy. Many lack interest in ESG commitments owing to their reluctance to change, and their risk-averse attitude. 

In generational family businesses, the reluctance to change can be prevalent, and it can be a great challenge for next-gen family members to persuade the incumbent leader, more so if he or she is the founder. 

The perceived risk can also deter family businesses from adapting to ESG, thinking that the need for new processes or resources may bring in more risks than benefits. For example, one perceived risk is hiring an expert who might implement entirely new processes that are not in line with the founding values of the family business. 

However, with global trends, increased pressure for ESG compliance for a sustainable future, as well as more policies in place, non-ESG compliant companies risk being driven out of the market. Thus, the benefits outweigh the risks.

Therefore, a major question is “How can family businesses respond to the urgent calls for ESG commitment?” 

We developed the AIR model that family businesses can adopt. The model encompasses three areas — awareness, implementation and measurement, and reporting transformation.

1. Awareness

Many family business leaders are members of associations and clubs specifically formed as a platform for business families, such as the Family Business Network (FBN). Such a platform provides the space for business families to network, learn new knowledge, share experience and exchange opinions.

Business families can leverage such platforms to raise awareness of ESG commitments by exchanging opinions and sharing experiences, which can catalyse change among the community of family businesses. Family members coming from generational family businesses who find difficulty in communicating the importance of ESG to their family members can also utilise such a platform as an intermediary. For example, it might be more effective and more convincing when an incumbent leader hears about the importance of ESG from other family business owners in the industry than from a family member. 

If companies act collectively to promote ESG in industries where family businesses have great influence, the impact could be significant.

2. Implementation and measurement

Family business leaders can start to review their strategy and redefine the strategy to be ESG-compliant. This can be done by first determining which operations within the business are harming the environment, what needs to be changed, how to prepare human capital to facilitate a smooth transition and what kind of support mechanisms should be established to ensure inter-departmental alignment. 

In terms of measurement, there is no exhaustive list of ESG issues, but it can usually be measured in terms of deforestation, waste management, gender and diversity, human rights, bribery and corruption, and executive compensation. 

The good news for family business owners is that committing to ESG does not necessarily mean hiring an outsider to bring about a 180° change for the business but it is to assess the current operations and re-strategise. The management team must actively internalise these ESG issues into strategies, invest in the improvement of human capital and implement new directions.

3. Reporting transformation

Next, a family business leader should create a reporting structure as the core of the business, which then can be used as a tool to check progress and evaluate goal attainment. 

With this established structure, family business leaders can track the activities through a series of milestones and adjust strategies or directions along the way. Moreover, regulators can also assess their compliance for stakeholders to understand their initiatives. 

This approach may be of great help in creating a business transformation. Also, proper documentation keeps the business accountable in reducing the risk of being questioned by the authorities or being put under the spotlight due to non-compliance with policies implemented by the government. 

The impetus for family businesses to address ESG issues and opportunities may continue to grow in the foreseeable near future. The AIR model that we have developed and outlined above can help family business leaders to drive the changes needed for the business, including stimulating greater awareness of ESG, embedding ESG in business strategies and publishing ESG reports — ensuring sustainability for generations. Given the important role of family businesses in the economy, this effort could go a long way towards instilling sustainable beliefs and practices among important players in the world economy.

Dr Yong Jing Yi (Serene) and Dr Feranita are senior lecturers at the School of Management and Marketing, Taylor’s Business School, Faculty of Business and Law, Taylor’s University

This article is a collaboration between Family Business Network (FBN) Asia and Taylor’s University. FBN Asia, a regional chapter of FBN International, which represents family businesses in 65 countries across five continents, offers opportunities for stakeholders of the family business to learn, thrive and transform across generations to build a sustainable future.