Creating Value: How Private Equity- Backed Portfolio Companies Can Move the Needle on Sustainability

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.¹ 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.²

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.

Do you agree that your organization's executive leadership team effectively embraces opportunities for ESG?

• 44% of portfolio company executives agree or strongly agree 
• 67% of public company executives agree or strongly agree 

_{Source: Russell Reynolds  Associates,  2021 Global Leadership Monitor, base n = 195 private equity-backed portfolio leaders}

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.³ 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.⁴ 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.⁵ (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.⁶

How PE-backed portfolio company leaders are integrating sustainability into business and talent considerations

• 20% are involved in internal efforts to examine the organization's environmental or social impact
• 9% embed sustainability competencies into talent decisions 
• 5% have compensation linked to meeting ESG goals

Source: Russell Reynolds  Associates,  2021 Global Leadership Monitor, base n = 195 private equity-backed portfolio leaders

Call to action for portfolio companies: Prioritize sustainability in talent considerations

To ensure that PE firm sustainability commitments translate into portfolio company action, PE investors will want to incentivize portfolio company leaders to reconsider how and why they are running their businesses. Most importantly, however, portfolio companies need to hire leaders who can champion sustainability. This does not necessarily mean hiring leaders who bring a wealth of sustainability experience; rather, it is about assessing leaders on whether or not they bring the right orientation and mindset.

What defines a sustainability orientation and mindset? Russell Reynolds partnered  with  the  United  Nations  Global Compact to conduct a study focused on understanding differentiating characteristics of sustainability pioneers. The study interviewed 55 global chief executive officers and board directors with a demonstrated track record of driving change by integrating sustainability into business strategy and analyzed each leader’s background and career history. This data was compared with data from 50 chief executive officers from global Fortune 500 organizations with poor sustainability rankings. The study showed that sustainability pioneers demonstrate specific, critical leadership attributes that are driven by a sustainable mindset.

Leaders with a sustainable mindset base their leadership on the belief that business is inherently connected to the wider societal and environmental context in which it operates. Sustainable leaders demonstrate the following four critical leadership attributes that are driven by a sustainable mindset.⁷

To address increasingly complex business challenges, particularly those stemming from the evolving pandemic, portfolio companies need to be led by curious, results-driven leaders with high levels of ambition.

Sustainable leaders possess high levels of empathy and authenticity to build collaborative relationships with diverse stakeholders ranging from limited partners to employees to external communities.

Sustainable leaders possess the courage to challenge traditional approaches.

Sustainable leaders understand that sustainability is not achieved overnight. These leaders set audacious goals and are resilient and courageous in staying the course.

_{Source: UN Global Compact-Russell Reynolds Associates, Leadership for the Decade of Action, 2020}

Investing responsibly and being accountable to societal and environmental consequences are integral to PE firm’s reputations, as well as the brands and reputations of their portfolio companies. With sustainable leaders driving change, portfolio companies will create meaningful value for its customers, employees, business, and ultimately investors.

Additional Authors

Alix Stuart is a member of Russell Reynolds Associates’ Center for Leadership Insight. She is based in Boston.
Joy Tan is a member of Russell Reynolds Associates’ Center for Leadership Insight. She is based in New York City.

References

<sub>1. Private equity vows to help the world. Lenders want proof. Bahceli, Yoruk, Simon Jessop. Reuters, June 9, 2021.
2,3. The Expanding Case for ESG in Private Equity. Seemann, Azel, Dale Hardcastle, Deike Diers, Jacqueline Han. Bain & Company, March 1, 2021.
4,5,6. 2021 Global Leadership Monitor: Leadership Preparedness for the Road Ahead. Crookes, Jemi, Tom Handcock, PJ Neal, Alix Stuart. Russell Reynolds Associates, May 4, 2021.
7. Leadership for the Decade of Action: A Study on the Characteristics of Sustainable Business Leaders. United Nations Global Company, Russell Reynolds Associates, July 9, 2020.</sub>