ESG in The Boardroom: Who, What, Where

When the history books are written, we will surely look back to this time as revolutionary in terms of our changing focus on the world around us. Whether it be global warming, changing values amongst millennials or the fallout from the important #MeToo movement, we now have more of an awareness and sensitivity to sustainability and societal burdens than ever.

Within the context of business this is most certainly the case. Environmental, social and governance (ESG) conversations and debates have become ubiquitous.

In a 2019 study on responsible investing by RBC Global Asset Management, 70% of respondent’s stated that ESG principals are used somewhat or significantly as part of their investment approach and decision making. In 2019, State Street Global Advisors launched “R-Factor” (Responsibility-Factor) which is an ESG scoring system. R-Factor measures a company’s ESG practices and attempts to quantify disparate data and improve transparency around ESG. Also, in 2019, Alvarez & Marsal reported that “companies ranked in the bottom 50 percent of ESG performance are significantly more likely to attract activists’ attention.” https://www.hedgeweek.com/2019/12/03/280998/poor-esg-performance-increases-likelihood-activist-investor-attention. And the list goes on.

We are in the midst of a sea change in attention to these critical matters and the implications of responsibility for businesses. No where is this clearer than in the recent statement by the Business Roundtable (BRT) which stated that “corporations should commit to serving the interests of all stakeholders – employees, customers, suppliers and communities where they do business.” https://www.businessroundtable.org/business-roundtable-redefines-the-purpose-of-a-corporation-to-promote-an-economy-that-serves-all-americans

As stewards of the corporation, boards of directors must not only be acquainted with the ESG conversation but must demonstrate leading edge thinking on these matters and how they affect strategy and the ultimate operations of the business to which they are tasked with overseeing.

The question then becomes how to best accomplish this. Where does ESG responsibility reside within the board? Do boards require separate ESG committees? Or perhaps only ES committees as “G” is generally covered by the nominating and governance committee? And, do boards need a director who is an ESG expert or is it enough to receive reports from within the company?

The short answer is, it depends. There is no one size fits all and ultimately structure and responsibility and the manner in which ESG matters are handled depend on the company, its industry, culture as well as challenges and objectives.

As an example, for companies in the oil and gas industry, the environment is inseparable from business operations. Who can forget the catastrophic Exxon Valdez oil spill which contaminated 1,300 miles of coastline, killed thousands of animals and cost the company over $7 billion? For those in this industry the “E” aspects of ESG are intertwined with basic business operations and board structure must be reflective of this. Examples are ExxonMobil which rightly has a “Public Issues and Contributions Committee” which includes focus on the environment and Occidental Petroleum which has both an Environmental, Health and Safety committee as well as a Sustainability and Shareholder Engagement committee.

In terms of “S” factors like labor standards, health, safety and diversity, boards having varying degrees of framework for attending to these matters. Certainly, conversations about all things related to human capital have been proliferating within the boardroom and it is definitely time. State Street Global Advisors has urged boards to focus on corporate culture and Blackrock and Vanguard are also widening the conversation. Diversity remains a “hot” topic and no matter what the historical track record, companies can no longer afford to drag their feet on this matter. Board committee structure and composition are changing to reflect this evolution. Examples of this in practice include Energizer Holdings and UNUM Group which have a Human Capital Committees on their boards. Additionally, the number of board directors who were previously CHROs or bring human resources expertise is slowly but surely growing.

Finally, any improvement and increased focus on governance (“G”) is very welcome. While approaches to governance have been advancing over time, there is still room for much improvement. “G” falls under the purview of the Governance Committee on the board (often structured as the Nominating and Governance committee) and is critically important to everything that transpires within the company. In fact, in a 2018 study by Russell Investments, 91% of investment firms say governance has the greatest impact on investment decisions (among ESG factors.)

Aside from determining where ESG resides within the board, companies should ask themselves if their Directors have enough proficiency in these matters or whether a bona fide expert is required. Again, this will depend on the unique circumstances of the company however it is safe to say that this discussion should take place. Alphabet, the parent of Google recently appointed Frances Arnold to its board. Arnold is a Nobel Prize winning biologist with expertise in chemical engineering, bio-engineering and biochemistry.

ESG is a term used to describe a very complex and varied group of issues. One can even argue that these three letters do not belong together as each individually merits its own attention and discussion. However, the fact of the matter is that boards and the companies they serve cannot afford to be casual about this. ESG and all of its implications must be high on the agenda as it is part of ever-growing answerability of the board.