The Board’s Role in ESG Implementation
Eight important ways directors can help grow their companies’ sustainability programs.
Boards are wrestling with evolving global financial reporting standards, regulations affecting other communications and investor expectations about their companies’ ESG programs. Each company’s ESG challenges and opportunities are different, and each company is likely at a different stage in its ESG program development and implementation.
It is almost impossible to imagine a situation in which ESG has no relevance to a particular company or its board because ESG is an omnibus term that encompasses traditional governance topics, such as executive compensation, employee relations, shareholder proposals, fair employment practices, reputational matters arising from branding and corporate conduct, disclosure practices and financial and operational risk. It is equally unlikely that all boards will find that every ESG topic is relevant and material. That said, virtually every board is already covering some ESG topics on a regular basis, and they will likely discover other pressing ESG topics.
It remains true that, on a day-to-day basis, company officers and employees are responsible for developing and executing ESG programs. Still, directors have important and necessary roles that are implicated by new ESG regulations and by longstanding principles of corporate governance.
Seek out education. The first duty of directors is to educate themselves, because the focus on ESG risk and reporting is real and maturing. Before deciding where to come out on ESG issues, a board should develop a working understanding of:
- The subject matter ESG covers
- Existing and prospective sources of regulation of those matters
- The current state of thinking about determining the materiality of ESG risks
- Distinctions between activities where materiality or some other threshold is relevant
- How the company’s current policies and operations affect those issues.
Directors may also be interested in topics peer and competitor companies address and issues that rating agencies cover. Board education is an ongoing project that can be addressed through presentations by management and/or external consultants.
Boards can also recruit to add experience and diversity. According to The Conference Board ESG Center working group, “The Roles of the Board in the Era of ESG and Stakeholder Capitalism,” 54% of S&P 500 company directors and 33% of Russell 3000 company directors have some kind of ESG experience already, though existing expertise concentrates heavily around corporate governance and human resource management and falls off steeply when looking at cybersecurity, climate and ESG as an overall topic area. In general, boards report that the value of industry knowledge, combined with intellectual curiosity and openness to change, is equal to or greater than the value of specialist expertise.
Define what ESG means to your company. Once directors have created some context and common language through education, it is useful to take a step back before considering the details of an ESG program. Determining the components of an ESG program entirely or primarily by reacting to what stakeholders request can exhaust attention and resources. Stakeholders’ interest in these ESG measures will vary depending on subject matter, scope, geography, detail level and more. In order to keep ESG program development meaningful, the board should first work with management to define which ESG or sustainability matters are important to the company at a high level, not only in terms of risk, but also in terms of innovation and opportunity. While answers are necessarily influenced by industry, sector and prior stakeholder engagement, the outcome of this exercise should be a concise, bespoke statement of the salient aspects of ESG that the company’s leadership believes are worth addressing.
For this exercise, it may be useful to directors to rank what makes an ESG topic worth addressing. Some items will be regulated and therefore must be attended to as a matter of legal compliance. Others rise to the top because they entail meaningful costs or other risk. A third category would include items arising from stakeholder expectations, which should be addressed to avoid reputational risk. Finally, there may be issues outside these three categories that management and the board agree are strategically important for the longer-term success of the company.
It is not useful to stakeholders for companies to address ESG implementation as if using a generic checklist. By thoughtfully defining what sustainability means to the company, the board and management will provide a framework within which to design, discuss and disclose ESG efforts in a meaningful way. Sustainability disclosures have been around long enough that shareholders have had time to observe that the most valuable ESG discussions relate ESG policies and practices to the company’s core business and strategic goals.
Understand and support management’s ESG program. For public company boards, it is the job of company officers and employees to take the board’s direction and establish a detailed ESG program to guide day-to-day operations, communications and conduct. Boards then provide oversight, guidance and periodic evaluation as to whether the program, and progress against it, remains right for the company over time. Boards need to know:
- Who in the company is accountable for program design and execution?
- What is the content of the program and its relation to the company’s sustainability goals?
- When will the design, implementation, monitoring and evaluation phases occur?
- How will company personnel address what the program requires, including whether the company needs to add any skills or other resources?
For companies with an international footprint or supply chain, it is important for boards to understand the extent to which laws in the United States and elsewhere affect the company’s sustainability program.
Take the long-term view. One of the most valuable things a board can do when articulating the company’s sustainability goals is to be mindful about the value to company shareholders of adopting short-, medium- and long-term sustainability goals. This is especially true with respect to ESG program goals that address long-term risk and/or long-term opportunity or require long-term study and adaptation (e.g., addressing climate risk). Addressing corporate challenges and opportunities that require long-term attention is not unique to ESG implementation. However, focus on ESG in the boardroom has lawyers, corporate executives and directors paying close attention to concepts, statutes, policy arguments and precedents interpreting directors’ duties, some of which vary from state to state. Taking legal advice on the substance of the board’s deliberations about consideration of short-term impacts (and impacts to nonshareholder stakeholders) en route to the pursuit of long-term value can help protect the company from shareholders focused solely on short-term gains.
Identify committee assignments and ongoing management reporting responsibilities. After developing an ESG program that speaks to core business strategy, corporate culture and risk management, boards may find it useful to turn the exercise around and integrate ESG assessments into regular management reports on these topics. It is useful to note that few boards have delegated ESG oversight to a single committee, even if they have a standing or ad hoc ESG committee. Because many sustainability subjects touch matters already in the purview of nominating, governance, audit, compensation, ethics or other standing committees, it can be prudent to integrate sustainability subjects within each committee’s regular workflow.
In the Russell 3000, 96% of companies report having assigned ESG responsibilities to the full board or one or more committees, according to The Conference Board ESG Center. Many companies have launched efforts under the leadership of the nom/gov committee, but many are on a path to separating general oversight of ESG implementation from oversight of specific topics. The demands on expertise, time and resources may support a broader delegation of responsibilities or the establishment of new committees as companies move forward to take a deeper dive.
Engage with investors and stakeholders. Boards can do better at discharging the new responsibilities under responsible capitalism by staying abreast of stakeholders’ concerns. Some companies have offered directors the opportunity to observe or participate in employee town halls, and many boards are asking for reports on trends in shareholder proposals and shareholder voting.
Keep up with public policy developments. Boards may also benefit from staying informed about public policy developments, particularly the current backlash against ESG at state and local levels. Bloomberg Law recently reported that at least six states have divested public funds from asset managers that consider ESG factors and 19 attorneys general have spoken publicly against the use of climate risk considerations. If a company has a presence in a state where a local government proposal will require or prohibit conduct in a manner that the board considers an unwanted restraint on its stewardship, discussions with management and legal counsel about the value of asking government relations staff to address such proposals are worthwhile.
Evaluate on an ongoing basis. Evaluation should cover management and board performance in implementing the ESG program and — perhaps separately — stakeholder relations. Issues identified as salient at the earlier stages should map to the board’s evaluation exercises, in addition to considering new developments that merit reconsidering or adding to original program goals. Because measurement and evaluation tools are evolving, boards will benefit from considering in advance what they will need — or at least what’s available — to conduct annual and other periodic evaluations as appropriate.
Consensus is growing among company directors that ESG and the advent of the responsible capitalism theory of governance will have significant and durable impacts on companies over the medium and long terms. Most boards are turning their attention to sustainability, and those who have surveyed the subject long enough to identify what is possible, what is necessary and what is prudent are starting to carve a manageable path from which they can oversee both the forest and the trees.
Alexandra Poe is a corporate partner and leader of the private funds and ESG practices at Hughes Hubbard & Reed LLP. She is a recognized thought leader in ESG investing since 2013, having served many types of investors in governing, executive and consulting roles.