As most board members know, environmental, social and governance issues (ESG) are all the rage, with institutional investors putting pressure on public companies to think beyond maximizing value for shareholders by adding a focus on the impact of the corporation on its other stakeholders — including employees, customers and communities. But what does that really mean, and how can it be measured, much less sustained? Ultimately, does this ask boards for something that they can’t possibly deliver?
To provide some answers to these questions, Directors & Boards convened a forum in November to bring together board members from public and large private companies, along with select corporate governance thought leaders, to discuss the implications of ESG for board members. The forum was designed to be a working event, with all participants contributing to the key takeaways we present in this section.
The forum was built around the following key questions:
• Should a corporation have a social purpose? What is a corporation’s broader responsibility to society, if any?
• What is ESG (or corporate social responsibility)? Does it emphasize the E, or the S, or the G? Is “ESG” even the right term?
• How can ESG initiatives be measured?
• Should management be compensated and incented on ESG performance?
• What is the impact of ESG on culture, employee retention and recruiting?
• What is the role of institutional investors in shifting focus away from short-term performance towards long-term goals?
• Will ESG need government intervention to ensure compliance?
• How should boards monitor and report their ESG initiatives?
Key notes and takeaways were kept live during each session and are presented in edited form here. These takeaways were summarized and organized during a working lunch and are presented in Robert Rock’s introductory piece to this section, where he focused the findings on what a chair or lead director can bring up at the next board meeting.
Here, we go into additional detail for some of the questions our participants found most important.
Should a corporation have a social purpose?
“Purpose” does not need a modifier like “social.” Purpose is how the company is operated. “Social” confuses things and makes it sound like corporate America is trying to solve the world’s problems. But a clear disclosure of purpose is key, since the next generation of employees and customers care a lot about this.
Great companies have always thought about ESG, but they have used different words. It is valuable to model private companies, which often have a clear sense of purpose and a long-term strategic horizon.
But this doesn’t mean profits aren’t important. ESG is an opportunity to restore long-term thinking, but it can’t be used as a “get out of jail free” card to excuse poor financial performance. That said, if investors could agree that a missed quarter shouldn’t define the success or failure of the company, boards could think more long-term. In this sense, alignment between the board and the management is critical. The CEO needs the boardroom to be a safe place for long-term thinking. ESG will require a strong sense of trust among all players — the board, management, investors and stakeholders.
Ultimately, ESG isn’t a charitable undertaking. There is a relationship between purpose and profits, but it’s not an either/or, it’s an “and.” Moral codes should be in sync with business codes.
Does ESG emphasize the “E,” the “S,” or the “G”?
ESG starts with human capital. Boards need to be better to the people closest to their companies. Boards should look at the organizational chart and know what all employees are paid. The compensation committee should consider how to financially motivate the entire workforce, not just senior executives. Perhaps the compensation committee needs its charter expanded to encompass all human capital.
The board should require a dashboard from senior management that includes measures of turnover and employee satisfaction. Would employees refer their family members to work for your company? What other metrics could be valuable?
Start with the board. What is the board’s culture, and how does that drive corporate culture? Culture is a tool to enable strategy. The board needs to be the “culture carrier” for the rest of the organization. Does the board’s composition reflect its stakeholders, and where the company is headed?
Answering these questions will lead to the second ESG stakeholder: customers.
How can boards shift focus away from short-term performance towards long-term goals?
The new paradigm: Companies and investors agree that the goal of companies is to build long-term value, not quarter-to-quarter returns. But is this “the old paradigm?” It is important to remember that the business judgment rule protects directors on reasonable long-term decisions.
Long-term investors must support the corporate strategy in the long run. Pay attention to your top 10 investors. Do they have different priorities? How do you address their different perspectives?
Can ESG survive an economic downturn? Or can adherence to ESG help you survive a downturn?
ESG has a close relationship to being lawful/“other-regarding” to stakeholders. Directors can’t rationalize decisions management makes that negatively impact ESG. Talk to fellow board members about the implications of a company’s actions. ESG reporting isn’t separate from the business, it helps a board avoid a business malfeasance. Committee work can be a way for board members to meet other members of management, find out what’s going on beyond what the CEO is sharing.
How can ESG be identified and measured? What role should government play in ESG?
There is enormous confusion around how to measure and report ESG. Companies have to take control of ESG and boil it down to 10 key ESG issues tailored to the company. A way to get clarity is to ask questions around ESG materiality for each company. Start with the Sustainability Accounting Standards Board, but recognize that 400 measures of sustainability really need to be consolidated to what’s material to a given company.
Currently, ESG is driven by a stakeholder mandate versus a government mandate, but is it unfair if some companies go all in with ESG, while others don’t? The market should take care of badly run businesses.
It must be recognized, though, that companies will need a new infrastructure for ESG reporting. It is a differentiator, however, for the corporation to improve the quality of its financial and ESG disclosures. Think about unique and comprehensive reporting (along the lines of Finland’s sustainability reports) versus a standardized, check-the-box grid.
The role of government in ESG needs a light touch. Self-identification and -regulation could create the incremental change to head off regulation.
Would government incentives help with ESG implementation? Does ESG push a corporation into the political sphere?
How should management be compensated and incented on ESG performance?
What gets measured gets paid attention to in compensation metrics.
Sixty-one percent of the S&P 100 have ESG measures in their compensation plans, but the majority of these plans have annual, rather than long-term ESG measures, which doesn’t make much sense. (Though sometimes it’s best to start with ESG in annual incentives so that you can create near-term milestones to measure progress.)
Fit ESG metrics within a typical compensation structure. But be careful when putting ESG goals into compensation plans. It should be measurable, timely and actionable. (As a board you should be willing to consider ESG in compensation design, but it must have a governance and cultural background.) If ESG comp measures are strategically based, it should be 10-15% of total compensation. However, there are very few good ESG comparability measures.