Environmental, social and governance:
Supporting the bottom line and the greater good.
By April Hall
ConocoPhillips Co. director Jody Freeman sees environmental, social and governance issues, or ESG, as part of the board’s key responsibilities and an essential part of strategic planning.
“We play the same oversight and fiduciary role on behalf of shareholders on ESG issues as we do on everything else,” says Freeman, who sits on the public policy committee of the energy company.
Encouraging corporations to consider the greater good is nothing new. It has had many iterations and names, i.e. corporate responsibility, socially responsible investing and “the triple bottom line.” ESG is the latest salvo, broadening the concept to include everything from gender inequality to bribery to climate change; and it’s gaining momentum in Corporate America.
For ConocoPhillips, these issues have been a strategic concern since Freeman joined the board in 2012, a fact that’s an exception among many corporate boards.
ESG issues ranked lowest among business strategy drivers, according to a PwC survey of nearly 800 board directors; and anecdotally Directors & Boards found many directors who didn’t even know what ESG was. But there’s growing pressure from investors and other stakeholders to make ESG a bigger priority in the boardroom.
If the issues are not addressed in the boardroom, trillions of investment dollars could be at stake, which is why investors have the power to bring these issues to the board and make an impact.
“Investors have done a terrific job of getting this to the forefront,” says Paula Loop, leader of the Governance Insights Center at PwC, about ESG.
“There is a fair amount of education that needs to happen,” she notes. “Executives need to speak about it during strategy sessions with the board and with investors — executives need to embed it in the broader strategy sessions.”
Too often, she adds, ESG topics and the risk surrounding them are siloed into separate conversations and taken off the table when it comes to company strategy.
Freeman says her experience at ConocoPhillips is just the opposite.
“The board takes these issues very seriously,” she says. “Managing these issues well is integral to the company’s strategic thinking, and they are built into our robust scenario planning. No one thinks of them as tangential.”
Freeman provided a rundown of the tools the board uses:
• Stakeholder engagement — ConocoPhillips proactively engages with stakeholders at the local, state/provincial and federal levels to understand their interests, concerns and culture. As appropriate, the company incorporates lessons from stakeholder engagement into its business and action plans.
• Action plans — ConocoPhillips has adopted company-wide, three- to five-year action plans to drive performance. These plans include specific, measurable goals and require accountability for results. The company has climate change, water, biodiversity and human rights action plans.
• Scenario planning — ConocoPhillips uses four main corporate supply-and-demand scenarios, one of which represents a carbon-constrained future, which takes into account alternative energy technology advancement and government policy actions.
“ConocoPhillips is very committed to sustainable development on many fronts,” Freeman stresses, “including managing health, safety, environmental and climate-related risk.
Force feeding ESG
Vanguard is among the mega investors pushing ESG issues in the boardroom as a way to bolster business in the future.
“What is important to us is a company’s long-term performance,” says Glenn Booraem principal and investment stewardship officer at Vanguard. “If the company is governed well, it will perform in the long term. Understanding a company’s impact on the environment, not just the environment on the company in terms of regulation, affects the long term.”
Boards are starting to adjust their strategies to align with what investors are looking for in the long run, he maintains, but there are still conflicts.
“There is still a fair amount of short-term pressure in the market,” he notes. “We need to shift the orientations; people are still hung up on quarterly guidance.”
In the realm of governance, Booraem identifies four pillars that Vanguard evaluates in order to decide on the potential of investment for near-permanent investors.
1. That board members have the right skills and backgrounds for the company’s needs and possible risks.
2. That there is the appropriate governance structure that allows a shareholder, over time, to hold the board appropriately accountable for performance.
3. That compensation incentives are appropriately aligned to performance.
4. That the company articulates a clear purpose and approach to risk to the board and investors.
In addition to the pillars, he continues, is environmental risk mitigation as a conduit of business risk and gender diversity, both of which can impact the bottom line. Business strategies addressing purely social issues, like income inequality and access to healthcare, are not seen as directly affecting profits.
“What’s important is we’re investing on the part of 20 million clients who entrust their money to Vanguard,” he explains, adding that those investors may have different issues of concern in the future. But “the unifying force of clients in a fund is to track this investment objective, not addressing an ideological perspective. Those are social issues of broad interest. It’s less clear how they affect the company.”
Some investors, however, do focus on a broader range of social good issues.
The members of Interfaith Center on Corporate Responsibility (ICCR) controlling $200 billion in investment dollars, are evaluating companies through ideology.
Its members focus on ESG, “including human rights, public health, economic fairness, food and water sustainability, and the protection of our environment,” wrote ICCR representatives School Sisters of St. Francis, Inc. in a comment to the Securities and Exchange Commission (SEC) related to proposed new disclosure mandates. “We believe this work has a positive impact on companies’ long term profitability and shareowner value as it helps companies to improve financial performance and sustain shareholder and long-term value while securing a better future for their employees, their customers, their investors and other stakeholders.”
Many directors see their main job as protecting the bottom line and, in turn, shareholders’ interests. But do they have a responsibility to the greater good? And can you have one without the other?
Aligning business strategies to help the greater good is the role of board directors, says Rebecca Henderson, the John and Natty McArthur University Professor at Harvard University.
To continue to make the most profits, corporations will have to work to the benefit of society and the environment, she adds. Even beyond the bottom line, leaders of business have a responsibility to the communities their businesses serve.
“I don’t think directors have a fiduciary responsibility to society — I think they have a moral responsibility to pay attention to society, if indeed they hold to [economist Milton] Friedman’s core values of prosperity and freedom,” says Henderson, who also teaches “Reimagining Capitalism” as part of the Harvard’s M.B.A. program and is a research fellow at the National Bureau of Economic Research.
Telling the ESG story
In addition to changes being pushed by the investment community, corporations may have to contend with new ESG disclosure requirements in the future.
Companies are required to periodically report on risk factors, and the SEC provided guidance back in 2010 on how to report risks related to climate change, but the agency has come under fire for not strongly enforcing such disclosures.
Last Spring the agency sought public comment on modernizing financial disclosure requirements and acknowledged that investors are considering ESG issues in decision-making and they need the best information possible to make decisions. The commission received hundreds of comments from the public regarding the proposal, but no decision has been made.
In a move to give corporations guidance, the nonprofit Sustainability Accounting Standards Board released standards for 79 industries in 10 sectors, based on the issues of environment, social capital, human capital, business model and innovation, and leadership and governance.
Another organization that has outlined it’s own reporting standards is the Global Reporting Initiative, an international independent standards organization that helps businesses, governments and other organizations understand and communicate their impacts on issues such as climate change, human rights and corruption.
These standards were the ones United Parcel Service Inc. (UPS) used for its current ESG report.
The board at UPS is very involved in the corporation’s sustainability program and reporting, says Jennifer Garner, a spokeswoman for the firm. Each year, along with company executives, the board reviews its annual report and follows up with questions and/or suggestions.
The focus on ESG comes from the top.
“As we build the smart logistics network of the future, we must stay disciplined to ensure these investments are made responsibly and sustainably, so our customers and our communities grow along with us,” states David Abney, the CEO and chairman of UPS, in the company’s most recent sustainability report.
In the report, the company issued updates on the continued reduction of carbon emissions and future goals, including the amount of charitable donations the company targets to make by 2020.
At Unifirst Corporation, in addition to addressing environmental issues, the board reviews diversity and corporate culture, which are also written into the company’s policies, but ESG issues are not built into the board’s business strategy discussion, says Kathleen Camilli, a director for the uniform and uniform services firm with revenues of $1.5 billion.
Looking ahead, she says ESG is going to become an even bigger issue for boards, pointing to Cornell University corporate governance professor Lynn Stout’s perspective on the issue.
Stout wrote in The Shareholder Value Myth: “while earning profits is necessary for the firm’s long-term survival, it is not the only corporate objective. Once profitability is achieved, the firm can focus on satisfying other goals, including future growth, controlling risk, and taking care of its investors, employees, customers, even society.”
For now, broader societal concerns aren’t largely a concern for directors in the United States. Social issues, including immigration and income inequality, ranked lowest in PwC’s 2017 Annual Corporate Directors Survey.
It’s important to parse out the difference between those social issues being of concern to the world at large and whether they are concerns in the boardroom, says PwC’s Loop.
Directors, she continues, are “not necessarily saying whether or not they are social issues. They are asked, ‘Do you think these social issues will affect your business strategies?’”
Some believe directors have some latitude when it comes to focusing on social issues even if they’re not directly related to business strategy and profits.
While boards have to focus on shareholder return, “that doesn’t mean directors have blinders on,” maintains John W. Noble, who served as a vice chancellor of Delaware’s Court of Chancery from 2000 to 2016.
“They have a lot of discretion as to how much they can take those issues into account and in what context,” adds Noble, who is now a partner in Morris James’s corporate and commercial litigation group. “Directors can take social matters into account because they operate in communities and their companies are impacted by what happens in those communities.”
ConocoPhillips board does just that, Freeman maintains. “I imagine different boards view these issues differently. We see that our stakeholders, including employees, care about safety, sustainability, inclusion and other social issues.”
She offers her recommendation to directors looking to bolster ESG:
“The best advice I can offer is the most obvious: Think strategically about risks to the business and frame discussion in those terms. My own experience is that board members are open to thoughtful points backed up by good information, especially when they are coupled with a willingness to listen.”