In a 2019 article entitled “The Future of the Compensation Committee,” we observed that compensation committee members were, organically and of their own accord, expanding their purview and areas of interest beyond executive compensation and into an increasing array of pay and people issues.
In 2020, we introduced the term “human capital governance,” based on growing board member interest in a broader set of human resource issues, including talent acquisition, DEI, fair pay, benefits access and culture. We speculated at the time that 2020 would be the “year of the S” in ESG, even though social issues had been gaining only limited traction at that time. Little did we know that the pandemic and other earthshaking events of 2020 would amplify and accelerate board-level interest in both the E and the S in ESG and raise concerns about risk.
Almost overnight, boards became intensely interested in the health and well-being of employees, their work locations and their productivity. Employee safety, DEI and pay equity became top boardroom issues, followed in 2021 and 2022 by concerns over retention, turnover, inadequate staffing and low morale.
A recently completed Willis Towers Watson study of the proxy statements of the S&P 500 shows that compensation committees increasingly have broadened their scope and their charters to address:
- Constructing and sustaining an inclusive and diverse workforce.
- Preparing for leadership transitions beyond just top-level executives.
- Executing on business strategy by acquiring and keeping key talent.
- Strengthening workforce engagement and productivity.
- Establishing a strong and healthy corporate culture.
Over the same period, board members became more concerned about the range of risks facing their organizations and the likelihood of multiple risk events occurring simultaneously. Multiple low-frequency, high-impact events occurred — and continue to occur — nearly concurrently: the global pandemic and its aftermath, cyberattacks, a series of “hundred-year” weather events, social and political disruptions, supply-chain imbalances, talent shortages and the other human capital challenges already mentioned.
Boards need better predictive analytics and holistic risk assessment to understand the most severe threats to their organizations, how those threats may be interrelated and how best to anticipate and mitigate them.
Adding to this expanding list of challenges, investors, regulators, customers and employees are increasing pressure on boards and management to demonstrate their commitment to climate issues (the E in ESG).
Effectively addressing climate issues is particularly challenging for boards and varies greatly by industry. Boards need to work with management to prioritize the issues critical to their company's business and determine how they will affect financial performance, risk and value creation. They must also articulate their priorities to investors, employees and others.
The demands on boards and the breadth of topics of interest to board members have expanded dramatically in a relatively short time. How do boards sort through competing and overlapping issues and establish effective oversight priorities and processes?
Global Stewardship
Against this backdrop, and based on our observation of and engagement with boards and board members during 2022, we developed a model that captures how we think effective boards should operate — or strive to operate — regardless of ideology, industry or business strategy.
Stewardship is a meta-principle that encompasses the comprehensive, long-term responsibility of a board of directors for the health, well-being, performance and sustainability of the organization that has been entrusted to them. It is the careful and responsible management of assets, liabilities, intangibles and equity.
Effective corporate stewards preserve, protect and increase value over time. Stewardship also implies a responsibility to owners and to all other constituents and stakeholders.
We propose a new stewardship model of corporate governance, based on the core tenet that companies must consistently create sustainable growth and long-term value. This concept may sound basic, but conversations about performance and risk often are muted during discussions of other governance matters. Companies must perform well and consistently over time to be capable of providing opportunities for employees, serving their communities, protecting the environment and pursuing their purpose.
Working with the boards of close to 1,000 organizations over decades, we've found performance and long-term value creation must come first for the others to be viable. Most organizations that perform well over time recognize a responsibility to their various stakeholders. Today's boards, acting as responsible stewards, recognize this relationship and provide effective oversight for the five Ps of global stewardship: performance, protection, people, planet and purpose.
Performance. The core responsibility of a board and its committees continues to be the company's sustainable financial performance and long-term value creation — and ensuring the necessary leadership, strategy and resources to achieve those objectives. The advent of stakeholder capitalism and ESG does not change or diminish this priority.
Long-term sustainable financial performance and value creation are the appropriate lens to view decisions about ESG issues, which should be studied as business issues with real short- and long-term costs and benefits specific to each organization. Companies should be able to tell their investors, their employees and others how various investments and actions affecting the environment, people or communities will also impact the company over the near and long term.
Each company and industry has unique environmental and people challenges and priorities, cost/benefit trade-offs and risks to be measured, managed and mitigated. Financial performance and value creation remain effective tools for evaluating and prioritizing ESG and other stakeholder-related decisions and investments.
Protection. Enterprise risk management is now almost as important as performance to most organizations' long-term sustainability. The array of low-frequency, high-impact risk events that occurred nearly simultaneously in recent years has stretched companies' ability to adapt and protect their businesses.
Effective stewards manage such risks by viewing them through a common lens at the enterprise level. By considering a portfolio of risks cohesively, companies can achieve better outcomes than by managing them individually. Advanced analytics and statistical models addressing connected vulnerabilities lead to improved foresight and judgment and help organizations avoid downward performance spirals created by multiple interrelated factors.
Market perception of a company's overall risk is reflected in the volatility of its stock price and cost of capital. Effective risk management can support higher and more consistent shareholder return and a more sustainable business over the long term. Boards and senior leaders must understand their portfolio of risks and how they relate to each other. They must also know the most cost-efficient way to mitigate, manage and transfer them.
People. A new generation of board members is much more interested in wide-ranging people issues than before. This new, more diverse generation is asking more questions. They have grown as business leaders in an era when human capital is seen as equally as important as, if not more important than, physical assets, products, brands and intellectual capital. Their personal experience has taught them that a healthy, diverse, skilled and engaged workforce is essential for long-term viability and success.
This is reflected in expanded board and committee charters and agendas, which now regularly include deep dives into the engagement, productivity, fairness, skill sets and well-being of the company workforce — and at all levels. The amount of interest and scrutiny once reserved for overseeing the executive team has expanded to the whole workforce. For board members to exercise this broader oversight effectively, they need a significantly expanded suite of meaningful, relevant data and insights about the company's critical people asset.
Planet. Climate change — and the attention being paid to it by investors, regulators, customers and employees — presents interesting risks and opportunities. From a board perspective, assessing, managing and mitigating physical risks to the company's assets and supply chain are paramount to how the changing environment impacts the company.
Similarly important is measuring and managing the company's impact on the environment, including not only greenhouse gas emissions, but also other forms of pollution and their impact on people and communities. Lastly, but at least as important, are the business opportunities that climate change and environmental concerns present: Which new products, services and technologies should be invested in to drive growth, profits, returns and long-term value creation?
Sorting environmental concerns into these three categories may seem simplistic, but it can help boards quantify, understand and prioritize issues where beliefs and passions can be strong.
Purpose. For many companies, purpose may not be about saving the planet or benefiting all of humankind, but rather producing goods and services that create value and fulfill a societal need. This may include developing new vaccines and drugs, distributing essential goods, producing food, providing capital and powering cities. It may also include a company's commitment to its people, its communities, its customers and the environment.
We see no dichotomy between purpose and profits: They are intertwined. But it is important for companies and their boards to accurately and honestly articulate their purpose, mission, values and strategy. This gives people something to align with and rally behind. It helps attract people and customers. A clear purpose also drives consistency in company culture and establishes a standard that can support the company and its board in turbulent times while guiding decision-making, capital allocation and value creation.
Looking Ahead
We believe that global stewardship captures the full array of a board's responsibilities for guiding an enterprise effectively over the short and long term. We have proposed this model, including the five Ps, as a tool and framework for board members to ensure they are covering all the bases of effective governance, particularly as the scope and demands of good governance change and evolve.