The following is an excerpt from a conversation that took place at MLR Media’s Character of the Corporation conference.
SPEAKERS: Lawrence Cunningham, special counsel, Mayer Brown LLP; director, Constellation Software Inc., Kelly+Partners Group Holdings Limited, Markel Corporation; Anthony DeCandido, partner, sustainability solutions leader, RSM US LLP; Sonita Lontoh, director, Sunrun Inc., TrueBlue Inc.
DeCANDIDO: What do you view as the top considerations that boards should be making today as it relates to ESG strategy and governance?
LONTOH: I think the first consideration is boards should ensure that their ESG strategy is actually a part of the company’s overall business strategy, core values and culture for long-term value creation. Our role as boards, especially for public companies in the United States, is really as a fiduciary to shareholders. I think boards should have the mindset that ESG is really a way to manage material risks and opportunities for long-term value creation.
The second one is about materiality. We all know ESG can be everything including the kitchen sink. ESG rating agencies will ask you hundreds of questions. But the truth is not all of those will be material for your particular business. I think doing the materiality assessment, understanding the different expectations of your stakeholders, but then not just understanding it, but actually analyzing it against the significance and relevance for your particular business and focusing on what are the most material for you is very important.
And then once you understand what’s material, you focus on those ESG factors that are the most material for you. You have to ensure that those factors are supported by long-term commitments in a budget, resources, goals and metrics.
CUNNINGHAM: Directors have to remember that they are legally bound by the laws of the place where their corporation is incorporated to do certain things. That obligation varies from country to country and state to state, but that’s got to be the starting point: That they are typically fiduciary and typically their duty is to act in the best interests of the corporation and its shareholders.
Sometimes a state law will permit corporations and directors to act in the interests of other stakeholders, so long as that action is consistent with the interests of shareholders. So any time you’re evaluating objectives, priorities or trade-offs, you should keep the legal framework in mind that we’re not free agents. We can’t just decide, “Oh, we think this is the way to go.” You’re in a legal setting and a legal construct, and I think you have to appreciate that.
Sonita said ESG can be like a kitchen sink. In its origins, it was incontestable. When the U.N. coined the concept in 2004, it began by arguing that we need to stamp out war, poverty and hunger. These are incontestable objectives. A community grew up around the model, a community of managers and investors with equally incontestable goals of protecting the Earth, especially water scarcity and protecting constituents of corporations, especially workers and the supply chain. So incontestable ideas caught on and then evolved over the succeeding 19 years into a massive ecosystem where millions of people are invested in the movement. And so many firms make their living from promoting the concept.
But as that proliferated, the kitchen sink came in. It became an avenue to advocate for unlimited interests and constituents. That has, in the past few years, stalled the movement somewhat and in some quarters produced some backlash against it. It’s now evolved from an incontestable set of wonderful ideas to a highly politicized and charged controversy in some ways.
What does that mean for directors? Directors need to take care and not lean in or out, but think on it topic by topic. What is in the best interests of this corporation and its shareholders? That may or may not be promoting a particular item on the agenda of an institutional investor or a nongovernmental organization or other constituent.
The other thing I notice about the dilemma that directors face in navigating this terrain is that, during the expansion of the ESG movement, especially in the late 2010s and into the early COVID years is investment dollars migrated intensively toward ESG funds, toward funds that promoted these values and these interests. That continued into 2021 and 2022.
And then beginning in the first quarter of 2023, it stopped and funds flowed outward. And that’s been true in each quarter. So the investment community and the shareholder constituents are obviously conflicted about the state of play. I think directors need to always keep that North Star in mind, that their job is to act in the best interests of the corporation and the shareholders and not succumb to pressures that may in fact be transitory and often political. I think it’s a dilemma and requires significant thought and attention.