Today, most Fortune 500 companies—and many smaller ones—have grown accustomed to issuing sustainability reports communicating the company’s mission, community involvement, diversity measures, environmental performance and other ESG initiatives. But while this may have been sufficient five years ago, today’s investors are demanding more: more transparency, more metrics, more reporting and more standardization. There’s no doubt: boards and leadership teams are feeling mounting stakeholder pressure to act and report on an increasingly wide-ranging list of issues. In a recent survey conducted by Corporate Board Member and EY’s Center for Board Matters, some directors reported feeling that the demands can, at times, be unreasonable. Pet insurer Trupanion experienced that pressure firsthand when a proxy advisory firm expressed concerns that director Robin Ferracone found surprising for a financial services company. “ISS came along and said, ‘You are high risk from an environmental perspective,’” she recounts. “What it came down to is we were only high risk because we hadn’t reported heavily on it, and we hadn’t filled out the ISS survey and the ISS scorecards.”
The Need for Nuance
While acknowledging that investment firms need data to accomplish their research and benchmarking, directors point out that requests don’t always fit the business or can be tricky to meet. “The questions they ask are very detailed, and it’s hard to get the data around your carbon footprint, for example,” explains Ferracone, who serves on the company’s compensation committee, adding that the company is nonetheless “working in earnest to incorporate ESG into what it does.”
But often, directors we talked to say these issues warrant a deeper conversation than the one analysts and investors seeking benchmarking data are able—or willing—to have. “They’ve got 150 companies’ earnings calls they’re doing in three weeks, so it’s a quick hit,” says Mike Gianoni, president, CEO and executive director at Blackbaud andchairman of the board at Teradata, adding that it’s with the savviest of investors that companies can discuss the value-add of ESG. “It’s the longer conversations outside of those [earnings] calls that try to get into the ‘who is the company’; that’s a whole different thing,” he says.
Frank Brandenberg, who is chairing KEMET’s board through the company’s integration with acquirer Yageo Corporation, says he understands why some directors push back on ESG demands from investors. “I feel the same way,” he says. “I don’t want to be lectured and forced into doing something or have shareholder pressure or social pressure to tell me what to do, yet they’ve never really participated or sat in the chairs that we sit in. I understand that you can go overboard to the point where you’re doing things that are just for appearance purposes and not for real profits.”
Ideally, ESG should be integrated into every company’s strategy, adds Brandenberg, who notes that identifying and executing on what that means for each particular business can be challenging. “Employee morale is an extremely important part of your profitability,” he says. “A lot of companies say employees are our most important asset, yet they don’t necessarily behave that way.”
Understanding what investors want to see in the context of their respective businesses is part of the challenge, say directors. When asked to rate their understanding of their shareholders’ ESG expectations, directors rated the “G” a 4.1 out of 5 (on a scale where 1 = low understanding and 5 = great understanding)— but the “S” and the “E” a mere 3.4/5.
The issue, as many survey participants pointed out, is that “which aspects of ESG are important is very specific to each company,” says Ferracone. And shareholder priorities also range widely.
Meanwhile, ESG reporting guidelines are coming from all quarters, from SASB and GRI frameworks to Nasdaq’s global ESG reporting guide for public and private companies and California’s Climate-Related Risk Disclosure Advisory Group.
“The hard part,” Gianoni says, “is there are no standards. It’s not like SEC reporting or accounting standards. There’s no body of work that creates any standard of good, and it’s different by company. For example, the environmental side is pretty darn easy for a cloud software company like mine, but it’s pretty darn difficult if you’re a manufacturer building in 40 countries; you got a whole scope of environmental [issues]. It’s quite different.”
The lack of standards is an issue for the investor community as well. “A lot of what we hear from investors is that the disclosure is so fragmented and company-specific that they can’t compare it or benchmark it,” says Stephen Klemash, leader of EY Americas Center for Board Matters and a partner in this research. “That’s part of why they’re pushing for companies to use these frameworks and potentially pushing regulators to do rulemaking, to have something standardized so that they can do performance analysis, benchmarking and have a uniform set of data.”
Ideally, investors want companies to use external frameworks as a base and add company-specific data points to tell their unique story, he explains. “Investors want standardized data as a baseline to make it easier to benchmark and compare and want to see companies supplement that with company-specific reporting as helpful to understand the business, the strategy, the overall risk management and the business context of what people are doing,” Klemash says.
Some directors, however, argue that the topic of ESG is too broad and complex for standardization. “How do you have a standard for the ‘S’ side of that?” asks Gianoni. “I think the objective is to, every year, always get better in all of the categories. Our company is half male, half female, so our big focus on diversity is all of the underrepresented groups. And for gender diversity, are we helping our female associates get higher and higher in our chart? If in the next three years, we go from 50 percent female to 70 percent, but we do not improve the total percentage of the other underrepresented groups, I think we failed. Everyone starts from a different place, so to have those standards, it’s really tough to do.”
While most directors say their companies would “do the right thing” regardless of requirements, the majority of those surveyed say they are only considering ESG issues in response to compliance, disclosure obligations and shareholder pressure. Twenty-six percent of directors don’t believe environmental initiatives materially impact the company, while only 20 percent of directors participating in the survey say they view the “E” aspect of ESG as an area that presents risks and opportunities for the business.
Despite the skepticism, directors report being relatively confident of their grasp of material environmental issues. Just 5 percent of those surveyed reported lacking confidence in their understanding of what the “E” component means for their business, and even fewer feel ill-equipped in their knowledge of the “S” (4 percent) and “G” (1 percent) components.
Directors have long reported feeling confident about their understanding of the G component of ESG, but the survey data shows half (49 percent) of them also say they have an “excellent” understanding of their company’s specific risks and opportunities when it comes to the “S”, and most particularly with respect to workforce diversity, equity and inclusion.
Of course, every industry is impacted by these issues to varying degrees. But while the “E” may be more material for heavy carbon emitters than for a professional services firm, for instance, Kathy Misunas, a seasoned board director and advisor to various businesses, argues that it’s still worth examining in the current climate. “Even a consultancy has the ability to look at how their people travel or if they’re traveling, for instance, on an airline that has stated that it is going to be carbon free by 2030. Every company has some opportunity to have an effect.”
Larry Bickle, a retired public company CEO who is now a director at hydrocarbon exploring company SM Energy, points out that companies that produce products containing petrochemicals, from phones, cosmetics and clothing to carpets, food preservatives and medical devices, can push for more ESG in their operations. “I was on the board of Tucson Electric company for 15 years, and I’m proud to say that during the time that I was there, we went from 2,400 megawatts in coal down to 400 megawatts in coal. We replaced it with natural gas, and that made a huge drop in our environmental footprint. Switching from coal to natural gas is a huge improvement in CO2 emissions for generating essential electricity.”
Brandenberg advises companies to be intentional about understanding what ESG means to their companies and translating that to goal-setting. “Some companies consume tremendous energy; some don’t, so energy conservation may not be the issue at hand to them, but figure out among those topics what would be important to your company, and then just start talking about it and do some internal measurements, set some goals,” he says. “The trap is people will follow those measurements just for the sake of measurements, but that doesn’t tell them anything, they don’t set goals. So, if they’re going to measure something, they have to have a goal in mind as to what they would like to achieve, something that is relevant to their profit or the health of their company.”
Ferracone agrees that establishing a baseline is crucial. “From where are we starting?” she asks. “What does our company do now? Where are the gaps in pay, representation, inclusion or promotions or other areas in which the treatment isn’t even? So, it’s an internal measure, and the question is, ‘How do we improve?’”
Measure to Matter
For Christopher Franklin, CEO and chairman of Essential Utilities, a Pennsylvania-based utility company that operates in 10 states under the Aqua and Peoples brands, success begins with setting clear objectives and establishing metrics. “It’s like any other objective that we set for ourselves in business. If you measure it, you’re going to improve it. So, if we’re going to make improvements in some of the areas like diversity in our suppliers, diversity in our employment, environmental measures, we’re only going to do those by setting targets and then achieving them.”
While the full board must be involved in the ESG conversation to ensure that everyone understands the materiality of the issue and that the board has the right skillset to address ESG moving forward, committees play an important role, according to Klemash. “Nom/gov committees may want to dive into how it all impacts the governance of the organization and how they’re communicating it in the proxy,” he says. “The audit committee may want to look into the type of assurance or attestation they will need when reporting on that data. The comp committee may be looking at whether there’s value in tying executives’ goals in compensation to ESG and communicating the why—and most importantly the why not.”
Overall, he advises taking a step back to assess where the company is today and where it intends to go in the future, and to think about the ways to broadly communicate these assessments and decisions, whether it’s under a regulatory standard, an earnings call discussion or an impromptu request by a pool of investors. “It’s no different than total shareholder returns on a stock,” he says.
ESG and Pay
As pressure to be more proactive on ESG issues mounts, some boards are pondering tying ESG metrics to compensation. Ferracone, who’s also the CEO of Farient Advisors, a compensation, performance and governance advisory firm, has seen boards land on both sides of the ESG incentive debate.
“I have one client who said, ‘You know what? We do a lot of things. We take DEI, as well as all kinds of ESG things, very seriously,’” she says. “And they’re thinking that if they were to put these types of measures into their incentive system, it would actually narrow the focus of people…. Others say, ‘ESG is not going to get the attention it needs unless we actually put it into our incentive system.’ It becomes a judgment call, but I think one of the things that’s become more standard is that comp committees and companies feel like they need to at least look at the subject. So, even if they decide not to put stakeholder incentive measures into the incentive system, they’ve at least looked at it, considered it, understand the pros and cons of it, and they move on with that knowledge. I’m seeing a lot more people taking it seriously.”
To Gianoni, the lack of ESG standards across industries makes incentivizing ESG impossible. “You can tie executive comp to so many things. But ESG is not standardized or regulated, so it can be so broad that it could be very subjective and not objective. That’s what I worry about when you start to tie compensation to things like that.”
In his eyes, it’s about building the right culture. “The ‘E’, the ‘S’ and the ‘G’ are all linked together as one thing. They’re different categories, but they do the same thing, which is building a competitive, financially viable company. If you have a really good culture, you can win at business. It’s just connected,” Gianoni says. “Having a good culture means you also have diversity and inclusion. It means you have to do the ‘S’ in ESG. You have to do all of that. If you don’t do that, you will not have a good culture in today’s and the go-forward world. And I believe most board members would agree on that.”