ESG Playbook 2023

At Corporate Board Member’s recent ESG Board Forum, investors, academics, attorneys and directors set out to separate signal from noise.

Boards are pressed daily by new demands  for compliance and information in the ever-  exploding arena of environmental, social  and governance issues, but their commitments and capabilities aren’t keeping pace  with the rising clamor from progressive  NGOs, activist investors, probing politicians  and regulators, attuned employees,  agenda-driven media and socially minded  rank-and-file shareholders.  

A case in point: The Securities and  Exchange Commission recently proposed  rule changes that would require companies  to include climate-related disclosures  in their stock-registration statements and  periodic reports, including information  about material risks from climate change  on their businesses. The move represents a  significant ratcheting up of the pressure on  corporations to heed ESG sensibilities.

“You need to think about what’s material  for your specific business,” said Jonathan  Bailey, head of ESG investing for asset  manager Neuberger Berman. “For instance,  clearly, many companies have climate risks  and opportunities. So what are you doing  around climate-risk management and  opportunities for your business and transitioning  to a low-carbon future? That has  got to be top of mind for board members.”  

That’s why Corporate Board Member recently convened its ESG Board Forum,  an online event that helped directors dive  deeply and practically into the challenges  of complying with the demands of this ever-  expanding sector of responsibilities—and  into opportunities for making leaders out of  their companies in an important new area of  differentiation for U.S. corporations.  

Here’s some of what experts in the ESG  domain shared at the forum:    

Tips For Creating Good  ESG Oversight

Melissa Waller, ESG and Sustainability Committee  Chair, IperionX: “You need to not just  talk the talk but walk the walk as an organization  and what you’re reporting on and how  that aligns with the SEC.” Also, “internal stakeholder feedback is important because employees  are touching things daily and living and  breathing the experience of the organization.”  

Jamie Gorelick, Board Member, Amazon and  VeriSign: “Try not to proliferate committees if you possibly can. My recommendation has  been that the ‘E’ part and ‘G’ part be handled  by the nominating and governance committee,  while the ‘S’ part in the care and feeding  of employees be in compensation and development  committees, except to the extent  that the ‘S’ part deals with vendors who are  external, and then it goes to the nom/gov  committee.”  

Roel Campos, Board Member, Regional Management  Corp., and former commissioner,  SEC: “Large investors will be asking for more and more information about [ESG] because  they have constituents and investors themselves  who want to know about this. So have  very objective measures: Is there a governance  structure to deal with client risk? What committees or subcommittees are involved? Is  there a process for risk management? These  are object things without even getting to  things like carbon measures [that will be] requested by investors.”    

Ensuring The Right Information  

John Roe, managing director and head of  investment stewardship for the Americas for  BlackRock, the $10 trillion (AUM) investment  firm, outlined a “chain of answers and steps  that have to happen” for boards to be assured  they’re getting the right information about material  ESG matters and are using it correctly:  

Institutionalize interest: “The board has to  be interested in receiving the information,” as  demonstrated by committee structure and  assignments. “There’s no silver bullet. Maybe  rename an existing committee or the way  you’ve divided overall responsibilities among  the board itself. But doing it somehow is important.” 

Identify specific risks: “The key ESG risks are  different for everyone. You can turn to materiality  determinations or the [Sustainability  Accounting Standards Board index] as great  starting points. Highlight what the external  market is seeing as your key risks. But the  board needs more information to say what  they should be focusing on; for instance, with  human capital, what is the specific set of risks?  Is it how diverse employees are progressing  through the seniority pipeline? Environmental  risks such as water for data centers? There are  real environmental risks that businesses are  facing that they may not think they have.”  

Link with management: “Determine the links  between management and the board so that  information can flow across. How is it being  filtered? Do you trust the process? Make sure  it’s working properly.”  

Create “free-rangers”: “How can the board  get information on its own if it feels the need  to do so? Some people call themselves ‘free-range’  directors, able to roam the company  and source information where they think it is  important for them to do so—not in a rogue  style, but in way that’s instructive, to bring additional  information to the boardroom. What’s  the equivalent of that ‘free-range’ director for  your board? You may have a management  team that’s fabulous and that you trust 100  percent, or not.” 

Nota Bene: Calpers Isn’t Happy  

The California Public Employees’  Retirement System (CalPERS) has  hundreds of billions of dollars in  assets and is perhaps the most influential  of the public-employee pension  funds that comprise a huge portion of  America’s investment capital. CalPERS  has been at the vanguard of agitating  boards concerning ESG and takes a  broad definition of the field to cover  other areas, including human-capital  management as well as more typical  ESG concerns.  So when James Andrus, CalPERS’  managing investment director of  board governance and sustainability,  speaks about ESG, board members  should listen. And Andrus shared a  largely dour view of how well most  U.S. corporations are addressing  CalPERS’ growing list of concerns and  demands in this area:  

On companies’ current reporting:  “The baseline for information is quite  low in terms of what is actually provided  by companies, especially within  financial statements,” Andrus said.  “They provide very little information,  [although] some of this is material. Climate-related information isn’t in there,  and yet [the Financial Accounting  Standards Board] isn’t even taking up  this [deficit] as a research project.  “Some would say this information  isn’t material, but no—that information  isn’t there because the standard setter  hasn’t done the work to place it there.”  

On the lack of a long view: “Financial  statements don’t look long-term. If  they’re looking forward at all, it may  be just one or two years, and anything  longer than that is just speculative. But  we’re in a technology age where we  can do substantially better. Investors  need better information, and [companies]  have all the systems available to  do that. And companies get better” when they provide such information.  “Some of these pieces of information  in regard to ESG can be incredibly  critical to certain companies, such as  in identifying long-term risks such as  climate change and in how companies  treat their employees.”  

On internalizing “externalities”:  “We’re focused on having companies  internalize the externalities that companies  create,” Andrus said. “Externalities  are, for example, when a company  can operate in a market and cause a  burden on people who aren’t part of  the basic contract—like a chemical  plant that is in a community and isn’t  benefiting the community in any way;  there are no jobs, and there’s no relief  from odors or additional traffic.  “Those things won’t stand anymore.  We live in a technology environment  where people won’t sit and take it. This  causes a future burden on the company.  It’s better to be a great corporate  citizen now and into the future so that  you don’t have that pushback. You  need to take a responsible-contractor  approach that will benefit the company  and the community.”  

On human-capital issues: “We have  [an] issue with labor costs: People are  companies’ most important asset, but  you can’t find that information within  financial statements. We need to correct  that.”  Andrus continued, “There are foundational  issues with regard to how you  treat other human beings. Some activities  are going on in the U.S. that could  not go on in other countries, such  as how people treat farm workers. In  some places, it’s not a requirement [to  provide] farm workers with water and  shade.  “The questions become: Can huge  companies, paying executives huge  salaries and having sophisticated directors,  operate in 2022 in a [way] that  is on some level and in some manner  treating people in a disgusting manner?  We would prefer companies up  their game and treat people better,  especially their workers.”    

Five Factors Driving Esg In 2023 

ESG is “one of the top board-level topics today in  the North American marketplace, up there with  digitalization and technology, regulatory affairs,  the future of work, inflation and sustainability,”  said Anthony Decandido, ESG advisory partner for  RSM U.S. LLP, a provider of tax, audit and consulting  services for mid-market companies.  

However, thus far the ESG movement “has been  mostly stakeholder-driven,” he explained. “This is  a difficult point for many boards to get around  because we have a tendency in the North American  economy to respond to instances of [regulation]. I  promise you [ESG activism] is being done mainly  because of the preference differences among folks moving into executive and management ranks now.”  

Yet, Decandido stressed, “the level of interest and  requirement around ESG will change dramatically” in  large part due to five factors:  

1. Companies are struggling to understand their  poor ESG-compliance scores by big investors,  NGOs and others grading their performance. “It’s  hard to get credit,” he said. “You might be doing  some great things organizationally, but if you’re  not disclosing them, you’re not going to get credit  in the market valuation of your business just yet.”  

2. Outside agencies are available to help with this  task. “Companies are struggling how to understand  and support [information] and how that  Anthony Decandido, ESG  Advisory Partner and  Financial Services Senior  Analyst, RSM US LLP  might be decision-useful to stakeholder groups,  the board and the C-Suite,” Decandido said. But,  “There’s a lot of interest in market consistency and  comparability over these reporting frameworks.”  

3. Help for boards in framing responses is on the  way. For example, he said, the Financial Accounting  Standards Board has put out a whitepaper  “about the convergence of sustainability topics  with traditional financial-reporting topics. So if  you’ve got an operating footprint in an area that’s  prone to natural disasters,” for instance, “and you  represent a certain existential risk for operating  there because of climate-related issues, FASB  is now saying you have to consider that in your  financial disclosures.”  

4. The SEC’s climate proposal “is a watershed  moment, a signal that the market wants this, that  things have to be sorted out.” But the public-comment  period on the proposed standard is likely to  be extended, Decandido said, “because the reality  is a lot of companies lack the competency to report  climate-related carbon emissions at this time.”  

5. The Biden administration’s infrastructure-improvement  package “signals that things are  heating up for ESG” because of its many  aspects that boost spending on environmental  quality and sustainability.   

Four Ways To Get Good Esg Reporting  

Boards and management may demonstrate the  will to improve and execute ESG metrics, but how  can they make that happen in a field where competence  is still only developing yet demands for  reliable information are outstripping its availability?  RSM’s Anthoney Decandido suggested four  approaches:  

Recruit on campus: “Folks coming out of universities  now have the opportunity to study sustainability,  while most [directors] didn’t. The limitation  there is that these [graduates] don’t have a rich  degree of business acumen.”  

Seek certification: Programs are emerging that  offer professional licenses “that [require] a relatively  limited cost” to get people up to speed who  “want to re-tool themselves” and provide ESG-reporting  expertise in the new era. 

Start by crawling: “Reduce the number of things  you’re presenting” at first, Decandido said, instead of  falling for the temptation to over-report. “Ultimately,  there are going to be business units in the company  that have a high degree of competency with data  aggregation, while others may not. That’s OK. It’s a  journey, not a sprint. “Think through things that you can report quickly  and accurately, so that when it’s published to the  outside world, you can put your hand on your heart  and say, ‘You can rely on this data.’”  

Sponsor it: At the board and top-management  levels, he said, “sponsorship is important” to make a  priority of thorough, accurate and comprehensible  reporting on ESG metrics. “You’re going to need at  least a handful of people who are going to hold the  company flag up on this and say, ‘This is important,’  or nothing will pick up traction.”    

Tying ESG Performance To Executive Compensation    

Investor and societal pressure is one thing, but  board-designed incentives are the key to getting  management to move deliberately and swiftly on  ESG metrics and initiatives. So directors must be  figuring out how to tie ESG performance effectively  to executive evaluation and compensation.  

“Start with the idea that compensation is an  extraordinarily powerful tool, and pair that with  swift performance appraisals,” said Joseph Bower,  board member of Loews and of New America High  Income Fund. 

A long way evolved from old-fashioned notions  of “corporate social responsibility” that often were  “divorced from strategy,” companies today “see  ESG as integral to their strategy in terms of risks  as well as opportunities, and remuneration is really  important to that,” said Hazel McNeilage, chair of  the human capital and compensation committee for Reinsurance Group of America. 

Tara Tays, partner with Pay Governance, a compensation  advisory firm, suggested boards should  “inventory the company’s most crucial ESG topics  or issues and determine what has the most impact  on enterprise value creation. An ESG materiality  assessment and discussion can enable companies to  have a multi-stakeholder view for what to consider  including in incentive plans.  

“Then you have to figure out how best to  measure ESG performance” by executives. “Are  there internal reporting mechanisms? What is the  appropriate time horizon for measuring ESG performance?  How should incentives be tied to ESG  measures?” Tays said.  

Be careful about “slipping into metrics and  goals that are completely unachievable or that  are homeruns for management,” McNeilage said.  “Do materiality assessments comprehensively, and  make sure you really understand where you’re  starting from and that you’re paving the way for  something that can work well.”    

Promoting The ‘G’ In ESG  

Neuberger Berman manages hundreds of billions of  dollars in assets, and the investment firm has created  an initiative called NB Votes in which it discloses its  voting intentions for proposals at dozens of shareholder  meetings. ESG issues have moved to the  heart of its concerns.  

“There are companies that we own [shares in]  where it’s important to focus on getting the ‘G’ in  ESG,” Jonathan Bailey, head of ESG investing for  the New York-based outfit, told the Forum. “People  sometimes assume that governance is great in the  U.S. But there are board members who are more  the petting-zoo version of governance than the oversight version.” He added, “So over these last  three years, we have become very public about  some of these votes.”  

Bailey cited some examples: 

Boeing: Neuberger Berman intended to vote this  year for a shareholder proposal encouraging further  progress against key climate indicators after the  plane maker had made what NB Votes believes are  several improvements pertaining to climate-risk  practices and disclosures in the past few years.  

The firm also voted several years ago against  a board member who was chair of Boeing’s audit  committee, which had responsibility for product  safety amid the company’s disastrous experience  with safety risks in the 737 Max model. “We felt that was a failure [in governance], so we voted against  that individual,” Bailey said.  

“Not everything is perfect at Boeing [now], but  we’re also engaging them on environmental issues  and their role in the climate transition,” including  private meetings with company executives and  directors about “putting in much more explicit oversight  of climate risk,” he said, including “steps the  company is taking in measuring [so-called] Scope 3  emissions and other oversight.”  

“This is incredibly difficult for an aircraft manufacturer  to do, but they have to be at the center of  that solution, because at the end of the day, a more  efficient flying engine is better for the end customer  and the planet.”  

General Motors: “GM is facing a generational shift  in the type of cars it’s going to make, and we are  fully supportive of its capital allocation to make that  happen,” Bailey said. “It will cost in the short- and  medium-term, but it’s important that the executive  team and board are behind that. It’s important to  have that in their long-term plan.”      

Questions To Answer On The ESG Journey  

Witold Henisz is a professor and founder of the ESG Analytics Lab at the famed  Wharton School at the University of  Pennsylvania and author of Corporate  Diplomacy: Building Reputations and  Relationships with External Stakeholders.  He laid out some pragmatic thoughts for  board members looking to link purpose  to profits. Here are a few of his top-line  thoughts from the Forum:  

Nothing but noise: Most data about  ESG performance is still “bad,” he said.  “This data doesn’t allow people to assess  materiality. You look at the correlation  of ESG data across providers, and  it’s almost noise. For the most part it’s  a cloud, with almost no pattern. Most  asset managers still aren’t incorporating  ESG because they can’t prove an  investment thesis or a business case.”  

Weighting is important: How an individual  company scores can depend greatly  on how E, S or G factors are weighted  against one another and on how various  impacts of corporate practices are  compared.  “If Apple is in the bottom quartile  or the top one” of an ESG evaluation  “depends on how much you weigh  human-rights atrocities in factories  against greenhouse-gas emissions from  Apple facilities in the U.S.,” Henisz said.  “Is it good or bad to be in or out of  natural gas? And even if you dollarize  it and say, ‘What is the negative impact  of emitting carbon?’ we disagree on the  social cost of carbon.”  

Pick and choose: For such reasons,  he said, companies so far have been  free to report different responses to  ESG concerns. “Most report on carbon  and on worker training,” Henisz said.  “Beyond that, they choose what makes  them look good and omit what makes  them look poorly.”  

Threatening the core: ESG issues don’t  only stay on the fringes but can “affect  value of top-line growth, the costs of  waste, the costs of manufacturing, the  costs of logistics and distribution and  a range of additional costs if you have  to pay security guards, lawyers and  media-repair experts,” he said.  “Will you be sued and brought into  government hearings, and how well will  you manage that? There are a number  of high-profile cases, from Volkswagen  to Boeing, where companies have been  on the verge of bankruptcy because of  ESG issues. And before that, these same  firms were among the worst-performing  in their sector on specific ESG issues  they were subsequently sued for.”  

Apply a proven tool: “You need to use  your enterprise-risk management system  here,” he said. “In terms of ESG, it’s  about looking out across the business  and all of its functions and identifying  the biggest risks and opportunities,  and building a governance system and  strategy for identification of them, for  measuring your performance in seizing  those opportunities and for repeating  the next cycle.”  Boards could have been used to  assess “safety or operational risks, but  now you add climate risk or a risk of  the lack of diversity and start modeling  the impact on the organization, and  start recognizing where you are on the  journey.” 

Not a question of morality: “ESG isn’t  about goods and bads, rights and  wrongs. Boards and executives may  want to take stands,” Henisz said. “But  I’m talking about material impacts on  business, ESG factors that will change  the P&L. You need to understand those  linkages and manage them. If you manage  them, you’ll have a win-win. Boards  must manage material risks and make  sure executives are doing that, focusing  attention not on moral challenges per se  but on those material to your business—  and making sure management addresses  or mitigates them appropriately.”


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