Following the social unrest last summer, environmental, social and governance (ESG) issues became an even bigger focus for U.S. companies. In the months since, we’ve heard a lot about the ESG risks that can diminish a business’s long-term value. A climate-related wildfire can wipe out a company’s operations in a region. A single #MeToo scandal can lead to a significant drop in the number of women willing to work for a company. And corporate silence on movements like Black Lives Matter can result in calls for boycotts of a companys’ products.
Given investor’s growing focus on ESG and the call for better reporting, directors are asking us for best practices in board oversight. Should the audit committee oversee ESG? Nominating and governance? Should it be a separate ESG committee?
Our view is that companies should not treat ESG as a separate issue, but integrate it into their strategy and risk profiles. Since strategy and risk discussions fall squarely in the wheelhouse of the full board, it can delegate some areas of risk oversight to certain committees, but the full board should understand and be aware of the risks. ESG is a huge issue that encompasses everything from executive compensation and proxy disclosures to corporate messaging. As a result, parts of ESG fall easily into the committee structure.
For example, the compensation committee already sees executive compensation, so it would be the natural committee to hold discussions about linking ESG accountability to executive pay. Because the audit committee provides oversight of metrics and financial reporting, it might pick up the reporting aspects of ESG. And because the nominating and governance committee is responsible for shareholder engagement, it might focus on a company’s ESG messaging.
Along these lines, the following structure can help boards allocate ESG oversight in a way that assigns its components to the appropriate committee while leaving overall responsibility to the full board.
With this approach, the full board oversees:
• Strategy: Are ESG risks and opportunities integrated into the company’s long-term strategy? How is the company measuring and monitoring its progress against ESG milestones?
• Messaging: Do ESG messaging and activities align with the company’s purpose and stakeholder interests?
• Risk assessment: Has leadership identified material ESG risks and incorporated them into the ERM? Should the board retain oversight of these risks or allocate them to the committees?
• Reporting: What are the best communication channels to use for the company’s ESG disclosures?
The audit committee oversees:
• Disclosures: Are ESG disclosures (both qualitative and quantitative) investor grade? Which ESG frameworks and standards is the company using?
• Processes and controls: Does the company have processes and controls in place to ensure ESG disclosures are accurate, comparable and consistent?
• Assurance: Should the company obtain independent assurance to ensure ESG disclosures are reliable?
The compensation committee oversees:
• Accountability: Are the ESG goals and milestones effectively integrated into executive compensation plans?
• Talent and culture: How is management organized to execute the ESG strategy? Are the right people and processes in place? Does the company have a culture that embraces ESG efforts?
The nominating and governance committee oversees:
• Engagement: Is the company communicating its ESG story to investors and other stakeholders effectively?
• Board composition: Does the board have the necessary expertise and skills to oversee ESG risks and opportunities?
• Education: Does the board understand why ESG is important to investors and other stakeholders? Is the board appropriately educated on ESG?
Oversight allocation is just the beginning. Boards also need to disclose their ESG oversight efforts in company proxy statements or other ESG reporting. Your stakeholders need to know it’s a board priority. So, if your board is still working through how to oversee ESG, consider including a paragraph in the proxy that explains you’re developing a plan. If you’re further along in the process, let stakeholders know what your oversight structure is.
Ultimately, boards will need to decide how to best assign oversight responsibility based on their existing committee structure, the director skills required to address ESG topics, director time commitment and meeting schedules. But embedding the responsibilities in your current structure demonstrates that you are not treating ESG as a bolt-on activity but embracing it as part of the company’s business practices that will deliver long-term value to stakeholders.
For more insights on this topic, read PwC’s “ESG oversight: The corporate director’s guide.”