Prepping For Proxy Season

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ESG is back on boardroom agendas with a vengeance in 2021. Here’s what directors should be thinking about on each branch of the acronym.

The topic of ESG, which had held the spotlight ever since Larry Fink’s 2018 letter asking CEOs to clarify their company’s purpose and long-term value, took a temporary backseat last year as companies struggled to keep the lights on during the global pandemic and economic freeze. In 2020, very little of directors’ time in the boardroom was allotted to ESG, and just 27 percent said investors had raised the issue for discussion, according to Corporate Board Member’s 2021 What Directors Think survey.

But with the vaccine rollout in full swing, hope abounds for a return to some sort of normalcy this year, and ESG is back in focus and very likely to be a key topic of interest during the 2021 proxy season. Recent quarterly earnings calls may have provided a preview of the larger role ESG will play: Twenty companies in the S&P 500 mentioned the acronym or sustainability on earnings conference calls between Oct. 1 and Dec. 31, compared with only six companies three years earlier, according to FactSet, a data provider. Globally, the term ESG was mentioned 205 times on investor calls during the fourth quarter of 2020.

And for the first time this year, investors have made clear that they are prepared to vote against directors who sit on boards that don’t measure up on environmental, social and governance goals. “We are going to consider voting against this year if there is no racial or ethnic diversity,” says Peter Reali, senior director with Nuveen, the investment management arm of TIAA. “We do believe the time is right to start taking action and holding companies accountable, especially if we haven’t seen any movement—for example, [if] they put on three new directors in the past three years and everyone fits a similar profile as previous directors, that’s going to flag for us a potential vote against.”

Attorney Marc Gerber, who represents companies in proxy fights, says he believes that for most investors, 2021 will be “kind of a warning shot” as far as things like racial and ethnic diversity. “In other words, we’ll highlight if you lack diversity or we’ll note it, but we’re not going to vote against the board in 2021—but we will start voting against in 2022.”

The key this year is for boards to find that delicate balance between transparency and competitive savvy, offering investors enough of what they want without putting their companies at a disadvantage compared with other players whose ESG data looks better—or whose data might also be less than stellar, but they’ve chosen not to disclose it.

Some companies have done materiality assessments to determine which issues are most critical to the company’s long-term value, while others are still sorting through the risks. To help boards prepare, Corporate Board Member’s ESG Special Report lays out the three branches of the oft-misunderstood acronym and what directors might expect from investors this spring.

The ‘E’ Green Goals

Ever since the furor over Volkswagen’s “diesel dupe” in 2015—which was in large part blamed on lax governance— boards have been well aware of the potential risks of failing to catch poor processes and controls around environmental issues. Until recently, some companies with relatively small carbon footprints—e.g., service firms, software providers—were thought to be exempt from serious scrutiny on the green front, but this year, investors are ratcheting up the pressure all around.

Phyllis Campbell, Chair, Pacific Northwest Region, JPMorgan Chase; Director, Air Transport Service Group

In his 2021 annual letter to shareholders, “[Larry Fink] absolutely painted the bullseye on climate change,” says Phyllis Campbell, chairman, Pacific Northwest JPMorgan Chase and director on the board of Air Transport Service Group. BlackRock followed that with a memo in February saying that directors of companies in which it invests must have “climate fluency” and must disclose their short-, medium- and long-term plans to reach net-zero carbon emissions by 2050. If a company does not voluntarily meet BlackRock’s new standards, the firm said it was prepared to support shareholder proposals that would force them to do it. Vanguard and State Street have issued similar challenges to companies to step up their ESG games.

“Those investors control somewhere upwards of 30 percent of companies’ stock collectively, so those are the Big Three [boards need] to pay a lot of attention to because other investors tend to follow their lead,” say Campbell. More than half of investors surveyed by EY said “climate risk and natural resource constraints” were among the biggest threats facing companies over the next three to five years. To be successful in the future, those investors said companies would need to integrate climate and other sustainability risks into business strategy.

Doing that requires some thinking, however, because there is no one-size-fits-all answer, says Campbell, who until last year was a director on the board of Alaska Airlines, for whom emissions was a major issue. But nearly every company can find a way to relate to climate risk and ways to mitigate it, she says, pointing to Microsoft as an example of a software company that chose to set a big long-term goal—to be not only net-zero on carbon emissions by 2040 but net negative. “So, they’re looking at alternative sources of energy; they’re looking at their carbon footprint with their buildings; they’re looking at their vehicles’ standards around carbon emissions and employees who commute,” she says. “It may not be as big [for them] as for an airline, but there are definitely ways to benchmark and things companies can do within their own assets.”

As boards consider how the “E” risks apply, they may want to keep in mind the following:

Study the standards.
Jan Babiak, Director, Walgreens Boots Alliance, Bank of Montreal and Euromoney Institutional Investor

The hodgepodge of sustainability standards has long been a challenge for both companies and the investors attempting to evaluate them—a world apart from financial reporting, which offers essentially two options, IFRS and U.S. GAAP. “Those two choices means you have comparable numbers, and you can’t just opt out,” says Jan Babiak, who sits on the boards of Walgreens Boots Alliance, Bank of Montreal and Euromoney Institutional Investor. “If a company didn’t want to disclose how they were accounting for revenue recognition, for example, they don’t have that choice because the auditors won’t sign off on it.”

There might be light at the end of that confusing tunnel. In the fall of 2020, five leading standards organizations—GRI, SASB, CDP, CDSB, IIRC—announced their intent to collaborate on a single standard, and, separately, the International Financial Reporting Standards (IFRS) Foundation released a proposal for developing a comprehensive standard. They face several key challenges, including materiality, which varies widely, and comparability of disclosures around multiple ESG issues. “I think we’re kind of becoming ‘woke’—if I can use that millennial language—to the fact that we need to have some accountability around this, but the path to clarity and transparency and comparability is not yet clear,” says Babiak.

In the meantime, boards and management need to know which research firms—e.g., Sustainalytics, MSCI, Thomson Reuters, Bloomberg—their biggest investors subscribe to and should understand which data investors are most interested in and how much weight they give to absolute scores vs. underlying data. Boards also need to ensure information is being communicated effectively; if a comprehensive sustainability report is published on the corporate website but is not picked up by data providers, it likely won’t reach investors. “Some directors get frustrated because they say, ‘We have all this stuff out there,’ but if it’s not put out there in a way that it’s being captured by the investors, that’s not helpful,” says Reali, who adds that because of this, there will continue to be a push for ESG information to be provided in “financial-type documents,” such as an 8-K.

S: Social Substance

In the aftermath of a pandemic that shut down the economy, led to massive layoffs and highlighted the severity of income inequality—not to mention a year marked by extreme racial unrest following the death of George Floyd—all boards need to be familiar with “S” risks and must be prepared to show investors:

Progress on diversity.

Around two-thirds of investors surveyed for EY’s 2021 proxy season preview report said they planned to press for robust diversity disclosures for boards and the workforce. For the latter, most said they wanted diversity data aligned to the U.S. Equal Employment Opportunity Commission’s EEO-1 Survey data, and many said they would look for a narrative about the company’s human capital strategy and goals. Campbell notes that State Street highlighted ethnic diversity in the workforce. “That’s the first time I’ve seen them be explicit about that.”

But Jamie Smith, EY Americas Center for Board Matters investor outreach and corporate governance specialist, says investor firms do understand that it’s a journey. “They have some of the same issues,” she says. “They know the numbers aren’t going to look good, but they want to see those numbers and see the plan for progress.”

In her work with board members, Maria Moats, leader of PwC’s Governance Insights Center, recommends that boards have a dashboard with “a manageable list” of key workforce diversity data they can follow, such as workforce composition, retention, promotion, pay equity. “So, it’s at the level where you can ask questions like, why is there a leaky pipeline? Why is it that when you look at promotion rates between white males and Hispanic females, one of them is going faster than the other—and what are you doing around that?” It’s sometimes an uncomfortable conversation, she adds, “but it’s okay to be uncomfortable as long as your questions are coming from a good place.”

A solid HCM strategy.

For the past several years, investors have been asking to understand how a company’s human capital was part of its strategic long-term value consideration, but if anything, the pandemic trained a more intense spotlight on HCM, given the life-and-death impact on employees. This year, companies with front-line workers will be expected to show a continued focus on safety, and all companies will be scrutinized for the way they treated employees and managed the remote workforce during the economic shutdown.

Courteney Keatinge, Senior Director, Glass Lewis

Courteney Keatinge, senior director, ESG for Glass Lewis & Co., suggests companies in higher-skilled industries also pay attention to potential losses from the “she-cession,” as it’s being called. A disproportionate number of women have been leaving the workforce because they are more often the primary caregiver to children home from school and elderly parents who are at higher risk for Covid. “Companies have been spending a lot of time and energy and resources to develop women and promote them within the organization, so they could be losing a lot of investment on these women they’ve been developing if they’re not more flexible right now and don’t manage the needs of those employees,” she says. “This is hopefully a temporary situation that in theory will resolve itself at some point. So, you don’t want to lose longterm investment over what is hopefully a short-term situation.”

Healthy culture.

Reali says he will be looking for signs in the narrative of a healthy culture. “I will be the first to admit that that presents some challenges from a systemization standpoint, because you can’t press a button and say, tell me all the companies that do a good job in that.” But the board makeup, board evaluation and diversity in the executive ranks and the pipeline will offer hints as to whether the company is practicing inclusion, he adds.

Given the shift to remote work, culture is even harder to monitor, says Campbell, which makes it even more of a critical board issue. “We need to know, how are we overseeing remote work? How is management bringing people together who aren’t in the day-to-day workplace environment?”

The ‘G’: Good Governance.

According to CBM’s 2021 What Directors Think survey, fielded in partnership with the Diligent Institute, 43 percent of directors called their success measuring progress on “G” initiatives “highly successful” compared with just 18 percent and 17 percent for “E” and “S” respectively. That may be because delivering good governance is something boards have been doing for decades. But even so, several topics under the “G” heading could use a second look in advance of proxy season:

Board diversity.

Like workforce diversity, stakeholders want to see progress on diversifying the board. They’ll want to know, for example, what policies exist to ensure the nom/gov committee looks at women and racial minorities when appointing new directors, says Keatinge. Disclosure and narrative will be key. If a board lacks diversity, “they could say nothing and not be violating any norms or laws,” she says. “However, it really does kind of demonstrate the seriousness with which they are approaching this issue. If they have engaged four recruiting firms and are implementing the ‘Rooney Rule’ and doing all this stuff to ensure that they have a woman on their board in the next two years, that’s an instance where we probably would not recommend against any directors on the board. So definitely, telling your story is important.”

Board refreshment and composition will also be in the spotlight, particularly given ISS’s policy update, which shifted from recommending against term-limit shareholder proposals to considering them on a case-by-case basis. “There will be a stronger focus on really wanting to understand how board expertise aligns with strategy and the current challenges companies are facing,” says Smith, who has heard investors question the relevance of long-tenured directors. “The burden is on the board to make that case. Looking at the challenges—digital transformation, changing stakeholder demands, the focus on human capital’s role in driving value, the role of diversity and growing sustainability risks—looking across this horizon, how do directors around the table have the skills to be resilient and create long-term value?”

Whistleblower allegations.

Audit and risk committees should dig into the quality of the company’s process for receiving complaints and how they’re handled, says Moats. “Look at your process with management, how can we enhance this? Does this allow for people to freely submit their complaints and reinvestigate?” In light of the riots and attack on the U.S. Capitol in January, boards also are being encouraged to increase oversight around political activity, political donations and lobbying. “That’s always been out there, but it’s mainstream now.”


Following the year of Covid-19, investors will be looking at how compensation of top executives, including the CEO, align with broader human capital decisions, such as pay cuts, furloughs and layoffs. “There were a lot of announcements last year about executives foregoing bonuses and whatnot,” says Reali. “Then you saw a little bit of making up for that with bonuses [at the end of the year], so we’re just going to be looking to make sure that pay continues to be aligned with performance overall.”

Stakeholders may also be looking at how companies are tying their diversity goals into executive compensation. A recent FW Cook study on the use of ESG in incentives plans found that 56 percent of U.S.-listed companies with market capitalizations in excess of $25 billion used one or more ESG measure in their annual or long-term incentive plan. However, the majority of those used discretionary rather than formulaic methods of applying those metrics, indicating that identifying quanitifiable goals is still an issue for many companies. “The challenge is how do you translate goals that may be more difficult to measure and translate that into something concrete that you can put into a compensation plan and motivate people to achieve that,” says Gerber.

Reali says he is less concerned with tying pay to DE&I metrics. “We’re not trying to micromanage that,” he says. But if a board has decided to do that, he hopes to see more granularity around the metrics, what exactly is being incentivized and what they disclose. In other words, no window dressing. “What we really want to do is get at the root cause of systemic underrepresentation. How will this solve those issues?”

Moats stresses that when in doubt, boards should err on the side of transparency because that will build maximum trust with stakeholders and attract investors. And while she hears directors fretting over what a new administration and new SEC chair will mean from a regulatory perspective, she reminds directors not to be too caught up in that. “This is a time in history that we have not seen before, when stakeholders are demanding more of leadership and of companies. We are the most trusted institutions. So, what are stakeholders demanding? What is your purpose? What is your strategy? Why the E, the S and the G? Start with that—that’s your real story.”

Just starting? Don’t try to boil the ocean.

When Alaska Airlines was trying to make oversight of ESG more structured, the company selected three metrics in each major category to monitor. “Don’t pick the 10 things that management’s looking at but ask, what are the most material to our moving the dial and to institutional investors,” says Phyllis Campbell. “So, they chose waste and carbon emissions.”

For the ‘S,’ given Alaska Air Group’s strong culture of employee engagement and customer satisfaction, the board started with metrics along engagement, which was tied to employee surveys and other data sources. The culture climate issues were overseen by the audit committee, while the employment data was overseen by compensation and leadership development, Campell says.

“So, just pick two or three that are material, tied to your long-term strategic plan as well as your culture, and monitor those. Over time you might adjust them and change them, but you’ve got to start somewhere. Getting the board and management both to agree on what those metrics are is probably a good starting point. And then at least you have a baseline of something you’ve been following over time and something that you can actually benchmark in terms of change.

Your ESG Roadmap

It’s not enough to publish a corporate sustainability report; companies need to show they have a cohesive ESG strategy that is linked to purpose and woven into operations.

1. Take stock of your stakeholders: Identify each stakeholder group, including employees, and determine which aspects of your business are most important to each.

2. Lead with purpose: Now that you know what is important to stakeholders, define your purpose, set related goals and lead accordingly. Differing aspirations among stakeholders may make it difficult to gain acceptance on a set of measures. Be intentional with achievable goals.

3. Develop and report metrics: Develop consistent and controlled policies for quantifying and reporting metrics.

• Align metrics reported externally with those used by management in running the business.

• Organize metrics in a systemic way while leveraging standards or frameworks.

• Offer comparison figures to demonstrate consistency.

• Determine the appropriate format and how frequently to report.

• Implement controls over the preparation and reporting of metrics with the same rigor as controls over traditional financial reporting.

• Provide context—the most relevant metrics consider the entity’s industry and markets.

4. Encourage action: Incentivize employees through their participation in setting the company’s goals and by connecting aspects of compensation to achieving them.

5. Re-evaluate: Changes in the social, economic or political environments can lead to changes in stakeholder views. Periodically assess whether the metrics continue to resonate with stakeholders.

Source: PwC’s “ESG oversight: The Corporate Director’s Guide,” Nov. 2020

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