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As most large public companies host their annual meetings this spring to vote on shareholder proposals, the E, the S and the G (but especially the E and the S) continue to top the list of issues on proxy radars. Environmental and social proposals dominated the last few proxy seasons and are on track for a repeat performance, obliging board members to strengthen their oversight of ESG governance.
In fact, signs suggest ESG-related proposals will receive even greater traction in 2022, now that the ambiguities and indecision surrounding the pandemic are easing. Nearly three-quarters of investors (73 percent) reported that ESG oversight will be a more important factor in how they evaluate and vote on directors this proxy season than it was in the 2021 season, according to a recent report from Ernst & Young, with climate risk emerging as the most acute area of focus.
Directors echo the sentiment. “During the peak Covid environment, shareholders gave boards a level of discretion, especially around ESG compensation matters, due to the uncertainties impacting the revenue and target setting,” says Sheila Hooda, an experienced director who serves on the boards of multiple public and private companies. “It’s expected now for ESG to come under a bigger microscope.”
The view that strengthening ESG practices is integral to long-term value creation and risk mitigation is driving heightened interest in companies demonstrating commitment to providing greater accountability and more robust disclosure of their actions on environmental, social and governance issues.
“ESG affects everything, from CEO succession and M&A to executive compensation, compliance and risk management,” says Ana Dutra, who serves on several public, private and nonprofit company boards, including financial derivatives exchange CME Group, e-commerce company CarParts, biotech Amyris and Elkay Manufacturing. “The difference with anticipated shareholder proposals in the upcoming proxy season compared with past seasons is their emphasis on how ESG will be measured and managed, as opposed to what you are doing. This puts enormous pressure on boards to ensure a robust and executable ESG framework is in place.”
The challenges for boards are manifold. Although ESG is composed of three core elements, the individual criteria in each are abundant, intricate and thorny. These risks must be transparent, measured and, if deemed material, disclosed to the Securities and Exchange Commission. (In March, 2022, the SEC voted to propose rules on climate change disclosures. Workforce disclosures and corporate board diversity may be close behind.) Making matters problematic is that each industry has unique ESG risks and opportunities, some overlapping, as is the case with governance and environmental laws.
Dividing and Conquering
It’s a thorny task but one that boards have been attacking, often by altering their structure and committee assignments to provide ESG-related advice and guidance. Some of the boards Dutra serves on are fragmenting the constituent components of ESG for supervision by the standing committees. “For example, certain ESG issues have been put under the lens of the audit and risk committees and others under the nom/gov, compensation and other committees,” she says.
Other seasoned board members echo the approach. “On many of the boards I serve, the nom/gov committee is tasked with overseeing sustainability, whereas most compensation committees have incorporated human capital and overall talent management into their remit,” says Anna Catalano, who sits on the boards of WTW (formerly Willis Towers Watson) and polymer manufacturer Kraton, among others.
A similar tale is being played out at 99-year-old Amalgamated Bank, a certified B Corporation and the first publicly traded financial services company in the U.S. to incorporate as a Public Benefit Corporation. ESG oversight is shared across several board committees, says board member Maryann Bruce.
“The audit committee and enterprise risk oversight committees examine different parts of the bank’s ESG performance,” says Bruce, an experienced board member serving several public company and private company boards. “The audit committee reviews the performance of the ESG metrics, for instance, while the enterprise risk committee ensures that the ESG risk factors are aligned with Amalgamated’s mission, vision, values and strategy.”
As stakeholders like employees, customers, vendors, the broader community and shareholders sharpen their focus on a company’s ESG efforts, the onus is on boards to adapt in order to more effectively oversee this agenda, making sure it aligns with strategy, and vice versa. To provide this supervision, the board’s governance structure must consider ESG “more intentionally,” says Maureen Bujno, audit and assurance governance leader and managing director at Deloitte’s Center of Board Effectiveness. “Everyone agrees that ESG may be the number one topic at annual meetings and has become this broad umbrella under which business decisions must now be made.”
Committee Consensus
While there is no one-size-fits-all approach, several board members say the audit committees will likely take on oversight of ESG metrics, ESG key performance indicators and ESG controls, and the integration of these components into the ERM framework to ensure accurate SEC disclosures and financial filings.
Other standing committees will assume their share of ESG supervision. The board compensation committee, for instance, is expected to have oversight accountability for the human capital components of ESG, a broad remit that includes employee engagement, recruitment, succession planning, talent development, corporate culture and the company’s diversity, equity and inclusion initiative. These many duties are on top of traditional responsibilities like CEO compensation.
At Amalgamated Bank, the charter of the compensation committee was recently changed into the compensation and human resources committee, Bruce notes, due to the value of having the committee focus more specifically on human capital management issues like diversity, inclusion and equity.
Dutra projects added responsibilities for members of a board’s risk committee. “While the full board has responsibility for overall risk oversight, the risk committee’s purview may be expanded to address ESG matters specifically relating to ERM (enterprise risk management), such as mergers and acquisitions, joint ventures and cybersecurity,” she says. For a company looking to acquire another entity, “the question is whether the target makes the acquirer more or less ESG proactive and compliant—what are its practices and are they a good fit for us from an environmental or social standpoint?”
Another possibility is the creation of a standing board committee given full ESG oversight, whose members are drawn from the chairs of the other committees or come together as a cross-functional group with specific ESG skillsets. “A single ESG committee, instead of multiple committees reporting to the full board on ESG matters, may be an opportunity to create a more cohesive ESG strategy, goals, metrics and public reports,” Dutra says.
A new standing committee was formed for this purpose at Amalgamated Bank. “We recently created a corporate social responsibility committee, with support from dedicated CSR staff at the bank and its newly appointed chief sustainability officer,” says Bruce, a member of the new CSR committee.
The Composition Imperative
Many board members are still learning the nuanced components that describe a company’s ESG conscientiousness, and have yet to grasp the efficacy of the ESG metrics and disclosure standards. Time is of the essence, as a company’s failure to get ESG right can adversely impact revenues and profitability, an existential threat causing investors to flee and board members to fret.
“The board of an energy company that doesn’t see the long-term implications of the reliance on pumping oil and gas is out of touch with reality,” says Marc Goldstein, head of U.S. research at proxy voting advisory firm ISS. “Cynics would disagree, saying there’s still a lot of money to be made pumping oil, but investors in pension funds and big index funds are taking the long view. They want these companies to take steps now to ensure they’ll still be around in 20 years, or 50.”
Also taking the long view is Amalgamated Bank. “Having woven ESG into the structure and performance of the board, our job is to measure the bank’s ESG commitments like zero carbon emissions; greater equity, diversity and inclusion among employees and other stakeholders; and no investments in companies that make guns or fossil fuels,” says Bruce. “This is a crucial responsibility to ensure the bank achieves the profitability objective.”
The breadth and scope of issues that ESG now encompasses coupled with the need to understand where they fit into a company’s specific industry, size, geographic footprint, business model and operations are prompting many companies to rethink their approach to board composition.
For nom/gov committees, pressure is building to determine if boards have the expertise necessary to effectively oversee ESG issues. A good start is reexamining the existing skills matrix to determine if member have it what it takes to provide effective ESG oversight, says Catalano. “You can look at the spreadsheet and see what’s missing to support the business strategy and the governance aspects of ESG and take steps to find the right mix of voices at the table.”
A board needs to be prepared to take action by adding directors with expertise in ESG matters when the results show a gap. “The broader ESG remits reemphasize the importance of skills matrices ensuring boards have the knowledge, capabilities and diverse experiences to make the best decisions,” says Catalano. “Board membership is transforming from nominating people who you know to selecting members for what they know. That is a pivotal change, and it is being accelerated by ESG.”
A dearth of board expertise in the ESG space—directors who understand strategy, operations, finance and compensation, in addition to the business risks posed by climate change and human capital management issues—may necessitate addressing the gap with education and training for existing board members. Says Bujno from Deloitte, “While the E and S are getting a lot of attention, we cannot forget the G, the need to ensure the board has the skill sets needed to understand the company’s governance policies.”
While there is no all-encompassing approach, sitting on the fence to see how other boards address their ESG remits is not a solution. As Dutra puts it, “Companies need to identify the components of the ESG framework that are relevant for their industries and organizations, inventory current practices, set ambitious but achievable goals and implement effective incentive and rewards systems for business leaders.”
As companies get these in motion, board members must be in lockstep with them.
