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Jun 16, 2021

Comment: Getting your board ready for ESG shareholder activism

Melissa Paschall explains lessons boards can learn from the recent director elections at ExxonMobil

Oil majors received stunning climate mandates from their shareholders during the 2021 proxy season, including a historic vote to replace three ExxonMobil board members with individuals from an alternative slate nominated by activist investor Engine No 1. But such shake-ups should not come as a surprise: the real surprise is how long it took for them to happen.

The growing climate risks companies face have been clear for years. The rising impacts on the economy and society of a warming planet, the role of fossil fuels, the shifting policy landscape and the increasing concern among large investors that change is necessary – not just to incrementally reduce emissions, but also to develop business models that can thrive in a net-zero future – are all evident. As fiduciaries to the corporation and stewards for its long-term performance, boards have a fundamental responsibility to engage on relevant ESG issues in a thoughtful manner. ESG competence is the bedrock to all of this.

Major investors have been pushing companies to scale up the climate competency of their boards for years:

  • As far back as 2016, State Street Global Advisors published a climate change risk oversight framework stating that ‘companies in high-risk sectors should assess board composition and director expertise in relation to climate competence of the board, [and] establish mechanisms such as access to climate experts to help educate directors on evolving climate-related risks’
  • In June 2020 Vanguard publicly outlined its expectation that the boards of its portfolio companies become ‘purposefully composed of individuals who are competent on climate matters’
  • During 2020 BlackRock voted against 64 directors of carbon-intensive companies and put another 191 companies ‘on watch’. Then in early 2021 BlackRock CEO Larry Fink warned that ‘those companies risk votes against directors in 2021 unless they demonstrate significant progress on the management and reporting of climate-related risk, including their transition plans to a net-zero economy.’

Combined, these asset owners are the largest shareholder in 88 percent of the S&P 500. When unified, as they increasingly are on climate change, their proxy voting influence is enormous. No example makes that clearer than the Exxon vote, where BlackRock and Vanguard joined with other major shareholders in voting to install the new board members.

After the Exxon vote, the urgency of director climate competency should be crystal clear. The next logical question is: how can boards build that competency proactively, before shareholders challenge their fitness to serve?

First, establish a process for onboarding relevant expertise
Adding a token climate ‘expert’ – or even more than one – is not enough to change board dynamics and decision-making, and shareholders know this. Susan Avery, former president of the Woods Hole Oceanographic Institute, has been on the Exxon board since 2017, but her presence as a well-respected climate scientist did not assuage investors.

By bringing on new directors such as Kaisa Hietala, who led the high-growth renewable fuels business at Finnish oil company Neste, shareholders have ensured the revised Exxon board has expertise not just in climate science but also in business transformation.

Many boards use a skills matrix to ensure that key competencies are represented. This tool can be used to systematically include relevant expertise in climate or other material ESG issues. Necessary skills will vary by industry and company, but it’s essential for all boards to reflect on how these may have evolved over time, and address skills gaps proactively. Board refreshment policies, which limit the tenure of board members, provide opportunities to add these skills over time.

Nominating committees can also recruit directors who have experience interacting with or representing stakeholder groups that offer insights into a company’s material sustainability impacts. This provides the advantage of bringing both relevant expertise and background diversity to the boardroom, which can be useful in challenging assumptions and breaking through outdated thinking.

By seeking out candidates who bring a range of attributes, expertise and desired skills to the table, nominating committees will proactively prepare their companies for the future on their own terms rather than waiting for a contentious proxy voting battle to force their hand.

Second, educate the full board on climate and ESG oversight
Although ESG experts need to speak the language of business, the full board also needs to be fluent in the fundamentals of sustainability. Material environmental and social issues should not be siloed within individual experts or committees. All directors must have ‘fluency’ to enable nuanced discussions and make smart decisions.

One way to do this is by ensuring that new directors with ESG competence are embedded into current board deliberations, particularly on strategy and risk. Rather than being siloed on an ESG committee, they must participate in the full board functions, structures and processes so that their insights and expertise are integrated into discussions about core business issues and board decision-making.

Companies can also require regular education on material ESG issues for the whole board to keep directors updated as these issues evolve. Education, training programs and site visits should build knowledge over time and make connections to operational or management realities.

Many organizations have developed helpful training across a range of formats and price points, providing many avenues for directors to build their competence in climate and ESG. For example, the National Association of Corporate Directors recently launched an ESG ‘continuous learning cohort’ with more than 150 directors enrolled. The World Economic Forum oversees the Climate Governance Initiative, a worldwide network of chapters dedicated to implementing core climate governance principles.

At Ceres, we have published research and recommendations in a number of industry-leading governance reports and offer webinars and other events designed to build board fluency in climate and other ESG issues. Through a partnership with the UC Berkeley School of Law, we have developed a short online course on the board’s role in ESG and we offer customized presentations at board meetings.

Finally, deepen engagement with stakeholders and external thought leaders
Environmental and social issues tend to evolve quickly, and something just appearing on the horizon now could be at our doorstep tomorrow. Both internal and external stakeholders, when engaged proactively and constructively, can help boards monitor the landscape and anticipate new ESG priorities. Boards should find regular opportunities to engage these stakeholders on environmental and social issues.

In particular, external advisory councils can be a critical board resource, acting as the eyes and ears of the board and offering expert insights as new information arises. To deepen communication, board members should be involved in the deliberations of these councils systematically – for example, by scheduling council meetings just ahead of board meetings, and inviting directors to attend. Such councils can also provide recruitment opportunities for new board members with sustainability expertise.

Boards should also incorporate material sustainability issues into board-investor dialogues. Investors increasingly expect boards to engage directly and systematically with them on critical issues. Given the growing focus of the investor community on the board’s oversight role in climate and other ESG issues, material environmental and social factors should be made a part of any board-investor dialogue.

Engaging with internal experts is critical, too. Many large companies have a sustainability team, but not all such teams have visibility at the board level. Scheduling regular presentations, one or more times per year, will help board members gain a more nuanced understanding of how management is anticipating and addressing ESG issues and offer an opportunity for questions and discussion. This can help the company not only mitigate risk, but also pinpoint opportunities for creating long-term value.

The recent proxy season, and the Exxon vote in particular, tells boards only what they should have known already: that investors recognize the climate risks and opportunities their portfolio companies face, and they expect boards to embed the right skills and experience to successfully transition to a low-carbon future. Where companies fail to do so, a critical mass of investors will vote directors out.

The good news is that there are clear mechanisms and resources for onboarding directors with relevant expertise, educating the full board to a level of fluency that allows for meaningful discussion, and engaging internal and external stakeholders to supplement the board’s own knowledge.

Given these concrete, actionable recommendations on how boards can raise their sustainability competence, how could companies fail to build a climate-competent board? We’ll find out soon enough, when alternative director slates are put forward in the 2022 proxy season.

Melissa Paschall is governance manager of the Ceres Accelerator for Sustainable Capital Markets at the sustainability non-profit Ceres

Melissa Paschall

Melissa Paschall

Governance manager of the Ceres Accelerator for Sustainable Capital Markets