Boards are central to companies addressing ESG issues and should look to enhanced diversity and expertise to fulfill this role in a positive way, according to SEC member Allison Herren Lee.
‘The world’s largest asset managers and other institutional investors have been direct and vocal in conveying that they consider ESG material to their decision-making,’ Lee said in a speech earlier this week to the Society for Corporate Governance. ‘No matter the view of regulatory involvement in climate and ESG disclosures, directors must reckon with this growing consensus and growing demand from the shareholders who elect them.’
She outlined what she sees as key steps for boards seeking to maximize ESG opportunities, signal their commitment to these matters and position themselves as leaders on ESG – starting with increasing diversity within the board.
Lee explained that despite some progress, evidence suggests directors have been slow to understand the need to integrate climate and other ESG issues into governance practices. She cited a 2019 report as finding that only 6 percent of US director respondents picked climate change as a focus for the coming year and that 56 percent thought investor attention on sustainability issues was overblown.
‘This suggests that some boards may need to refresh and diversify perspectives,’ Lee said. ‘There are many reasons for companies to seek to enhance the diversity of their board, not least because investors increasingly expect them to do so. Indeed, recent proxy seasons have reflected investor focus on both board refreshment and greater diversity.
‘Board refreshment introduces opportunities to put new directors on boards, and emphasizing diversity increases the likelihood new directors will actually bring new thinking. This, in turn, could facilitate more current and proactive approaches to climate and ESG governance.’
Lee also noted that boards need the right expertise to address climate and other ESG risks, and that investors increasingly expect to see this. In its recent response to the SEC’s request for comment on climate change disclosure, Vanguard writes: ‘Based on our extensive experience engaging with public companies on climate-related matters, we believe an SEC mandate to disclose baseline climate information in a clear, concise and comparable manner would efficiently standardize disclosure practices.’
The asset manager adds that an effective disclosure regime would at least provide baseline quantitative disclosure of Scope 1 and Scope 2 emissions, supplemented by qualitative disclosures to help investment and stewardship decisions regarding companies or industries facing more acute climate risks: ‘These disclosures should provide enough information so that an investor can assess the climate competency of a company’s board, how the company manages climate risks and how the board supervises the climate risk management process.’
But Lee noted that, although there has been some progress, research by NYU Stern’s Center for Sustainable Business identifies a lack of director expertise on ESG matters. That research finds that 29 percent of the 1,188 Fortune 100 board directors examined have relevant ESG credentials, but that this total is largely concentrated on the S (social) element of ESG. Twenty-one percent of directors have relevant S experience, but only 6 percent have governance (G) and 6 percent environmental (E) experience.
‘Companies should consider ways to enhance the ESG competence of their boards,’ Lee said. ‘These efforts could include integrating ESG considerations into their nominating processes in order to recruit directors who will bring ESG expertise to the board, training and education efforts to enhance board members’ expertise on ESG matters, and considering engagement with outside experts to provide advice and guidance to boards.’
Despite growing investor pressure for boards to link executive compensation to ESG metrics, the thinking about how best to do so is evolving, and gaps remain between what some investors and some companies view as the path forward and whether making such links is possible or desirable.
Lee offered support for doing so, arguing that financial incentives play an important role in the economy and that executive compensation is therefore an important means of achieving strategic company goals. ‘This dynamic is not limited to simply linking executive compensation to certain corporate financial goals,’ she said. ‘In fact, compensation works for any number of more specific goals or targets a company may set.’
She added: ‘In addition to helping achieve strategic goals related to issues such as reduced carbon emissions or increased diversity of the workforce, tying executive compensation to ESG metrics can offer an important way to deliver on a company’s commitment to issues that matter to investors and consumers.’ For example, she noted that some companies have gone beyond statements of support following the Black Lives Matter protests to tie executive compensation to diversity metrics.
Lee is not alone in seeing boards as key to addressing ESG issues. Peter Gleason, CEO of the National Association of Corporate Directors, earlier this year said his organization views tackling climate change as a ‘full board sport’ wherein the climate crisis is a risk multiplier across the organization, from regulatory and compliance to capital and human capital risks. As such, he argued that climate change cannot be a bolted-on item on the board’s agenda but must be treated as an integral part of where the company will be in the future.
A key role for the board is in making sure there is a clear owner of sustainability issues within management, and that management leaders can communicate the risks climate change poses and integrate that into corporate strategy so the board can oversee everything that is taking place, Gleason said.