Embracing new initiatives is not always easy, and usually needs to come from the top down. In a speech presented on June 28, 2021, the U.S. Securities and Exchange Commission’s (SEC) Commissioner, Allison Herren Lee, emphasized the importance of board and executive buy-in for Environmental, Social, Governance (ESG) initiatives.
Sustainability initiatives have not been at the top of mind for boards for very long. While CSR programs (predecessors of ESG programs) were historically considered separate from revenue-generating efforts (and thus, not seen as the responsibility of boards of directors), this has since changed.
Because of the vast amount of wealth that corporations hold they have a high economic foothold throughout the world. In fact, 71 of the 100 largest revenue generators were corporations – only 29 were nations. Stakeholders, suppliers, company employees, and investors are looking to organizations to design sustainable policies that address sustainability and equality issues, and they are placing more pressure on corporations to provide transparency into these initiatives.
Data supports this emphasis, as well. Almost 80% of directors have stated that their boards are zeroing in on ESG efforts, and 78% of organizations have at least one board committee overseeing environmental sustainability issues. However, this does not mean that there is enough engagement with ESG matters to adequately address this growing trend, and board expertise is not necessarily up to par to meet these demands.
“Our understanding of the significance of ESG and its short-, medium- and long-term relationship to financial performance has evolved to the point that the principal debates are about when, not if, these issues are material….it is clear the board has a role with respect to ESG.”
– Commissioner Allison Herren Lee
The recent proxy season has underscored the importance of ESG for board agendas. Recently, 98% of General Electric shareholders approved asking for transparency into how the organization will achieve zero net emissions in compliance with the Paris Agreement. And this demand for transparency is not only about climate-related issues. Amazon stakeholders proposed a racial equality audit be conducted, garnering strong support.
As the US re-enters the Paris Agreement, with a promise to cut emissions n half by 2030, the support for ESG has grown beyond shareholder proposals. Climate activists recently won three seats on Exxon’s board, zeroing in on the priority of ESG topics for board agendas.
“These developments place even greater responsibility on companies, and therefore boards, to integrate climate and ESG into their decision-making, risk management, compensation, and corporate transparency initiatives.”
– Commissioner Allison Herren Lee
In addition to shareholder focus, regulators also expect boards to implement ESG and have oversight obligations related to ESG hazards including identification, assessment, mitigation, and disclosure of these risks. These expectations come from both federal and state levels. Commissioner Lee explains, “Under the federal securities laws, the board plays a critical and mandatory role in the existing corporate disclosure process. This increasingly requires directors to think about and consider the impact of climate change and other ESG matters on the financial statements and other corporate disclosures.”
These types of disclosures also go beyond financial statements and include human capital as a disclosure topic, as well as risk oversight and climate change risks. Also, under duty of faith, directors are sometimes required to look into red flags where violations or harm to the corporation have occurred. This includes climate change and ESG issues. Uninvestigated red flags can implicate the good duty of faith.
As seen through recent shareholder proposals and regulations, stakeholders can put pressure on boards for climate and ESG efforts to be included in risk management. This can not only manifest through proposals but even replacing directors and taking their capital elsewhere.
In her speech, Commissioner Lee provided recommendations on how boards can begin to embrace and enact ESG programs within their companies:
A 2019 report stated that only 6% of corporate directors in the US identified climate change as being a primary area of focus for the upcoming year and that 56% of directors thought attention on sustainability issues was overdramatized. In part because of this, investors expect companies to diversify their boards. This presents opportunities through bringing in new thinking, allowing for “more current and proactive approaches to climate and ESG governance.”
In order to keep up with the demand for these types of programs, boards need to broaden their knowledge on ESG and sustainability measures. This can be done by including ESG considerations when nominating new board members and directors, providing ESG training to increase board knowledge, and engaging outside experts to offer guidance.
Providing executive compensation for embracing ESG efforts can be a powerful tool for executing new company goals. Compensation can be tied to reducing carbon emission and embracing workplace diversity, but also through committing to new strategic priorities that matter to customers and investors.
“Boards that tie executive compensation to ESG metrics are using one of the most powerful tools they have to make real progress on ESG goals, and at the same time signaling the strength of their commitment to these issues.”
– Commissioner Herren Lee
To learn more, read the full transcript of Commissioner Herren Lee’s speech at the 2021 Society for Corporate Governance National Conference.
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