Corporate Governance Update: How Boards Are Responding to a Heightened Focus on ESG
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A Q&A with BRG experts on the board’s role in addressing ESG strategies and initiatives
Amid cries of greenwashing and a growing “anti-ESG” backlash, some have described this latest chapter as “the end of ESG.” But most corporate boards of directors do not see things that way. In fact, these considerations have long been on their agenda. If anything, 2023 has seen a refinement of ESG strategy informed by policy and regulatory developments, as well as a natural evolution of the three pillars—environmental, social, and governance—that make up the abbreviation.
Yet what does the newest chapter of ESG look like for boards? How has it heightened pressure on their performance—and their ability to oversee ESG strategy and initiatives? What impact has the current political and regulatory landscape had, and what’s to come in 2024 and beyond?
All this and more are discussed in our ThinkSet Q&A with BRG’s Tom O’Neil, Robert Yates, and Yanqing Lei.
From a corporate governance perspective, what have been the most significant ramifications of ESG over the past several years?
Most significant is the recognition that environmental, social, and governance are now considered holistically as not only a spectrum of potential risks, but also a set of strategic priorities, if not imperatives. For many years, boards have focused on each of the three pillars to varying degrees depending on the organization’s mission, core values, industry, and competitive realities. But they are now an integrated concept in C-suites and boardrooms alike.
For instance, corporations and nonprofit organizations have been working on environmental decision-making and initiatives for decades, but the urgency of climate change has had a remarkable impact on every sector across the globe. And not surprisingly, regulators have leaned in as well. By way of example, earlier this year the US Securities and Exchange Commission (SEC) proposed long-awaited rules for public companies related to climate-impact disclosures.
The social dimension of ESG, including the core concepts of corporate responsibility and diversity, equity, and inclusion, has become a North Star of sorts for many organizations. Over the past few years, corporate social responsibility has evolved to be a critical driver of a company’s culture and brand. Corporations are increasingly held accountable for human rights abuses and forced labor in their supply chains, as well as for staff and employee well-being and for cultivating an organizational culture that priorities diversity at all levels and nurtures an internal environment that is equitable and inclusive.
Has the spotlight on ESG enhanced the performance of boards and governing bodies?
Board members are overseeing ESG commitments and initiatives with unprecedented rigor. The responsibility falls squarely within their fiduciary duties, and comprehensive and robust educational programs developed by governance organizations and leading academic centers are fueling a sense of urgency about all of these. At the same time, best governance practices have evolved dramatically in response to a marked shift in stakeholder expectations, including those of legislators, regulators, customers, staff, investors, and philanthropists. The shift in sentiment has also led to changes in corporate law.
Recent studies have confirmed that most board members view these developments as positive because, among other things, they have enhanced the efficacy and quality of organizational governance. The emergence of ESG as a strategic priority has been consequential for the global economy and societal ecosystems as well. For example, some auto manufacturers have committed to changing their entire business model to electric vehicles after spending decades largely ignoring the climate effects of their internal combustion engines. And clothing manufacturers have started to develop ethical supply chains in response to stakeholders’ reactions to reports of forced labor. But room for improvement remains. A recent Conference Board survey indicates that most C-suite executives believe their boards are meeting minimum expectations, but key focus areas include increasing board-member diversity, industry experience, and trust and understanding with stakeholders.
In fairness, board members often struggle to balance their other fiduciary responsibilities with overseeing ESG priorities. Management can facilitate more effective board oversight of ESG by allocating sufficient discussion time in board meetings, preparing meeting materials that are crisp and transparent about the leadership team’s strategic challenges and imperatives, and eliciting feedback from the board as the plan is crafted and executed. For their part, boards should also undertake, as warranted, educational initiatives to ensure fluency in key ESG areas.
Recognizing variance across sectors and individual organizations, are there high-level best practices for boards in overseeing ESG initiatives?
An emerging best practice is for the board to delegate ESG oversight to a committee, with the committee regularly informing the board regarding significant initiatives or developments. Over the last several years, the trend has been to delegate ESG oversight to board nominating and governance committees. In fact, although most companies avoid the term “ESG” specifically, there has been a significant uptick in boards adding the terms “corporate responsibility” or “social responsibility” to the name of their nominating and governance committees.
More substantively, effective boards now rigorously assess their performance and composition on a regular and ongoing basis. A significant issue affecting boards’ ESG oversight is that their member composition lacks diversity and the specific expertise required to effectively oversee ESG matters. A mix of backgrounds, skills, knowledge, and experience is essential in supporting ESG practices while aligning with the company’s broader mission and business objectives. The most effective boards utilize self-assessments in active recruitment initiatives to enhance, if not transform, their composition. This requires boards to broaden their priorities beyond the historical focus on CEOs and CFOs to a much more inclusive range of executives and business leaders.
Continuous improvement is a foundational aspect of board oversight. This is important not only for the corporation’s success on its own ESG initiatives, but also in the eyes of its stakeholders. Investors are frequently alarmed by boilerplate board evaluations that do not change over time and when “ESG performance” for a company is limited to a metric or two in executive compensation. Boards should annually conduct a robust board and committee self-assessment and use the results to develop and oversee action plans for the board, its committees, and individual directors, in addition to the recruitment efforts noted above. The most effective boards engage an independent expert to conduct such evaluations every two to four years to confirm the board’s self-assessments align with outside perspectives.
Has the so-called “anti-ESG” backlash impacted ESG in the boardroom?
No and yes. There certainly has been something of a recalibration, which some have characterized as an “anti-ESG” backlash. For example, critics have challenged the regulatory regime and level of transparency in the investment space. Some leaders have condemned ESG strategies and practices, arguing that they inappropriately prioritize political goals over investor returns, violate free-market principles, and hinder overall economic growth.
It is nevertheless inconceivable to us that ESG will somehow evaporate from the governance conversation. We have seen an unprecedented, and still increasing, acceleration in ESG investments in global markets. Ninety percent of investors globally believe that integrating ESG factors into their investment strategies will improve their returns, and, as of 2022, 80 percent of US investors planned to increase their allocations to ESG products over the next two years. In our view, particularly as the urgency of climate change becomes more acute and the notion of responsible corporate citizenship matures, these investors will continue to pressure companies—both public and private—to focus on ESG practices to meet their expectations.
It is also interesting that when faced with recent ESG headwinds, many companies have stayed the course from a strategic perspective while opting to deemphasize the abbreviation itself. A new Bloomberg study revealed that two-thirds of nearly 350 global money managers surveyed will stop using terms such as ESG but will continue to support efforts that lead to positive environmental, social, and governance outcomes.
What does the future hold? How should corporate directors (or board members) be thinking about ESG moving forward?
Corporate directors will still prioritize ESG in 2024 and beyond. The next chapter will likely focus on how best to effectively oversee the implementation of the organization’s strategy and how to measure success through incisive and sophisticated data analytics. The European Financial Reporting Advisory Group is developing new ESG requirements under its Corporate Sustainability Reporting Directive, but current metrics for ESG effectiveness can include quality and integrity scores, board-membership diversity statistics, surveys of ownership and shareholder rights, indices of compensation incentives for ESG efforts, and transparency in auditing and financial reporting.
A corporation’s ability to produce a robust and auditable ESG dataset will not only help to achieve its ESG goals, but also build trust with stakeholders and, ultimately, drive the company’s growth in a sustainable fashion. And the role and impact of artificial intelligence in this context will be a topic of conversation and debate at many board dinners across all sectors of the global economy.
