As a long-term investor, we are willing to be patient with companies when our engagement affirms they are working to address our concerns. However, when we do not see progress despite ongoing engagement, or companies are insufficiently responsive to our efforts to protect the long-term financial interests of our clients, we may signal our concern by voting against management. -BlackRock Investment Stewardship, Engagement Priorities for 2020
In 2020, BlackRock identified 244 companies (and took voting action against 53 of them) for 'lack of progress integrating climate risk into their business models or disclosures.' Coupled with strong investor stances on gender diversity, these voting actions send a clear message: Institutional investors will not be satisfied with 'all talk and no action' on environmental, social, and governance (ESG) issues.
Companies have been slowly realizing that ESG is good for business ' from maintaining market share and brand equity to attracting and retaining talent. Investor actions against climate change, coupled with their rising expectations for racial board diversity, underscore the fact that ESG components are quickly becoming core investment criteria for the world's largest asset management firms.
What does this mean for organizations and the boards that oversee them, particularly during the complex and evolving COVID-19 environment?
In a recent episode of Inside America's Boardrooms, Paul Washington, Executive Director of the ESG Center for The Conference Board, discusses investor expectations around ESG given the COVID-19 pandemic. Washington and host TK Kerstetter review BlackRock's sustainability expectations and five key performance indicators (KPIs), which are expanded below.
BlackRock's KPIs for ESG
BlackRock has established key performance indicators (KPIs) based on their own wide-ranging observations, the UN Sustainable Development Goals, and other frameworks such as the Task Force on Climate-Related Financial Disclosures (TCFD). These KPIs (discussed in the episdoe above) span five main areas explored in detail below: board quality, environmental risks and opportunities, corporate strategy/capital allocation, compensation to promote long-termism, and human capital management.
(1) Board quality: Because quality leadership is essential to corporate performance, BlackRock prioritizes board composition, effectiveness, diversity and accountability. Evaluate:
- How do you assess your board's effectiveness and performance?
- What is your board's position on director responsibilities and commitments, turnover and succession planning, crisis management, and diversity?
- Is a non-executive, preferably independent, director available to engage with shareholders on these topics?
'Investors want to see what you've said in the past about your ESG agenda, where it stands now, and if all your good governance procedures actually worked,' said Washington in his episode of Inside America's Boardrooms.
(2) Environmental risks and opportunities: BlackRock wants boards to disclose how they work with management to oversee policies, risk factors and opportunities that lead to long-term sustainable growth. To these ends:
- If your company is already engaged in TCFD-aligned reporting, are you disclosing sufficient detail across the four TCFD pillars?
- Have you set a timeframe for reporting fully in line with the 11 TCFD recommendations?
- Are sustainability risks and opportunities, like those identified in the SASB framework, integrated into business strategy, and do capital allocation decisions align with long-term strategy?
- Can you explain long-term strategic goals, the milestones that demonstrate progress, and any anticipated or incurred obstacles?
- Is the board fully engaged with management on the development and implementation of this strategy?
'Companies will need to talk to their shareholders with a high degree of transparency about where they are with sustainability, the projects that are on hold, the ones they're going ahead with, and the reasons why,' Washington said.
(4) Compensation to promote long-termism: BlackRock wants companies to link executive pay to long-term strategy, goals and performance. Question for the board and management:
- Do policies reward executives for strong, sustainable returns rather than short-term hikes in share prices?
- Do pay outcomes correlate with a long-term, business-relevant performance metric, like five-year total shareholder returns or returns on invested capital?
Given the ongoing COVID-19 pandemic and economic impacts, Washington recommends a cautious approach when prioritizing this area. 'Right now is not necessarily the time to be making a lot of changes to your executive compensation program,' he said. 'In fact, if companies are spending too much time on that, it may send a bad signal to the market that the board is focused on helping the C-suite and not thinking about operations or the broader employee population.'
Human capital management: Your company should have sound business practices that create an engaged, stable workforce. Examine:
- Does your board oversee human capital management strategies?
- Do you disclose your approach to ensuring the adoption of business practices in this area'or at least are you able to explain the type of information you review and how frequently?
Expanding the view from sustainability to stewardship
Despite the specificity of many of its KPIs, BlackRock refers to them in the context of 'stewardship priorities.' According to Washington, it behooves boards to address KPI areas with a broader view. For example, the COVID-19 crisis expands the purview of human capital management into areas such as physical safety and mental health. 'Companies, even in their crisis management teams, haven't fully deployed their HR or sustainability folks in responding to this crisis. There's an unused capability there,' Washington said.
In another example, BlackRock does address diversity and inclusion in its language about board quality. Washington advises thinking beyond this scope to 'the company's role as a citizen ' for instance, its position on public policy issues that relate to things like economic security and economic equality and the company's role in its communities.'
Overall, he said, 'I think boards face an even more daunting set of topics to cover than even those that have been outlined by BlackRock.'