Boards and governance professionals can no longer deny the importance of Environmental, Social and Governance (ESG) issues. Not only are activists and institutional investors demanding that more attention be paid to ESG oversight and disclosure, but sustainable business practices are increasingly being tied to positive company performance.
In BlackRock's recent paper, the investor explains that ESG factors have, in many ways, become integrated into traditional financial analysis as a means for evaluating risks and opportunities:
How a company manages the environmental and social aspects of its business (those that are relevant to performance and value creation) is a signal of how well the company is run and its long-term financial sustainability. Corporate governance (including board composition and its role in shaping and overseeing strategy) is another signal of the quality of leadership and management. Examining ESG factors can therefore support and enhance traditional financial analysis. “Exploring ESG: A Practitioner’s Perspective” BlackRock
From a reporting perspective, corporate boards have certainly begun to answer the call. As we learned in a 2016 report from PwC's Governance Insights Center, the percentage of S&P 500 companies reporting ESG metrics has quadrupled since 2011.
We find, however, that there's still a disconnect between what boards are reporting and what investors are looking for. 'ESG' can mean different things to different stakeholders, which has led to a misunderstanding about what "ESG" encompasses.
So what does ESG encompass?
Well...a lot. As we learned in our episode with Evan Harvey, Nasdaq's Global Head of Sustainability, ESG is often narrowly associated with emissions or political spending, but that's such a small piece of the pie.
Sustainability is everything that helps your company sustain itself'its people, its profits'well into the future. It's a long-term approach. Anything you can't see in a financial statement that contributes to that long-term mission is sustainability.“Evan Harvey, Global Head of Sustainability, Nasdaq”
Indeed, a company's carbon emissions and use of scarce natural resources (environmental), a company's benefits program and contributions to the surrounding community (social), and a company's board diversity and shareholder engagement practices (governance) all fall under the ESG umbrella. So what can boards do to oversee all these aspects and communicate with their shareholders?
1. Assess What ESG Information Your Board May Already Be Reporting
Here's the good news: your board is likely already monitoring and reporting on several aspects of ESG oversight. You just may not be framing it as such. In our recent episode with Granville Martin, SVP and General Counsel for the Society for Corporate Governance, we learned that there's often a disconnect in nomenclature.
"Think about the energy sector as an example," said Martin. "Energy firms have been focused on EHS—environment, health, and safety—for decades. There's a lot of overlap between the way that energy companies think about EHS and what ESG-minded investors are asking about."
Indeed, institutional investors are pushing for a standardization of ESG metrics and terminology, as the variations of current reporting methods prevent them from comparing information across companies. In the meantime, boards must make it as easy as possible for investors to understand their ESG story.
Goodyear's 2016 proxy statement provides a good example of an effective ESG snapshot. Not only does the Goodyear board explain how it monitors ESG factors throughout the year, but it highlights its "reduced injury rate" and "total number of worldwide patents" as examples of social responsibility and sustainable product innovation. (For more examples like this, check out the "CSR disclosure" section of Donnelley Financial Solutions' Guide to Effective Proxies.) Take a look at all the things your board is monitoring and decide what needs to be reiterated through an ESG lens.
2. Improve Your Information Gathering Framework
While your board may already be reporting on several facets of ESG performance, there are likely several aspects that you're missing without a formalized method for gathering information. Here are three elements the board should think about:
Responsibility for ESG oversight may belong to an existing committee, to a separate sustainability committee, or remain at the whole-board level. Regardless, designating ownership is the best way to ensure that ESG oversight doesn't get swept under the rug. In the case of committee oversight, committee members act as a liaison between the board and management on all ESG matters. They would also be responsible for integrating the board's sustainability efforts with the broader long-term strategy and determining how best to communicate that information to shareholders.
Arrange for an annual (or even quarterly) report from management.
Connectivity with management is key. Harvey suggests that boards arrange for the organization's VP of sustainability or someone from the facilities/environmental side to meet with the board on a regular basis. This person would report on the company's sustainability performance, outline current and future initiatives, and answer any questions the board may have.
Conduct independent research.
Boards must also look outside of their interactions with management to conduct their own ESG research. How does the organization compare with peers and competitors? What are they doing that we're not doing? What does the next five to 10 years look like? Good boards investigate; they don't take one person's word for it.
3. Consider ESG Factors Alongside Your Corporate Strategy
Boards often think about ESG as separate from or secondary to the company's long-term strategy; however, in this dawning age of shareholder engagement, ESG oversight should be tied back to the long-term plan. Several investors today expect boards to communicate their three-, five- and ten-year roadmap to value creation'and any environmental, social and governance efforts are often an inherent part of that. From board composition to product innovation, it all should be intertwined and geared towards long-term growth.
For more information on ESG reporting, we strongly encourage you to check out our episodes with Granville Martin (above) and Evan Harvey (below). PwC's 2016 ESG Pulse also offers a critical look at the gap between what investors want and what companies are providing.