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July 27, 2023 | Report
According to a survey of 80 general counsel and corporate secretaries conducted by The Conference Board in late 2022, 69 percent of firms believe that ESG will have a significant and durable impact on boards over the next five years. Fifty-three percent of firms believe the same about stakeholder capitalism. Since that date, three developments have challenged this view.
First, nearly half of US companies say they are experiencing some form of ESG backlash (an umbrella term that includes a range of opposition to the corporate focus on ESG but particularly relates to hot-button social and environmental matters), according to a survey of 125 respondents, a majority of whom are senior corporate executives. Second, there has been an increased level of ESG regulation from the SEC and the European Union, which may divert boards’ attention from the business opportunities and risks associated with ESG. Third, an array of market pressures, such as an economic slowdown or the acceleration of AI and technological innovation, may make other business priorities more urgent.
It is therefore a good time for boards to revisit their commitment to ESG issues and to review the company’s plan to balance the interests of multiple stakeholders. Are these still priorities? If so, in what way? Specifically, how can a focus on social and environmental responsibility, as well as on stakeholder interests, generate long-term value for the business? And how can the board serve as a strong partner to management in charting the company’s strategic course during this increasingly challenging era?
We suggest four steps that boards can take to make sure they are optimizing the business value of ESG and a multistakeholder approach in overseeing their companies.
Boards will want to ensure that ESG is integrated into their firm’s business strategy and operations, and not just something that is bolted on as an afterthought. They can start by asking management to identify the role that a focus on ESG can play in three areas:
As companies go through this process, their boards will want to consider how far they want to pursue relevant ESG topics. Is their goal to comply with the law, to reduce costs, to manage reputation or to become an industry leader? After all, it’s unrealistic for a company to lead on all of the more than 200 issues across the ESG landscape.
At the board level, there’s also an opportunity to better integrate ESG (and stakeholder impact) into board and committee decisions. While 95 percent of survey respondents say that their board’s agenda has been affected by ESG and stakeholder capitalism, only 52 percent say their board’s decisions are taking ESG and stakeholder impact into account. To do this efficiently, management can inventory the key vehicles that the board and its committees use for decision-making (strategic and business plans, operating and capital budgets, executive compensation, M&A and more), exercising oversight (financial, operational and compliance reports; risk assessments and others), and reviewing disclosures and reports. It can then evaluate the ESG information that the board and committees already receive and conduct a gap analysis of what the board and committees should receive as part of directors’ key decision-making, oversight and disclosure responsibilities with respect to both opportunities and risks.
The board’s responsibility, with management’s guidance, is to set corporate strategy that balances and serves the competing interests of investors, other stakeholders, society at large and the natural environment. Currently, boards are generally better at incorporating the “what” of ESG issues into their decisions than they are at incorporating the “who” of multiple stakeholders. Before they can integrate stakeholder perspectives into their decision-making, boards will first need to consider what matters to them. Are they interested in the state of the company’s relationships with shareholders and other stakeholders, the expectations of those stakeholders, the long-term welfare of those stakeholders, or some combination of all three? For example, all three areas matter in discussions about the company’s investor base.
Once boards understand what stakeholder information they are looking for, they can keep abreast of it through a combination of data and direct board engagement. Management should focus on what kinds of data the company is collecting on the views of customers, business partners, employees and others, and build that into regular reports to the board. With this knowledge, boards can determine how stakeholder perspectives are built into their decision-making. It can be helpful to develop a framework that incorporates a multistakeholder focus for making key business decisions. Such a framework can provide guidance for both the board and management on whether (and how) to act in a consistent and comprehensive manner.
Board members can supplement the information from management by directly engaging with investors and, on a selective basis, with other key stakeholders, such as employees. It is important for directors to share with the rest of the board the information they gather during stakeholder interactions, so nobody feels left in the dark.
Such shifts carry significant implications for board composition, structure and capabilities. Companies need boards with a diversity of backgrounds, skills and experience—and that are structured—to effectively oversee the expanding list of responsibilities.
Currently, about three-quarters of S&P 500 directors and more than 40 percent of the Russell 3000 have some form of ESG experience, according to data from The Conference Board and ESGAUGE. While specialist experience on the board can be beneficial if coupled with a broad-gauged ability to contribute to board deliberations, having specialist directors can be counterproductive if the rest of the board (or management) becomes overly dependent on them, or if they don’t contribute much to general board discussions. Boards are therefore better served by having well-rounded directors with general strategic business experience and relevant industry knowledge, and who can demonstrate fluency in ESG and knowledge of stakeholders.
In addition to individual directors, boards should address the full board’s role with respect to ESG and stakeholder capitalism. To date, of the firms that have assigned responsibilities for ESG at the board and committee level, only 11 percent have given general ESG strategy and oversight to the full board. Most have allocated this area to the nom/gov committee. While committee responsibilities vary by company, the full board is probably better suited to overseeing and making decisions on integrating ESG and stakeholder interests into the company’s business strategy and operations. Even if boards are temporarily allocating ESG responsibilities to the nom/gov committee, they should consider whether that committee has the right composition and resources to do its job successfully.
The board chair or lead independent director will play a pivotal role in helping the board fulfill its role during this period of business transformation. A board leader needs to be not only respected by fellow directors and management, but also open to change. It is important to ensure that the chair or lead independent director sees ESG and stakeholder capitalism as an area of opportunity, not just a risk or regulatory burden for the board.
The business-oriented focus on ESG and stakeholder capitalism should be reflected not only in the board’s responsibilities, but also in its processes for evaluating the company’s, senior management’s and its own performance. Just as ESG and stakeholder views should be integrated into business strategy and operations, so should ESG performance and stakeholder relationships be measured as part of an annual review of the company’s overall performance. While it may take time to develop relevant measures of performance (e.g., percentage of revenue derived from, or spent on, sustainability-linked products and services), boards will want to encourage their companies to start now by incorporating existing measures in their year-end (or even quarterly) assessments of corporate performance.
Additionally, there should be alignment between the board’s assessment of the company’s performance and its evaluation of senior management’s and its own performance. For example, if diversity is a key strategic focus, then the issue should show up when the board reviews performance at the company, management and board levels.
The shifts toward ESG and stakeholder capitalism do not mean the board needs to reinvent the wheel. Boards have long considered issues that now fall under the heading of ESG and have taken into account the welfare of employees, customers and communities into their decision-making. But now boards should take a fresh look at how they can efficiently build ESG and stakeholder perspectives into existing board and governance processes to seize on the opportunities that this new era is offering.
This article was first published on the Directors & Boards website.
