Good corporate governance matters more than ever. The integrity and effectiveness of the structures, systems and norms that determine how a company’s priorities are set and how performance is monitored and accounted for are essential. They will determine whether the company succeeds in managing shared risks and creating sustainable enterprise value for as many of its stakeholders as possible, or not.
In 2015, working with the G20 in the aftermath of the global financial crisis, the Organisation for Economic Co-operation and Development (OECD) revised its Principles of Corporate Governance, first published in 1999. The revised principles explicitly included stakeholders beyond shareholders. They stated:
Corporate governance involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined.1
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In June 2021, the Secretary-General of the OECD, Mathias Corman, re-emphasized the importance of a stakeholder-oriented approach. He commented:
In the context of rebuilding our economies in the wake of the COVID-19 crisis and promoting stronger, cleaner and fairer economic growth, good corporate governance plays an essential role. It fosters an environment of market confidence and business integrity that supports capital market development. The quality of a country’s corporate governance framework is decisive for the dynamism and the competitiveness of its business sector and the economy at large. It will also support the corporate sector to manage environmental, social and governance (ESG) risks and better harness the contributions of different stakeholders, be it shareholders, employees, creditors, customers, suppliers, or adjacent communities, to the long-term success of corporations.2
As outlined in Part I, the shift towards a more stakeholder-oriented and integrated corporate governance model that fully embeds ESG&D issues is being driven by a combination of the following:
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The growing materiality of ESG&D risks and opportunities to financial and operational performance, as a result of transformational technological, environmental, geopolitical and socio-economic shifts in the business context and more recently the impact of the COVID-19 pandemic and the climate change crisis.
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Changing investor expectations as both a result of and a driver of these shifts. The dramatic upward trend in assets under management, proxy resolutions, investment products and indices using an ESG&D lens has continued throughout the pandemic, with no signs of abating.
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Evolving corporate laws and regulations, both responding to and driving change. These include corporate ESG&D disclosure requirements in many countries, strengthened employee representation in certain European two-tier, supervisory and management corporate governance models, and expansions or re-interpretations of the fiduciary responsibility and duty of board directors in Australian, British, Indian, Canadian, French, South African, Brazilian and American corporate law, among others. Another example is the creation of the benefit corporation as a legal tool that provides “a traditional corporation with modified obligations committing it to higher standards of purpose, accountability and transparency,” including its obligation to “commit to create public benefit and sustainable value in addition to generating profit.”3
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Increased demands from other stakeholders and shifting public norms on the role of business in society, including increased social activism and calls for companies to be held more accountable for their impacts on people, prosperity and the planet, and to make more of a measurable contribution to the public good. After some initial pressure following the global financial crisis, stakeholder demands on companies have reached a crescendo in the face of the global COVID-19 pandemic, climate change and worldwide protests about inequality and racial injustice.
Despite progressive changes underway in many boards to address ESG issues and improve board diversity and stakeholder engagement, there is a long way to go in fully integrating these risks and opportunities and making stakeholder capitalism a reality in standard corporate governance “operating procedures.” Take PwC’s 2020 Annual Corporate Directors survey for example.4 It had participation from 693 directors representing a cross-section of US companies from over a dozen industries, 75% of which have annual revenues of more than $1 billion. The findings included:
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About 45% of the directors surveyed said that ESG issues are regularly part of the board’s agenda (up from 34% in 2019). Sixty-seven per cent said that climate change should be taken into consideration when developing company strategy, up from 54%. Yet, only about half the directors surveyed (51%) said their board fully understands the ESG issues impacting the company, and even fewer (38%) think those issues have a financial impact on the company (down from 49% in 2019).
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More than four out of five directors surveyed (84%) agreed that companies should be doing more to promote gender and racial diversity in the workplace. Yet, only 39% of the directors said they support including diversity and inclusion goals in company pay plans; only 34% said it is very important to have racial diversity on their board, and less than half of the directors (47%) said gender diversity is very important. Sixty per cent of female directors saw the link between ESG issues and company strategy compared to only 46% of male directors.5
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US boards are considered to lag behind their European counterparts when it comes to support for and examples of stakeholder-oriented corporate governance and integration of ESG issues in the boardroom. Consider a 2020 survey on stakeholder capitalism undertaken by the Diligent Institute, which included the views of 406 board directors and corporate leaders. In response to the statement, “We are in the midst of a fundamental change in capitalism from a primary focus on shareholder return towards a system in which corporations must have a societal purpose and serve all stakeholders,” there was “a 19 percentage-point difference in agreement between non-U.S. and U.S. respondents (92% vs. 73% respectively), and a 30 percentage-point difference in strong agreement (63% vs. 33%). Meanwhile, the level of disagreement among U.S. directors relative to their counterparts around the world was even more significant: In the rest of the world, only 5% of directors disagreed with the statement, but in the United States, 11% disagreed with it.”6
Even in Europe, substantial work is required to align corporate governance with the goals of stakeholder capitalism. A July 2020 European Commission study on directors’ duties and sustainable corporate governance, prepared by EY, concluded, “The focus of corporate decision-makers on short-term shareholder value maximization rather than on the long-term interests of the company, reduces the long-term economic, environmental and social sustainability of European businesses.”7 Shareholder pay-outs, for example, increased fourfold from less than 1% of revenues in 1992 to almost 4% in 2018, and the ratio of CAPEX and R&D investment to revenues has been declining since the beginning of the twenty-first century.8 The report identifies the following seven “key problem drivers” and proposes options for addressing them:
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Directors’ duties and company’s interest are interpreted narrowly and still tend to favour the short-term maximization of shareholder value.
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Growing pressure from investors with a short-term horizon contribute to the board’s ongoing focus on short-term financial returns to shareholders at the expense of long-term value creation.
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Companies lack a strategic perspective over sustainability and current practices fail to effectively identify and manage relevant sustainability risks and impacts.
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Board remuneration structures incentivize the focus on short-term shareholder value rather than long-term value creation for the company.
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The current board composition does not fully support a shift towards sustainability.
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Current corporate governance frameworks and practices do not sufficiently voice the long-term interests of stakeholders.
Not surprisingly, there are also clear differences between different industry sectors in the integration of ESG and stakeholder concerns in the board room. In 2018, for example, joint research by Ceres and kks advisors analysed the public disclosures of 475 companies from the Forbes 500, the annual ranking of the largest publicly listed companies in the world.10 The data was compiled by Vigeo Eiris, an independent provider of global ESG research and services, and the research team reviewed three key aspects of board governance systems—formal mandates for sustainability, director expertise in sustainability and executive compensation linked to sustainability. They found substantial sectoral differences. Utilities, consumer staples, energy and materials companies were the most advanced, and real estate and information technology, the least advanced.
While progress is piecemeal and varies between countries and industry sectors, there are clear examples of leading practice in the drive towards a more stakeholder-oriented and integrated model of corporate governance. In the following pages we illustrate some of the practical actions that all boards of directors can take in the following areas of board leadership:
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Revise corporate governance principles or guidelines to explicitly include stakeholders and ESG&D priorities.
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Enhance the board’s role in aligning corporate purpose, strategy and capital allocation with creating sustainable enterprise value.
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Expand the board’s oversight of risks, risk appetite and resilience to include material and salient ESG&D risks, not only to the company, but also to people and the planet.
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Focus on people, especially on diverse succession planning, talent management and corporate culture as being crucial to company success.
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Integrate ESG&D factors into oversight of and accountability for executive performance and incentives.
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Enhance the board’s own operational practices in terms of organization, composition and engagement with internal and external stakeholders.
4.1 Revise Governance Principles and Guidelines to Include Stakeholders and ESG&D Priorities
Publicly listed companies publish documents that are variously labelled as their governance principles, governance guidelines, board regulations, rules of procedure or mandates along with a set of board committee charters, based on the corporate law and listing requirements of the jurisdiction in which they are incorporated. These documents cover topics such as the board’s role and responsibilities, board operations and communications, board structure and composition, director qualifications and their selection, succession planning, evaluation and remuneration—in short, the purpose of corporate governance.
In his preface to the Principles of Corporate Governance, jointly published in 2015 by the G20 and OECD, the OECD’s former Secretary-General, Angel Gurría, stated, “The purpose of corporate governance is to help build an environment of trust, transparency and accountability necessary for fostering long-term investment, financial stability and business integrity, thereby supporting stronger growth and more inclusive societies.”11
Yet, the explicit language of inclusion, responsibility to all stakeholders not only shareholders, corporate purpose, ESG and sustainability, is still rare or piecemeal in most companies’ corporate governance guidelines and formal board mandates.
In the joint research carried out by Ceres and kks advisors in 2018, they looked at whether the boards surveyed had a formal board mandate for sustainability. The research team found,
Sixty-two percent of the companies we analysed state that they have some form of oversight of sustainability at the board level. However, only 13 percent show truly robust oversight practices, meaning there is both a formal board mandate for sustainability (either through a dedicated sustainability committee or through the inclusion of sustainability in another board committee’s charter) and the board receives regular reports on sustainability from management. … On the other hand, 38 percent of companies still have no discernible board practices in place for sustainability oversight.12
In a similar vein, while researching their paper entitled “The Illusory Promise of Stakeholder Governance,” Professors Bebchuk and Tallarita contacted the 181 companies that signed the seminal 2019 US Business Roundtable statement, which restated the purpose of the corporation to be for the benefit of all stakeholders—customers, employees, suppliers, communities and shareholder, rather than shareholders alone.13 Less than a third of the companies responded. As the researchers noted in an opinion piece for the Wall Street Journal,
We contacted the companies whose CEOs signed the Business Roundtable statement and asked who the highest-level decision maker was to approve the decision. Of the 48 companies that responded, only one said the decision was approved by the board of directors. The other 47 indicated that the decision to sign the statement, supposedly adopting a major change in corporate purpose, was not approved by the board of directors. … The most plausible explanation for the lack of board approval is that CEOs didn’t regard the statement as a commitment to make a major change in how their companies treat stakeholders.14
In 2021, Bebchuk and Tallarita published the findings of additional research in a paper entitled “Will Corporations Deliver Value to All Stakeholders?” This was based on the review of a variety of publicly available corporate documents for the 136 public US companies whose CEOs signed the statement.15 Among their six findings the authors concluded that “examining the almost one-hundred BRT Companies that updated their corporate governance guidelines in the sixteen-month period between the release of the BRT Statement and the end of 2020, we find that they generally did not add any language that improves the status of stakeholders and, indeed, most of them chose to retain in their guidelines a commitment to shareholder primacy.”16 Furthermore, they found that “reviewing the corporate governance guidelines of BRT Companies that were in place as of the end of 2020, we find that most of them reflected a shareholder primacy approach, and an even larger majority did not include any mention of stakeholders in their discussion of corporate purpose,” and “reviewing all the corporate bylaws of BRT Companies, we find that they generally reflect a shareholder-centered view.”17 As the authors commented in a second opinion piece for the Wall Street Journal, their research “casts serious doubt on whether corporations are matching the talk with action.”18
In short, for many companies in the US and elsewhere, publicly available board principles and guidelines do not appear to be keeping up with statements about sustainability and stakeholder capitalism made by their CEOs and executive teams or with changing stakeholder expectations about the purpose of business and its role in society. It is important to note, however, that in many companies actual practice and discussion on these topics inside the boardroom and in executive teams is likely to be ahead of what is written in their formal governance guidelines or other documents that are publicly disclosed.
As the BRT commented in response to the Bebchuk and Tallarita critique, “We disagree with the conclusion of the paper and find the thesis that the [BRT] Statement required changes in bylaws, governance guidelines, and corporate policies, as well as support for certain shareholder proposals, to be deeply flawed. The CEOs who signed the 2019 Statement believe it better reflects the conviction that businesses can’t flourish over the long term or return value to their long-term shareholders without investing in the stakeholders who make success possible. That view is consistent with existing corporate law and does not require any change to companies’ bylaws and governance guidelines.”19
In today’s operating environment, even when not legally required to do so, all boards can and should be proactive in reviewing and where relevant revising their published corporate governance guidelines and committee charters to:
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first, explicitly recognize the board’s responsibility for oversight of management in determining corporate purpose and strategy for creating sustainable enterprise value for stakeholders, including but not only shareholders; and
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second, provide language on the board’s responsibility for oversight of ESG&D risks, opportunities and performance in addition to financial and operational risks, opportunities and performance.
In addition to boards taking voluntary action to integrate stakeholder and ESG&D considerations into formal board documents and mandates, regulatory requirements are also evolving in this direction. The UK’s Companies Act offers an example.20 It uses stakeholder language similar to the Davos Manifesto and the US Business Roundtable Statement on the Purpose of a Corporation and incorporates it into law and public disclosure requirements. In 2018, new corporate governance and reporting guidelines were issued that require companies of a significant size to explain how their directors comply with Section 172 of the UK Companies Act. Section 172 addresses a director’s “[d]uty to promote the success of the company.” It states: “A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole and in doing so have regard (amongst other matters) to -
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the likely consequences of any decision in the long term,
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the interests of the company’s employees,
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the need to foster the company’s business relationships with suppliers, customers and others,
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the impact of the company’s operations on the community and the environment,
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the desirability of the company maintaining a reputation for high standards of business conduct, and
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the need to act fairly as between members of the company.”21
Another example of evolving regulation is provided by changes made in 2019 to the provisions of the French Civil and Commercial Codes, which have been supplemented by the so-called Pacte Statute on the Development and Transformations of Businesses.22 Each French company and French Boards of Directors and Management Boards must be managed “in furtherance of its corporate interest,” not shareholder interests, and “while taking into consideration the social and environmental issues arising from its activity.”23 In November 2020, a corporate responsibility initiative in Switzerland that would have mandated that multinational companies demonstrate respect for human rights and the environment was narrowly defeated in a nationwide referendum, despite gaining 50.74% to 49.26% of the popular vote.24
In summary, to respond to the changing operating context, boards need to be more explicit about the way they incorporate language about stakeholders, corporate purpose and ESG&D risks, opportunities and performance into their corporate governance principles, guidelines and committee charters.
4.2 Enhance Board Oversight on Aligning Corporate Purpose, Strategy and Capital Allocation with Creating Sustainable Enterprise Value
Boards should play a more proactive and deliberative role and provide greater disclosure on their oversight and guidance in:
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Approving and stewarding a clear statement of corporate purpose, outlining how the company aims to create sustainable enterprise value by addressing ESG&D issues and/or stakeholder needs
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Providing more robust and regular guidance on corporate strategy and its alignment with ESG&D issues and stakeholders
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Reviewing capital allocation and investment decisions through the lens of ESG&D issues and stakeholders alongside financial, operational and shareholder lenses
4.2.1 Support Management as Stewards of Corporate Purpose
As a growing number of governance practitioners, investors, advisers and academics are noting, the full board of directors should have input into approving the company’s purpose. Although it is the role of management to lead the work on developing a company’s purpose, values, mission and vision, preferably in a way that actively engages with their employees, the board should also be proactively engaged.
In particular, the board has a role in approving the company’s purpose statement and then providing oversight on how this aligns with the company’s values, strategy, business planning and operations, what its key goals and performance metrics are and how management is incentivized and compensated for achieving them. If a contribution to solving a social or environmental challenge or creating value for stakeholders beyond maximizing shareholder value is an explicit component of the company’s publicly stated purpose, this in turn sets the foundation for integrating material ESG&D issues into core business strategy, business models, risk management and operations. It also serves as a basis for stakeholder engagement and internal and external accountability.
In most countries, the development and disclosure of a corporate purpose statement remains voluntary, although stakeholder or ESG-related disclosure requirements in France, the UK and elsewhere in the EU are evolving. The UK’s revised Corporate Governance Code 2018, and Board Effectiveness Guidance, for example, states that the board is “responsible for aligning purpose, values and strategy.” It highlights three key principles in relation to corporate governance and purpose:
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Purpose is the reason a company exists.
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The board is responsible for setting and periodically reconfirming the purpose of the company.
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A well-defined, concise purpose helps companies articulate their business models and develop their strategy, operating practices and approach to risk, and facilitates engagement with the workforce, customers and the wider public.25
In addition to the widely publicized 2019 US Business Roundtable’s “Statement on the Purpose of a Corporation,” and the World Economic Forum’s 2020 refresh of its original stakeholder-oriented 1973 Davos Manifesto, other business leadership groups are starting to call for boards to be more proactive in defining and disclosing their company’s purpose. The World Business Council for Sustainable Development stated in a 2020 report that boards should “[e]nsure that the company’s purpose is clearly established and aligned with material sustainable development impacts and opportunities. … Clarity of company purpose can provide a direct communication about the future of the organization and deliver long-lasting and broad benefit to the business.”26
Along similar lines, a 2020 paper by the Enacting Purpose Initiative (EPI), a coalition of leading academics and practitioners, concluded, “When embedded at the most senior levels of decision-making, purpose acts as a ‘north star’ for Boards of Directors. It is a key driver informing strategic choices, helping directors make the critical trade offs and decisions that are required to fulfil their board responsibilities. This is purpose as strategy, and it differs fundamentally from purpose as culture. Purpose as strategy will facilitate the choices that need to be made as organizations rebuild or adapt after this crisis.”27
One of the specific proposals made by EPI is for
boards to start with a statement of purpose signed and issued by all the directors. The board chair and the governance committee should take the lead in drafting it. The statement should define how the company aims to create value by fulfilling unmet needs in society. It should acknowledge the negative impacts the company must mitigate if it is to retain public support and its license to operate. And it should present a distinctive message—not something so generic that the name of any major competitor could be substituted. If those criteria are met, the statement can be a powerful tool for sharing a company’s vision for long-term value creation, even in industries with negative externalities.28
While a growing number of companies have a corporate purpose statement that meets many of the above criteria, there are few where the statements have been signed by the board directors.
4.2.2 Provide Robust and Regular Guidance on Corporate Strategy
As the US Business Roundtable among others has stated, “The board should have meaningful input into the company’s long-term strategy from development through execution, should approve the company’s strategic plans and should regularly evaluate implementation of the plans that are designed to create long-term value. The board should understand the risks inherent in the company’s strategic plans and how those risks are being managed.”29
In the journey towards stakeholder capitalism, most boards need to focus on the following three strategy-related areas:
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First, spend more time on strategy and sustainable value creation discussions, generally
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Second, ensure clear and continued alignment between corporate purpose and strategy
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Third, integrate other sustainability- and people-related strategies with the corporate strategy (or at a minimum ensure that they are not working at odds with each other)
Spend more time on strategy: Boards need to spend more focused and quality time engaging with management on debating options for corporate strategy and long-term, sustainable value creation.
Drawing on research from McKinsey, Focusing Capital on the Long-Term (FCLTGlobal) states: “Boards with a demonstrated, long-term impact spend nearly twice as much time on high-level issues like strategy, business model, risks, and the company’s value-creation proposition.”30
In his 2016 Corporate Governance Letter to CEOs, BlackRock’s Larry Fink stated, “We are asking that every CEO lay out for shareholders each year a strategic framework for long-term value creation. Additionally, because boards have a critical role to play in strategic planning, we believe CEOs should explicitly affirm that their boards have reviewed those plans. BlackRock’s corporate governance team, in their engagement with companies, will be looking for this framework and board review.”31
The benefits of such an approach are obvious. If an experienced and diverse board of directors and management team spend more time together focused on understanding key competitive trends, potential market disruptions, changing stakeholder expectations and the company’s short- and long-term value creation opportunities—as well as value destruction risks—they are likely to develop a more robust and successful strategy. If these strategy discussions are regular and strategic plans are regularly stress-tested, the company is also likely to be more agile in adapting and course-correcting when needed and more resilient in times of crisis and systemic shocks. Regular strategy discussions can also help to build trust and values alignment between the board and management, while still enabling constructive and challenging debate around options for value creation.
The obstacles to boards getting more proactively and intensely engaged in strategy discussions are well-documented. They include growing regulatory and compliance burdens requiring more director time, inefficient organization of board agendas, certain issues or quarterly performance reviews that could be delegated to committee-level meetings being covered at the full board, too much time spent on management presentations rather than taking board papers as read, and over-boarding and some directors not having the time or commitment to do the necessary preparation work.
Most of these obstacles can be overcome with effective board leadership and adjustments to the way board meetings and management presentations are structured. Creative use of site visits and engagement with external stakeholders can also help to enrich and strengthen board-level strategy discussions and outcomes. As High Meadows Institute notes in its report on Corporate Governance for the Twenty-First Century, “Historically, boards focused on strategy once annually, often at a one- to two-day off-site retreat. Today, in most firms, discussions on strategy take place at each board meeting to ensure that progress is being made and that new competition or technology is taken into consideration. Many directors support frequent evaluation of strategy, deeper engagement, and greater board involvement at an earlier stage.”32
Align corporate strategy with corporate purpose: Boards need to also have an explicit focus on how corporate strategy helps to deliver on the company’s purpose, how it takes the creation of shared and sustained value for all stakeholders into account, including but not only shareholders, and how material ESG&D risks and opportunities are being integrated into strategic planning, alongside financial and operational risks and opportunities. At a minimum, boards should be asking how stakeholders and ESG&D issues may create risks for the achievement of the company’s strategic goals and how they might offer strategic opportunities for the company.
Integrate the company’s sustainability and other stakeholder-oriented strategies with corporate strategy: Board’s should monitor that there is internal alignment of goals, incentives and accountabilities between the company’s corporate strategy (and the strategic priorities that it presents publicly at investor presentations) with other key company strategies, such as the human capital and talent development strategy, the sustainability or corporate responsibility strategy and the government relations and communications strategy. Failure to “walk the talk” in terms of actual performance against a stated corporate purpose is one of the greatest drivers of mistrust in business.
Ideally, boards should encourage their CEOs and management teams to move beyond the goal of preventing misalignment between these different strategies to explicitly integrating them. The most material ESG&D strategic priorities, for example, should form one or more of the strategy pillars of the corporate strategy itself. Since executives and management are usually incentivized and compensated based on their performance against the company’s strategy, the greater the integration of ESG&D issues, the more likely they are to influence behaviour and results.
4.2.3 Review ESG&D Implications of Capital Allocation and Investment Decisions
The US Business Roundtable states, “The CEO and senior management are responsible for providing recommendations to the board related to capital allocation of the company’s resources, including but not limited to organic growth; mergers and acquisitions; divestitures; spin-offs; maintaining and growing its physical and nonphysical resources; and the appropriate return of capital to shareholders in the form of dividends, share repurchases and other capital distribution means.”33 In turn, it is the responsibility of the board to “have meaningful input and decision-making authority over the company’s capital allocation process and strategy to find the right balance between short-term and long-term economic returns for its shareholders.”34
In today’s business context, as outlined elsewhere in the book, “finding the right balance” in capital allocation requires not only balancing short-term and long-term economic returns to shareholders, but also returns to other stakeholders and other forms of capital—especially to human capital or employees and natural capital or the environment. One example is the substantial investments in research and implementation that many companies will need to make in new technologies, products, services and business models to achieve net-zero carbon emissions by 2050 or before. Other examples include investment in the well-being, training and development of employees, building the resilience and capabilities of suppliers and allocation to communities and corporate foundations.
When it comes to major investment decisions and business development activities such as mergers and acquisitions and new market entry, ESG&D risks and opportunities should be integral to competitive analysis and to the scoping, feasibility assessments, due diligence and decision-making associated with these investments and activities. In many industry sectors and companies, these risks and opportunities are also increasingly material to the outcomes of a major investment. Likewise in the case of research and development (R&D). ESG&D risks and opportunities can be a key driver of innovation in new science and technologies as well as a consequence of such innovation, both positive and negative. As such, the board needs to understand and debate both specific ESG&D risks and opportunities and broader scenarios or potential ESG&D outcomes associated with major investments, business development and R&D decisions.
4.3 Expand Oversight of Risks to Include Material and Salient ESG&D Risks
One of the key functions of any board that has become progressively more complex, dynamic and multi-dimensional is risk oversight. In the words of the Business Roundtable, the board is responsible for “[s]etting the company’s risk appetite, reviewing and understanding the major risks, and overseeing the risk management processes. The board oversees the process for identifying and managing the significant risks facing the company. The board and senior management should agree on the company’s risk appetite, and the board should be comfortable that the strategic plans are consistent with it. The board should establish a structure for overseeing risk, delegating responsibility to committees and overseeing the designation of senior management responsible for risk management.”35
Traditional types of operational, financial, market, political and regulatory risks have not gone away. Indeed, for most industry sectors and countries, these risks have increased and become more complex and challenging in the face of globalization, complex supply chains and disruptive technologies, as well as threats to globalization, systemic shocks such as financial crises and pandemics and growing political polarization both within nations and geo-politically. Add to these, the following two categories of risk oversight, which in many cases interact with more traditional risks, and it is clear that boards face a growing challenge in today’s world to ensure comprehensive and effective risk oversight:
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Oversight of material and salient ESG&D risks and risk appetite
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Preparedness for and resilience to systemic shocks and crises
4.3.1 Ensure Oversight of Material and Salient ESG&D Risks
There have been two related shifts in “risk oversight” that are essential to supporting the transition towards a more stakeholder-oriented and integrated form of corporate governance:
First is the growing materiality of ESG&D risks to the company and to its financial and operational performance. As outlined in Chap. 2, the costs to the company of “getting it wrong” when it comes to managing the company’s ESG&D performance have grown.
Second are the concepts of salience, double materiality and managing shared risk. Risk oversight needs to expand from identifying, mitigating and managing risks to the company—to its operations, financial liquidity, business continuity and reputation—to also being more explicit about and accountable for identifying, mitigating and managing risks to people and to the planet that may result directly or indirectly from the company’s activities or those of business partners along its supply chain.
The UN Guiding Principles on Business and Human Rights has started to popularize the use of the term salient risks to capture this dimension of risk oversight and management. Whereas material ESG&D risks pose a threat to the company, salient ESG&D risks pose a threat to people and the environment. Clearly, there is often an overlap between them—causing serious pollution or high levels of greenhouse gas emissions, for example, or being responsible for or complicit with human rights abuses, not only harm people and the environment, but increasingly also the company due to changing societal expectations, regulations and investor focus. However, in many cases there is not an overlap—or there is a weak one—and responsible boards and management teams should be systematic and consistent in assessing and being accountable for both material and salient risks resulting from the company’s activities.
Just as the audit committee is responsible for monitoring financial risks, ethics, integrity and compliance, a vanguard of corporate boards is establishing processes and/or committees with oversight responsibility for monitoring both material and salient ESG&D risks.
At a minimum, every board should engage in a regular review of the company’s enterprise risk management system and understand how material ESG&D risks are being integrated, ranked and managed alongside other risks. In addition, ESG&D risks should be one of the topics addressed in board discussions on the company’s risk appetite and tolerance.
Clearly, there are some substantial ESG&D risks that have risen to prominence in major companies over the past decade, which were outlined in Chaps. 2 and 3. At the top of most lists are climate change, human rights, inclusion and diversity, and data privacy and data use issues. Box 4.1 provides the example of the Climate Governance Initiative, which is focused on supporting boards to become “climate competent.”
Box 4.1 Building Climate Competent Boards
Changing regulations and more demanding and explicit climate-related disclosure requirements by both governments and investors are making climate competence a central pillar of directors’ fiduciary duties. In 2019, the World Economic Forum, in collaboration with PwC, published a set of Guiding Principles for setting up effective climate governance on corporate boards.36 These principles are relevant for all boards regardless of industry sector or jurisdiction and provide a useful framework for action. The eight principles focus on the following areas:
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Board accountability for climate
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Command of the climate subject through diverse board knowledge, skills, experience and background
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Integration of climate considerations into board structure and committees
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Material climate risk and opportunity assessment
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Strategic and organizational integration into investment planning, decision-making and management systems
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Incentivization of executives
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Public reporting and disclosure of climate-related risks, opportunities and strategic decisions
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Exchange with peers, policymakers, investors and other stakeholders on climate issues and good practices
These principles are also aligned with the recommendations of the Task Force for Climate-Related Financial Disclosure, which call on companies to publicly disclose their climate-related risks and opportunities under the four pillars of governance, strategy, risk management and metrics and targets.
In 2020, the Centre for Climate Engagement at Cambridge University, together with the World Economic Forum, established the Climate Governance Initiative. Its goal is to support chapters around the world focused on mobilizing, educating and equipping non-executive directors with the skills and knowledge to implement these principles and effectively address climate change at the board level. To date, more than a dozen national chapters or existing board leadership organizations have affiliated with the network. In addition, most Institutes of Directors and other director-led professional groups, as well as universities and climate-focused initiatives such as Ceres, are stepping up their skills building activities to help companies build climate competent boards. Every board should be assessing its capabilities and responsibilities against these principles and recommendations and taking action to address gaps.
In 2020, the COVID-19 pandemic and global protests on racial injustice and inequality also highlighted and intensified the “S” in ESG. As outlined in Chap. 3, the UN Guiding Principles on Business and Human Rights have played an important role in placing respect for human rights more clearly on the board agenda. Prior to the pandemic, however, the boards that focused strategically on their company’s responsibility to respect human rights or to address social risks defined in other ways were more the exception than the norm. Today, oversight of these topics is becoming central to good corporate governance.
Any company’s most salient risks and greatest responsibility are to protect the lives, health and safety of people who work for the company, who purchase its products and services or who live in communities surrounding its operations. Industries such as oil and gas, chemicals, mining, aviation, heavy transportation, construction and infrastructure have learned hard lessons over many years on the human tragedy and business costs of inaction or poor performance on occupational health and safety. As a result, most of the leading companies in these industries have a long-standing focus on health and safety as a priority in their values, risk management systems and board risk oversight. Likewise, road safety has been a long-standing priority for companies with large logistics and distribution networks. Consumer product safety is increasingly well-regulated and a major focus for board oversight in sectors such as healthcare and pharmaceuticals, food and beverages, toys and chemicals. During the pandemic, protecting the health and safety of employees and other relevant stakeholders became more of a priority for all responsible companies.
Moving beyond protecting people’s basic health and safety, a vanguard of companies has established employee wellbeing programmes, covering both physical and mental health and wellness, as well as financial health in some cases. Over the past few decades, gender diversity, and to a growing extent racial and ethnic diversity, have also become more of a focus for boards and management in many companies and countries.
As a result of both the pandemic and heightened focus on social injustice and discrimination, boards must address peoples’ health, safety and wellness and their inclusion and diversity more systematically and strategically in future. A survey by the Diligent Institute, for example, found that board directors are expecting to “discuss the impact of their decisions on non-shareholder stakeholders with very high frequency in the three years following the COVID-19 outbreak.” Forty-two per cent said they expected to discuss these topics at every meeting (compared to 26% in the past three years), and 73% expect to discuss them quarterly, compared to 47% in the past three years.37
4.3.2 Strengthen Preparedness for and Resilience to Systemic Shocks and Crises
Another core component of effective risk oversight at the board level is monitoring the company’s ability to respond to and recover from an acute or systemic crisis. As outlined in Chap. 3, this ability depends on the rigour and scope of the company’s risk management systems and its crisis preparedness processes, combined with an adaptive and engaged corporate culture and the quality of leadership at both executive and operational levels of the company. Boards play a vital role in providing oversight and support to management in these areas:
Improving preparedness: Boards need to work closely with management to undertake scenario planning, simulations and stress-testing exercises; develop crisis succession plans for key executives and mission critical operators; and review deployment options for emergency response assets and relationships.
Supporting crisis management and response: When a crisis happens, boards need to be equipped to immediately respond. Sometimes this will require the board or a senior non-executive director to step directly into an executive role, but more often it will require the board to support its senior management team. The following areas are important for boards to consider in most crisis situations, especially more systemic shocks: putting people first and doing everything possible to protect the lives and livelihoods of employees and other direct stakeholders of the company; supporting critical functions and operations for business continuity; providing oversight of financial risks, liquidity and resilience; and continuing to invest in key stakeholder relationships and partnerships.
Strengthening recovery and future resilience: While the duration, intensity and scope of a crisis management situation will obviously vary depending on the nature of the crisis and how systemic it is, as early as possible, the board and management team should be reviewing medium- and longer-term recovery plans and discussing lessons learned to strengthen the company’s resilience for the future. In addition to identifying key planning and relationship management priorities, they should be reviewing lessons learned and identifying gaps and opportunities to build future operational, cultural, financial and technological resilience. Once again, the quality of stakeholder engagement and developing or sustaining trusted relationships, both within the company and externally, will be a key factor in this process.
4.4 Focus on Diverse Succession Planning, Talent Development and an Inclusive Culture
Over the past decade there has been growing awareness that boards need to “up their game” on the employee and cultural dimension of their responsibilities and expand their oversight from CEO succession and compensation—although these remain as important as ever—to a broader understanding and oversight of talent development and succession planning, employee well-being, diversity and inclusion, and corporate culture. This focus needs to include but go far beyond the more traditional compliance-based approach to governance of employee and labour issues. Board leadership is especially important in the areas of:
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Oversight of CEO and executive performance, compensation and succession
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Guidance on corporate culture
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Championship of diversity, equity and inclusion
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Review and support of talent development
4.4.1 Integrate ESG&D into CEO and Executive Performance, Compensation and Succession
Boards play a crucial role in the oversight of CEO performance, compensation and succession planning. In a growing number of cases, this oversight is extending to the senior executive team more broadly, and this is an important shift for ensuring a more stakeholder-oriented approach to governance.
As boards review their CEO and executive team succession plans, in addition to all the traditional leadership capacities and operational, managerial, technical and functional skills that need to be assessed, there is also a growing need to focus on so-called softer skill sets and mindsets. Ensuring that the ability to manage ESG&D risks and opportunities is part of the skills matrix for the CEO and relevant executives, and that targets for ESG&D performance are included in performance reviews, incentive and compensation programmes, is an essential factor in embedding good practice.
4.4.2 Provide Guidance on Corporate Culture
There is a growing focus on the role of boards in both contributing to and monitoring corporate culture. All the values and purpose statements, ethical policies and standards in the world will not be effective if the company’s culture and, linked to that, its role models, accepted norms and behaviours, incentive systems and rewards are not aligned to these statements and policies. Indeed, failure to “walk the talk” is a key driver of the decline in employee morale and productivity and stakeholder trust more widely. The 2017 National Association of Corporate Directors (NACD) Blue Commission on “Culture as a Corporate Asset” commented that “organizational cultures and the factors that influence them are complex systems, incorporating elements such as: explicit and implicit rules; norms of behaviour and interaction; compliance and ethics policies; incentives; recruiting and training activities; processes for decision-making and prioritization (including budget setting); communication and information flows; and leadership styles.”38
Of relevance to the transition towards a more stakeholder-oriented approach, the NACD Commission also concluded, “Culture reaches beyond the company, since it is expressed not only in the treatment of employees, but also in interactions with customers, suppliers, communities and other external stakeholders.”39
Boards have an increasingly important role to play in “setting the tone from the top” and ensuring the rigorous monitoring of relevant training and awareness programmes, employee engagement surveys, whistleblowing mechanisms and culture reviews, in addition to demonstrating zero tolerance for harassment or harmful and unethical behaviour.
PwC’s 2019 Annual Corporate Directors’ survey found, “Culture problems are often at the root of corporate crises. Many companies and boards are taking a hard look at their own culture to see where culture problems might originate. Directors are also looking at who’s to blame. The tone set by executive management is cited the most often, but more directors are pointing the finger at middle management. Boards themselves are also taking more accountability: 29% of directors strongly agree that a lack of board oversight contributes to problems, up from 18% in 2018.”40
Research by KPMG highlights four key areas that any board should focus on when assessing their oversight of corporate culture:
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Understand what “culture” is and why it is critical today.
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Establish clarity on the foundational elements of the company’s culture: zero-tolerance policies as well as behaviours that will help the company excel.
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Clarify the board’s role in overseeing culture—recognizing that visibility is a major hurdle.
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Assess where culture belongs on the board and committee agendas.41
4.4.3 Serve as a Champion for Diversity, Equity and Inclusion
An increasingly important element of board oversight of corporate purpose, values, value creation, risk management and corporate culture is its role as a champion for diversity, equity and inclusion.
First, this should come from the demonstration effect and role model of the board’s own diversity.
Second, it should come from the board working with management to set and monitor clear goals and targets at all levels of the company. This includes making sure that these goals and the accountability for achieving them are owned by the full executive team and operational leaders, with expertise, support and tracking provided by the human resources team.
Third, board leadership on diversity, equity and inclusion should include support for and direct engagement with employee groups, business resource groups and affinity groups. Where relevant, the board should also have access to external subject-matter experts and advisers.
Boards—at the full board or committee level—should ensure that management is allocating sufficient resources to initiatives such as implementing equal pay for equal work throughout the company, supporting unconscious bias training and other types of training and awareness raising, requiring blind resumes and diverse candidate slates for both internal and external hiring, identifying and addressing other discriminatory practices, behaviours and symbols of exclusion, proactively broadening flexible working arrangements and other support systems to facilitate diverse working and family needs, understanding and making commitments to pay living wages, encouraging and facilitating employee dialogues, and creating mechanisms where employees can confidentially address difficult issues.
4.4.4 Review and Support Long-Term Talent Development
Linked to all the above is board oversight for the company’s overall human capital strategy and the resources that the executive team is allocating to develop the skills, capabilities and management “bench strength” or leadership pipeline in all business units and functional divisions. While much of this can be delegated to the committee level, with regular updates to the full board, it has become an increasingly important board task. As a result, in leading companies the mandate of compensation committees is starting to broaden to include leadership development, talent, human capital, and diversity and inclusion as well as executive compensation and remuneration.
4.5 Integrate ESG&D Priorities into Oversight of Executive Performance, Incentives and Accountability
Every quarter the board will be reviewing the performance of the executive team and the company against the strategic priorities and goals that have been established. Clearly, this includes performance against financial, operational, growth and business development targets. In today’s world, it should also include quarterly reviews of performance against the company’s most material and salient ESG&D risks and opportunities. In particular, the board should:
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Integrate ESG&D into business planning and performance oversight
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Align incentives to corporate purpose and strategy and hold executives accountable
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Commit to integrated reporting of the company’s performance and prospects
4.5.1 Integrate ESG&D into Business Planning and Performance Oversight
If ESG&D factors are an explicit part of a company’s strategy, they will also be integrated into business planning, target setting and performance review processes, and the board’s approval and oversight of these. To the extent that this cascades from the corporate level to operating units—be they different lines of business, different brands or different geographies—the more likely it is that the company will be well positioned to understand and manage key ESG&D risks and opportunities.
4.5.2 Align Incentives to Corporate Purpose and Hold Executives Accountable
A corollary to the adage “you manage what you measure” is “you implement what you are incentivized for.” Incentives for executives and managers are primarily viewed in financial terms, but clearly also include other forms of recognition, ranging from career advancement and promotion to awards and “honourable mentions.” Boards—or more specifically compensation committees, have an important role to play in ensuring that compensation and benefits packages are aligned with the company’s overall purpose, values and strategy and enable and reward managers for delivering on these. Four key aspects of corporate incentive and recognition programmes need to be reviewed and in many cases changed or refreshed to support a transition towards more stakeholder-oriented approaches.
First is the need to balance rewards for short-term results with long-term value creation and performance. This is an area that has seen considerable progress in recent years, with senior executive compensation packages focused increasingly on longer-term performance metrics and share ownership.
Second is the need to integrate performance on ESG&D issues into executive compensation packages. In certain industries, this has been done in the case of the company’s safety performance for several decades, but progress has been slower on other social and environmental issues. Performance on meeting targets for climate change and for diversity and inclusion currently appear to be the most common issues for inclusion in executive packages. Some boards use the company’s ranking in ESG indices as a proxy rather than focusing on executive performance in addressing a specific ESG&D issue or set of issues.
Third is the increasingly high-profile topic of fairness. This relates to the question of “equal pay for equal work” and the need for most companies to address gender pay gaps, racial pay gaps and/or nationality pay gaps. It also relates to the question of the gap between CEO and executive compensation and the compensation of employees, which has widened substantially over the past few decades. Over the past decade, regulations such as “Say on Pay” and those limiting so-called golden parachutes or enabling long-term compensation clawbacks for CEOs who have been fired for poor performance have started to address these issues. The first “line of defence,” however, should be the board doing a good job on alignment and oversight of executive compensation. Another growing focus in terms of fairness is the extension of share ownership schemes to a larger number of employees and in a few cases even host communities as a way of spreading shareholder wealth, albeit also spreading associated risks, to more of a company’s stakeholders.
Fourth is the importance of having clear consequences for non-performance on ESG&D targets as well as financial and operational ones. This can range from decreases in annual bonuses for failure to meet key targets in areas such as safety and the company’s other most material and salient ESG&D issues to termination of jobs, including the company’s CEO and/or its best performers, in cases where there is a verified breach in ethics and core values. Although still rare, decisions made by boards to fire a CEO or senior executive resulting from such breaches can send a strong internal and external signal that the company’s stated purpose, values and ethics really matter.
4.5.3 Commit to Integrated Reporting of the Company’s Performance and Prospects
In the same way that boards and their audit committees review and approve a company’s financial statements, leading boards are also starting to review and approve their company’s sustainability or ESG&D materiality assessments, targets, reports and disclosures. Detailed review and oversight are usually most effectively undertaken at a committee level, but the full board should be informed of the company’s public disclosures on ESG&D-related policies, commitments and performance and about trends in investor expectations on this topic. This topic is addressed at length in Chap. 6.
4.6 Strengthen Board Organization, Composition and Engagement
Finally, there is the important question of the board’s own practices and the need to continuously evaluate whether its current organization, composition and stakeholder engagement mechanisms are fit-for-purpose in an increasingly complex operating context. There are obvious differences between ownership structures and corporate governance models in different countries and jurisdictions that have an impact on board organization, composition and engagement, but some important factors and good practices for all boards to consider include the following.
4.6.1 Integrate ESG&D into Board Organization and Structure
A core question to consider is the appropriate allocation of discussions and decision-making on ESG&D risks and opportunities between the full board and relevant committees. It is no longer an either/or situation. In every industry sector, ESG&D issues are now sufficiently material and salient that they must be addressed by the full board. At the same time, the range of issues that are likely to be material and salient in any large company—from human rights, ethics and employee safety to climate change, water management and data stewardship—are sufficiently wide-ranging and technically complex and sophisticated that their oversight requires more time than can be allocated in most board meetings. As such, there is a growing need to ensure that relevant board committee charters also include oversight of these issues. This includes regular reviews of the appropriate balance between committee-level work and full board discussions and consideration of which ESG&D-related issues need to be addressed by which committee.
The appropriate balance and committee allocation will vary, depending on the industry sector, corporate law and disclosure requirements in the head-office country and current board structure. The key point is for boards to be intentional and systematic about how they integrate ESG&D issues into their core oversight roles and responsibilities.
Integrating ESG&D at the Full Board
In many companies, an annual presentation on ESG&D issues is now made to the full board. Growing public disclosure requirements on how companies are addressing climate change risks are resulting in this topic also receiving more systematic and regular attention by the full board. Such presentations are necessary but increasingly insufficient in most large companies that are operating globally. It is important for the full board to have more regular oversight of the ESG&D issues that management considers to be most material to the company and salient to people and the environment, along with changes in stakeholder expectations and the company’s policies, standards, strategies and due diligence processes for managing these risks and opportunities and its performance against targets. In addition, as outlined throughout this chapter, it is increasingly necessary for the full board to consider ESG&D issues in the context of and integral to other key board oversight topics and functions. For example:
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Approval of corporate purpose
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Corporate strategy discussions
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Capital allocation and investment decisions
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Enterprise risk management and risk tolerance discussions
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Business planning and target setting
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Oversight of corporate and business unit performance
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CEO and executive succession and incentives
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Public reporting and disclosures
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Corporate culture
Embedding ESG&D into Board Committee Charters
As emphasized throughout the book, the range of material ESG&D issues that need to be addressed by many companies and the technical complexity of some of these issues, most notably in the areas of digital and other new technologies and climate change, increasingly require additional time and attention of a board committee. There is no one-size-fits-all and no common definitions for the roles of such committees.42
Research by Ceres and kks advisors in 2018, for example, focused specifically on how responsibility for sustainability was allocated to different board committees. They found that 25% of the companies reviewed had established a Corporate Responsibility or Corporate Social Responsibility Committee, while 14% had an Environmental, Health and Safety Committee, 13% allocated responsibility for these issues to a Sustainability Committee, and 5% to a Social and Ethics Committee. Other companies had integrated responsibility for sustainability issues into existing board committees—the Nominations and Governance Committee in 18% of cases, a Public Policy Committee in 13% of cases, a Risk, Regulatory or Compliance Committee in 6% of cases, an Audit Committee in 2% of cases, and a Strategy or Compensation Committee in 1% of the companies reviewed.43
Committee options include the following:
A dedicated committee focused on ESG issues: A growing number of corporate boards have established a committee dedicated to addressing ESG, corporate responsibility, safety and sustainability or public affairs issues. Such committees are able to provide regular oversight of the company’s key risks, opportunities and performance with respect to its most material and salient ESG issues; review global strategies for these issues, for example in areas such as employee health and safety, climate and energy, water, and human rights; provide input to materiality and salience analysis and the company’s public disclosures related to these issues; and appoint expert advisers or reviews to address specific ESG-related challenges or crises. In some cases, geopolitical risks, government relations and other external stakeholder engagement are also a focus of such committees. Box 4.2 provides some examples.
Box 4.2 Examples of Dedicated Corporate Responsibility and Sustainability Committees
The following three companies from diverse industry sectors have had dedicated sustainability committees in place for over a decade. Their Charters or Terms of Reference provide useful models for other companies to review.
GSK’s Corporate Responsibility Committee was established in 2005. Its Terms of Reference were updated in 2021 to reflect the company’s refreshed corporate purpose and its three long-term priorities of innovation, performance and trust. The company outlines its trust priority as follows: “We are a responsible company. We commit to use our science and technology to address health needs, make our products affordable and available and be a modern employer.”44 The company has set 13 public Trust commitments in the ESG areas where it can make the greatest difference. These include commitments in the areas of new medical innovations; global health R&D; health security; pricing; product reach; healthcare access; engaged people; inclusion and diversity; employee health, well-being and development; reliable supply; ethics and values; data and engagement; and the environment. The Corporate Responsibility Committee oversees progress against these commitments.45 The board committee’s role is defined as follows: “The Committee considers GSK’s Trust priority and oversight of progress against the associated Trust commitments which reflect the most important issues for responsible and sustainable business growth. It has oversight of the:
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Views and interests of our internal and external stakeholders and reviews issues that have the potential for serious impact upon GSK’s business and reputation; and
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Enterprise Risks determined by the Board to be most relevant to the Committee’s area of expertise and responsibility.”46
Ford Motor Company’s Sustainability and Innovation Committee’s current charter was approved in 2015, building on the experience of previous committees and allocation of responsibilities. It defines the committee’s role as follows: “Sustainability and Innovation Committee shall evaluate and advise on the Company’s pursuit of innovative practices and technologies, as set forth in Section IV of this Charter, that improve environmental and social sustainability, and that seek to enrich our customers’ experiences, increase shareholder value, and lead to a better world.”47 The sustainability topics discussed by the committee include energy consumption, climate change, greenhouse gas and other criteria pollutant emissions, waste disposal, and water use; social well-being, including human rights, working conditions, and responsible sourcing; and trends in global mobility such as mobility infrastructure, vehicle ownership and business models, vehicle connectivity and automation in order to help provide accessible, personal mobility throughout the world. The committee’s innovation mandate includes discussing and advising on “the innovation strategies and practices used to develop and commercialize the technologies that contribute to the Company’s efforts to: (i) improve the fuel efficiency of our products, (ii) reduce the environmental impact of our facilities, (iii) provide products of the highest quality, (iv) improve the safety performance of our vehicles, and (v) continuously deliver industry-leading technology solutions that enrich customer experiences.”48
Newmont’s Safety and Sustainability Committee was established in 2004. The committee has the authority “to investigate any activity of the Corporation and its subsidiaries relating to health, safety, loss prevention and operational security, sustainable development, environmental management and affairs, relations with communities and civil society, government relations, human rights and communications matters.”49 In addition, certain safety and sustainability priorities are reviewed and overseen by the full board and by the company’s Audit Committee or its Leadership Development and Compensation Committee (LDCC). Underpinning the company’s purpose, values and business strategy are five foundational principles that guide continuous improvement and establish the objectives by which performance is measured by management and overseen by the board.50 They are health and safety; operational excellence; growth; people; and environmental, social and governance. In 2020, the company refreshed its Corporate Governance Guidelines to state:
The mission of the Board is to oversee the Corporation’s efforts to create enduring value for all stakeholders. To deliver on this mission, the Board will adhere to sound governance principles and the Corporation’s core values of safety, integrity, sustainability, inclusion and responsibility. In its oversight role, the Board must maintain a sense of responsibility to the Corporation’s stockholders, customers, employees, suppliers and the communities in which it operates to enable the Corporation to fulfill its corporate purpose of creating value and improving lives through sustainable and responsible mining.51
A broader risk committee: In other cases, boards are establishing a dedicated risk committee to provide oversight of a broader range of material risks to the business. These may include ESG-related as well as other material risks such as data stewardship, technology more broadly, geopolitics, and other business continuity and industry disruption risks.
A science, technology and innovation committee: Some companies are establishing science, technology and/or innovation committees to stay on top of key scientific and technology trends and disruptions and to provide better insight and oversight on key science and technology-related risks and opportunities faced by the company. Some of these will be ESG&D related or have substantial implications for the company’s performance on ESG&D issues.
The integration of ESG&D into other committees: In many cases, even with a dedicated ESG or risk committee, other more traditional committees have started to integrate responsibility for oversight of key ESG&D-related risks and opportunities into their mandates:
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Governance and nominating committees can play an essential role in ensuring that ESG&D-related skills, capabilities and experiences are integrated into director recruitment, onboarding, training and succession planning, as well as having oversight of committee charters and board peer reviews and evaluation processes. This tends to be the existing committee most likely to add ESG or sustainability oversight to its committee mandate or charter in cases where a dedicated ESG committee is not established.
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Audit committees should be reviewing the company’s ethics compliance, anti-corruption and integrity policies, systems and performance and in some cases its data stewardship systems. They should also be discussing and disclosing the financial risks associated with material ESG&D issues. In the case of climate, for example, the Task Force on Climate-Related Financial Disclosure highlights the need for boards to review and report on the financial risks and costs of climate, not only the environmental ones.
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Compensation committees in many boards are expanding their mandate and their name to encompass leadership development, talent management and inclusion and diversity, alongside their traditional compensation oversight responsibilities. Such committees can play a crucial role in ensuring the clear alignment of executives’ performance incentives and rewards with ESG&D performance, alongside their financial, commercial and operational performance. They can also provide oversight of ESG&D integration into the company’s human capital strategies more broadly.
4.6.2 Ensure Board Composition Is Fit for the Complex Operating Environment
Board composition or membership is as important as board organization. In today’s complex, multi-stakeholder, multicultural and multinational operating environment, there is growing recognition of the need for greater board diversity—diversity not only in terms of gender and race, although both are essential, but also diversity in background, experiences, skills, nationality and age.
The foundations of a strong board are well understood. Every board needs experienced directors who have extensive governance, executive and operating experience, both in the industry in question and in other industries that may offer different, but valuable, insights and lessons. In the wake of various financial scandals and crises, it is clearly essential for every board to have enough directors with financial, accounting and auditing skills.
At the same time, a growing imperative in many boards is to have directors with the technical and/or risk management skills and experiences needed to understand the massive technological disruptions and digital, data stewardship and other technology-related risks that companies are facing. Bringing one or two technically skilled younger directors on board can help in this area, as well as providing insights from a younger generation of leaders. Companies operating globally benefit from directors who live in and/or have worked in some of their most important countries or regions of operation, or a director who has extensive geopolitical and diplomatic experience in relevant areas of operation. And, increasingly, there is a focus on appointing directors who bring operational or academic skills and experiences related directly to understanding the company’s evolving ESG risks and opportunities.
There is the obvious need to balance the expanding range of necessary experiences, skills sets and mindsets with ensuring that the board is not too large for effective discussions and decision-making. As such, director recruitment and succession planning need to focus on finding directors who, on an individual basis, can meet a diverse matrix of skills requirements and backgrounds. Certainly, more and more former CEOs and other senior executives are well versed in managing ESG&D-related risks and opportunities, and this should be one of the skills or experience sets to look for in all director recruitment.
In addition, structured and staggered succession planning, alongside term or age limits, can help to ensure that a board balances the need for “institutional memory” with fresh perspectives and generational change in a rapidly evolving and often disruptive operating environment.
One of the topics gaining momentum in light of the growing focus on employees and the “S” in ESG&D, more broadly, is the question of employee representation on corporate boards. Countries with unitary board structures are looking at the experiences of the European two-tier board system, where employees and increasingly other stakeholders are represented on the supervisory tier of the board and engage strategically with the executives who serve on the management board. The question of employee and broader stakeholder representation on boards, including ongoing challenges for board seats from shareholder activists, will continue to grow in volume and significance. At a minimum, as outlined in the next section, boards should be developing more systematic processes for engaging with key internal and external stakeholders.
4.6.3 Enhance Board Engagement with Stakeholders
In addition to ongoing rigorous review of board organization and composition, boards need to understand and discuss the evolving boundaries of their engagement with stakeholders, both internally and externally. The growing focus by large institutional investors on stewardship and engagement and increasing calls for stakeholder capitalism suggest that boards need to, at a minimum, have a clear understanding of their company’s key stakeholders. Such an understanding needs to be at a much more granular and nuanced level than the broad categories of shareholders, employees, customers, suppliers and communities. At the same time, both shareholders and other stakeholders are demanding more engagement directly with boards. In almost all cases, executive management should take the lead on both internal and external stakeholder engagement, bringing non-executive and independent directors in when there is a specific need or request to do so.
Board Engagement with Internal Stakeholders
In many companies, non-executive directors are exposed only to the CEO, CFO and her or his executive leadership team. Such engagement is obviously crucial and at the heart of good corporate governance—aiming to achieve a healthy balance of rigorous oversight, questioning and challenging of management with mutual respect and a shared focus on the best long-term interests of the company. There are opportunities, however, for boards to expand their engagement to other managers and employees in the company, ranging from key business unit or site level managers to managers who have functional responsibility for the company’s most material and salient ESG&D issues to employee affinity groups and high-potential next generation leaders.
Having the full senior executive team attend all board meetings is an approach some leading companies are taking to ensure more holistic and robust oversight and discussions between the board and all the senior executives who are responsible for delivering on the company’s purpose and strategy and managing enterprise risks. From an ESG&D perspective, having the executive who is responsible for these issues attending all board meetings, not only doing an occasional presentation on ESG&D topics, is another way to help integrate these issues in the boardroom. Some companies are also establishing a senior-level ESG or sustainability committee, composed of senior executives in key operational and functional roles, that reports to the CEO and the board as part of the company’s governance process.
In addition to regular engagement between the board and the full senior executive team, other approaches that companies are taking to ensure their boards have a better understanding of the company’s risks, opportunities and culture include organizing regular site visits to operations and research facilities and inviting directors to participate in either large townhall meetings or smaller group discussions with employees. These approaches can give boards exposure to business unit or country and operational site managers, front-line supervisors, researchers, high-potential young managers, and the leaders of business resource, affinity or diversity groups.
Board and Executive Engagement with External Stakeholders
In addition to the CEO, CFO and other executives, the number of independent board chairs and committee chairs who meet with shareholders or other external stakeholders is growing.
Some companies are also establishing external ethics, technology, sustainability or country-focused advisory councils that provide regular input to senior management and engage with relevant board directors or board committees on some of the company’s most material ESG&D issues. These councils are explored in more detail in Chap. 5.
A growing area of oversight for boards is their company’s engagement in lobbying and political funding as well as membership of trade and industry associations. In the case of lobbying, for example, there are growing calls from investors as well as other stakeholders for companies to disclose not only political contributions (in countries such as the US where these are allowed), but also the company’s public policy positions and lobbying spending on important social and environmental issues. A 2019 report by the High Meadows Institute concluded, “[T]rade associations are influential, and their actions can either support or hinder adoption of ESG policies and practices by their members. As ESG integration becomes a mainstream investment practice, it will be increasingly important for investors to think critically about the trade association memberships of the companies in which they invest.”52
Taking a Holistic and Integrated Approach to Corporate Governance
In summary, a number of changes are underway to integrate oversight of ESG&D risks and opportunities and stakeholder expectations at the board level through changes in board organization, composition and culture, and stakeholder engagement mechanisms. In companies with good corporate governance, this remains a dynamic and ongoing process aimed at ensuring that board directors are well informed and equipped to meet their fiduciary duties and duty of care to the companies they serve.
As should be apparent, there is no one-size-fits-all approach. It is important for every board to consider the most effective way to develop a more integrated and holistic stakeholder-oriented approach. In addition, boards should be considering governance not only in terms of their own role, although this is obviously critical, but also how the board provides oversight of and support to other ESG&D governance structures—such as external advisory councils and panels and internal executive-level committees that have strategic oversight for ESG&D-related issues, as well as the company’s participation in trade and industry associations, lobbying and policy advocacy, and voluntary multi-stakeholder initiatives created to set industry-wide rules and standards beyond regulatory requirements. Examples of how some leading companies are addressing governance and stakeholder engagement in a more integrated and holistic manner are explored in Chaps. 5, 6 and 7.
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