Boards Face Pressure to Act on Climate Change

This is an abbreviated version of the July/August 2021 Directorship magazine cover story, exclusively for NACD members. If you are an officer or director of a public, private, or nonprofit organization, you can become an NACD member to view the complete article and related resources.

Following an earthquake, aftershocks can continue for weeks, months, or even years.

Similarly, boards and companies across sectors are still processing what happened at Exxon Mobil Corp.’s annual shareholder meeting on May 26. Engine No. 1, an investment firm that reportedly owns 0.02 percent of ExxonMobil, reshaped the company’s board by ousting three directors. The firm put forward a slate of four candidates and three were elected: Gregory J. Goff, former CEO of petroleum refining and marketing company Andeavor; Kaisa Hietala, former executive vice president at Neste, also a petroleum refining and marketing company; and Alexander Karsner, senior strategist at X (formerly Google X).

Engine No. 1 describes itself as “purpose-built to create long-term value by driving positive impact through active ownership.” Its challenge to Exxon’s board to think about its position in the transition to a carbon-free energy future was backed by powerful investors in the oil and gas giant: BlackRock, the world’s largest asset manager, and the country’s two largest public pension funds—the California Public Employees’ Retirement System and the California State Teachers’ Retirement System (CalSTRS). The Exxon vote is a cautionary tale for boards across industries that shareholders are clamoring for companies to address climate change.

“Our economy is littered with companies that couldn’t adapt to change, whether that be technology shifts or, in this case, climate change,” said Aeisha C. Mastagni, portfolio manager at CalSTRS. “You only have to look at some of those companies that couldn’t adapt and couldn’t be resilient in the face of change to demonstrate how there’s an urgency here.”

The Harvard Law School Forum on Corporate Governance found that while activist investor campaigns in general have had mixed success since 2017, the number of campaigns increased sharply for the most part in 2020. These campaigns are on pace to continue after a drop-off during a year dominated by COVID-19.

Activists are also zeroing in on boards, according to separate research from Insightia, which tracks data on shareholder activism. In the first quarter of this year alone, 41 percent of activist campaigns have focused on boards, which is only slightly lower than the figure for all of 2019.

A Dutch climate activist group offered three separate resolutions in May calling on Chevron Corp., ConocoPhillips, and Phillips 66 to reduce their emissions. All received strong support from shareholders: 61 percent, 58 percent, and 80 percent, respectively. Activist investors like Engine No. 1 teaming up with more established shareholders is another sign of change.

Mastagni believes the Exxon vote reflects a new dynamic between investors and boards, and a new way that companies will be scrutinized on their climate change efforts. “I do think that the vote represents how investors are going to continually hold corporate boards accountable for underperformance or a lack of strategy to compete as we transition to a low-carbon economy,” she said.

BlackRock raised a similar point in its vote bulletin on last year’s Exxon annual meeting: “the risks of climate change and the transition to a lower carbon economy present material regulatory, reputation, and legal risks to companies that may significantly impair [Exxon’s] financial position and ability to remain competitive going forward.” In its bulletin this year, BlackRock noted progress made by the company on climate commitments and disclosures, but said more needed to be done on both long-term strategy and short-term actions.

“We’ve all been focused on the significant risks associated with sustainability issues, but there are also significant opportunities—financial and investment opportunities—for companies that are first movers in terms of investing in innovation,” said Michelle Edkins, managing director of BlackRock’s investment stewardship team.

CGI Appeals to SEC for Mandatory Climate Disclosure

Based on the premise that “successful corporate action on climate change depends on a productive collaboration between business and policy makers,” the global Climate Governance Initiative (CGI), launched in collaboration with the World Economic Forum, issued a comment letter to the US Securities and Exchange Commission (SEC) in response to its March 15 request for feedback on the agency’s climate disclosure project. Input from the member chapters of the CGI, which includes NACD as its US representative, was reflected in the recommendations submitted by the CGI in a letter signed by its chair, Karina A. Litvack.

The CGI’s specific recommendations to the SEC, as detailed in its letter, include the following.

Reinforce the view that climate change will have significant implications for all companies and their boards, requiring them to revisit their corporate strategies to respond to it, and to integrate all relevant impacts within the financial statements and disclosures.
Set minimum disclosure requirements that apply to all companies, allow for comparability, and cover the entire value chain, as well as define some specific disclosure requirements that will be necessary for certain industries.
Frame its guidance as a mandatory standard that requires compliance but allows for the presentation of alternative performance measures (accompanied by reconciliations to those prescribed by the standard) and supported by fulsome explanations.

To read the full story and learn more about how to oversee climate change from the boardroom, keep an eye out for the upcoming July/August 2021 issue of Directorship magazine and check out NACD’s recently released Director FAQ on Climate Governance.

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Five Areas of Focus to Be Ready for Your Next Deal

Deal-making is back. After a recovery period following the initial shocks of the pandemic, mergers and acquisitions (M&A) activity has rebounded to reach historic levels. A company’s directors can play a critical role in determining whether this uptick in activity will be accretive for those companies that pursue M&A as a growth strategy.

The current environment in mind, here are five areas that boards should focus on when providing strategic oversight and guidance for their companies’ next deals.

M&A Readiness: Be Involved Before a Deal Is on the Table

Be proactive about understanding management’s readiness and preparedness to execute. Determine the following in advance:

What types of deals will the board be involved in? What types of deals (if any) will it not?
Does the company have the leadership, skills, capabilities, capacity, processes, scale, and advisors to successfully execute the deal?
Does the organization have leaders with M&A (or specific deal type) expertise?
What processes and tools does the business have for pipeline management, due diligence, and integration?
What have the board and company learned from prior deals?

Diligence Oversight: Emphasize the Qualitative, Moderate the Pace

Validate the quantitative, and drill deep on the qualitative. Be sure to:

Probe externalities such as market factors, culture, brand, and perception.
Ensure there is a strong focus on broad and deep diligence.  
Incorporate new considerations for areas such as people; culture dynamics; environmental, social, and governance issues; and cybersecurity.
Help moderate the pace, and don’t let the deal gain unsubstantiated momentum.

Also ask: How difficult will it be to achieve the operational objectives that will drive synergies? Where will changes drive the most opposition from stakeholders, and what is the company’s plan to address this opposition? If deal models and integration plans are predicated on unrealistic operational changes, the value won’t materialize. Good operational due diligence is just as—if not more—important than good financial due diligence, and it materially impacts speed to value. Make sure the company has objective inputs with the right industry and integration experience to evaluate and validate model and integration feasibility.

Integration: Stay in the Game for All Four Quarters

Set expectations on the metrics you will monitor over the course of the full integration, and be mindful of the time frame. Retention is a great example of an area in which the organization’s measurement needs to extend beyond key personnel. Similarly, the time horizon for measuring retention should be years, not months, after close. Slow and quiet value leakage from poor retention is extremely expensive.

Be ready to pivot when the company finds things that were not uncovered during due diligence. The best plans are encapsulated in an agile decision-making framework. Establish the rapport and processes with management that allow the company to adjust, resolve, and reposition if new information prompts different priorities.

Portfolio Optimization: Evaluate the Full Portfolio

Look beyond the next deal to scrutinize how management evaluates its deal-making over time. Most corporations don’t actively manage their portfolios like their private-equity counterparts do, at least not until there is a problem.

The issue with this approach is twofold: First, it assumes all deals are done well and for life. The reality is that tomorrow will likely not look like today, and deals that delivered on their objectives yesterday might not serve the organization’s future vision or needs. Second, waiting until there is a problem compromises the organization’s ability to optimize the value of any deal. No one pays top dollar for a “do-or-die” deal. M&A capital allocation needs to be a proactive, deliberate process.

Ask the management team to describe its enterprise portfolio optimization process, which could also include having a third party complete regular, objective reviews. The process should consider substantive differences in performance across portfolio companies, divisions, or business units; capital funding requirements; valuations; and alignment to the company’s current strategy and future direction. Outputs should include an executable road map that identifies performance improvement opportunities, considerations for restructuring or divestitures, and recommendations for targeted organic or inorganic growth.

Divestiture: Be Prepared Sell-Side

Following a consistent enterprise portfolio review process will no doubt yield strong candidates for divestiture. Although transparency to buyers has not been the norm historically, the limitations of the pandemic (e.g., a lack of in-person management meetings and site visits) have revealed some of the potential advantages of increased transparency. Buyer visibility into synergy opportunities, road maps, examples of quick wins, and clear separation and integration plans increase speed and value and also reduce risk, friction, and transaction costs—creating win-win outcomes. Transparency can also help the company pressure-test the decision to divest, as it may reveal entanglements and new assumptions about markets.

As one of our clients says, “High-consequence decisions are always improved by high-quality debate.” The board has an important role to play in scrutinizing a company’s M&A activity for strategic alignment, readiness, and progress against expected outcomes, in both the short and long term. Furthermore, ensuring management has processes in place for ongoing enterprise portfolio optimization is equally critical. Focusing on the right areas with management and deal teams can determine how much value an organization’s next deal can realize.

Colin Harvey is a managing director with Alvarez & Marsal’s Corporate Performance Improvement (CPI) practice in Austin and the national solution leader for CPI’s Corporate M&A Services.

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What Directors Should Know About Wage-Fixing and No-Poach Agreements

On July 9, President Joseph R. Biden Jr. issued an executive order to promote competition and antitrust enforcement in certain key sectors, with a focus on the labor market. The order includes a call to action to ban noncompete agreements and other clauses that may unfairly limit worker mobility, and it looks to strengthen guidance on collaboration to prevent the suppression of wages and benefits among employers. In addition, the US Department of Justice (DOJ) Antitrust Division, Federal Trade Commission (FTC), US Department of the Treasury, and US Department of Labor will be reviewing and reporting on the impact of competition in the labor market.

Corporate directors should expect to see further regulation as a result of this order, in particular as the agencies begin to implement the initiatives. That means it’s vital for directors to understand the context surrounding the order, the current rules, and what their organizations should be doing now.

Where did this all start, and why is it important?

In 2016, the DOJ and FTC published guidance outlining the types of agreements and information-sharing that could raise antitrust concerns with respect to the labor market. It states the widely accepted principle that employers’ agreements to not poach each other’s employees or to fix salaries or benefits may be unlawful. What is particularly noteworthy, however, is that the guidance states that so-called “naked” agreements—no-poach agreements among competitors that are not ancillary to a separate legal transaction or collaboration—are per se illegal.

Historically, this conduct was pursued as a civil violation. The 2016 guidance brought forth a major policy shift by introducing the possibility of criminal charges for these labor market violations. This triggered an onslaught of scrutiny in the market, and we have since observed an increase in investigations and enforcement of this conduct.

Almost five years after the guidance was issued, the DOJ began following through on its promise of potential prosecution. The agency has brought several wage-fixing cases in the health-care space: In December, the DOJ brought its first criminal wage-fixing case, and only a month later, a federal grand jury returned a two-count indictment against the company owner for alleged anticompetitive no-poach agreements. In a superseding indictment, another executive at the same company was charged in April with wage-fixing and obstruction. In March, a separate health-care staffing company and local area manager were indicted for allegedly colluding to suppress wages and not poach each other’s nurses at one school district in Las Vegas.

We are starting to see the agencies enforce these “naked” no-poach or wage-fixing agreements in the same way they enforce agreements for price-fixing or market allocation. We expect to see more indictments of both individuals and businesses for these alleged anticompetitive agreements and increased regulation surrounding this market. The agencies have indicated that they will continue investigating this conduct in the same way the DOJ traditionally investigates and prosecutes cartels.

First, directors should know what’s not allowed. Federal agencies have deemed the following practices to be per se illegal:

Wage-fixing agreements between organizations on how much to pay their employees and what types of benefits to provide, and those that impose salary maximums or a cap or that withhold pay raises or bonuses;
No-poach agreements that restrict the movement of employees between competitor employers, which can prevent mobility and career development; and
Exchanging sensitive information related to employees, such as their salaries, benefits, bonuses, and health care options. Such employee information should be treated the same way as any other competitively sensitive data within a company and should not be shared with competing employers.

“Naked” no-poach or wage-fixing agreements are agreements that are neither vertical in nature nor ancillary to certain legitimate agreements, as noted in the 2016 guidance’s exceptions. Ancillary restraints—agreements that are reasonably necessary to a legitimate business collaboration—are not per se illegal. A no-poach agreement may be allowed when contained within a reasonable business transaction, such as if the provision or agreement is reasonably necessary for a joint venture or a merger and acquisition.

If a business needs an agreement in this area, there should be a broader pro-competitive goal. The no-poach or wage-fixing aspect should not be the reason behind the agreement, and the application should be tailored. Businesses should avoid agreements with a broad scope and they should tailor agreements to a smaller group of high-level employees. Agreements that apply to entry-level attorneys, for example, are unlikely to be found to be necessary to accomplish a transaction.

Companies can also limit the duration of the relevant provision, such as only during a joint venture or merger. A business may be better able to justify these provisions during a contract with a fixed term rather than one that has a lengthy or indefinite period. The key is to narrow the scope: the less restrictive the provision, the less chance of scrutiny from the authorities. 

Directors should monitor competitive trends and activity in the market. Certain skills being in high demand but short supply, or a particular competitor going on a hiring spree, could create risky conditions that lead to illicit discussions or agreements. Companies should consider what their legitimate options may be to ensure they have adequate and appropriate protections in place.

Top Three Actions: Tailor, Train, Test

We recommend that boards work with management to take the following actions to avoid running afoul of antitrust laws:

Tailor. Review your employment agreements for risk, and tailor these agreements to adhere to the proper scope. Confirm that any existing or future non-solicitation clauses are within permitted boundaries.

Train. Educate your staff on the personal and company risks of illegal no-poach and wage-fixing arrangements. Develop clear policies to keep your personnel educated and informed.

Test. Health-check your human resources team. You should be aware of which industry group meetings and conferences they attend, which email and messaging listservs they’re on, whether they communicate with counterparts at rival employers, and whether they understand competition law limits. Encourage them to come forward with concerns, and spot-check emails or messages to identify risks. Consider legal privilege throughout this process.

Ashley Eickhof is a senior associate in Baker & McKenzie’s North America Antitrust & Competition practice group, and Jeffrey Martino is a partner in the firm’s Litigation and Government Enforcement practice group.

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Elevating Corporate Purpose, ESG, and Stakeholder Issues: Insights from Lead Directors

The forces reshaping the business landscape—the COVID-19 pandemic; accelerating megatrends; a Biden administration policy agenda focused on climate, racial justice, and other social issues; and calls for companies to address the concerns of stakeholders—are prompting introspection in the boardroom.

In our ongoing work as part of the KPMG Board Leadership Center Lead Director Initiative, the lead directors and independent chairs we interviewed (under Chatham House Rule) collectively highlighted key areas of focus for lead directors to help their boards raise their game and add value to their businesses.

It is clear from our discussions that the shift toward purpose; environmental, social, and governance (ESG) issues; and stakeholders is real—and these issues are now priorities for most companies, as well as their stakeholders. While for many companies, addressing ESG and stakeholder issues as strategic issues has been a formidable challenge, COVID-19 and the events of the past year have brought to light the importance of these issues, particularly the “S” concerns, and have helped companies identify the ESG issues that are most critical to creating long-term value. What is the role of the board in helping to ensure that these issues are priorities for the company—and that the company is “walking the walk”?

These are the key messages we heard:

Help focus the ESG conversation. While management should drive the ESG conversation, lead directors emphasized that if that isn’t happening, board leaders must help foster the discussion by asking direct questions about where their companies are on their ESG journeys.

“As lead director, it’s my job to help keep the boardroom conversation focused on the ESG issues that matter most to the business and understand how management is addressing them,” one director said.

Keep stakeholders front and center. As one lead director noted, the board can play an essential role in listening for instances in which management “may be tone-deaf or may be prioritizing shareholders and not giving other stakeholders proper consideration.” Another said, “Boards today need to be more aware of the context in which the decisions are made, particularly on issues such as ESG and [diversity, equity, and inclusion], and understand the importance of these issues to key stakeholders.”

Help ensure ESG is driven by strategy and linked to incentives. The lead directors we spoke to agreed that tying ESG performance to executive compensation signals the importance that the board places on defining ESG and how it fits into strategy. While companies often have meaningful initiatives at the operating level, said one leader, “finding a way to embed these initiatives in compensation incentives is a helpful signaling device and rewards those activities.”

Have a disclosure framework and a disciplined process. Finding the right ESG disclosure framework for the company is key: “It has to be the story that you want to tell about how you are stewarding E, S, and G,” one director said.

Once you have a framework, have a process for engaging the full board and its committees to determine what is material to the company. For instance, one nominating and governance committee chair said she views her role as that of the “ringleader,” coordinating those discussions and ensuring that they happen—and not solely at the nominating and governance committee level.

“Your ESG story should be about what is material to the company, and that varies greatly across industries and company size,” she said. “Figuring out what is material is part of the larger discussion of strategy and risk, so that disclosure flows from what is informing your business plans as a company.”

Since companies can have legal liability even for ESG statements not required in US Securities and Exchange Commission (SEC) filings, board leaders said it’s important to have an internal process for validating company-presented data that is as rigorous as the disclosure controls and procedures in place for information included in SEC filings.

Understand that ESG-related proxy activity is intensifying. ESG has been front and center in shareholder proposals this proxy season, consistent with the trend over the last five years. This season is also seeing “Say on Climate” proposals (asking for shareholder votes on how companies are addressing climate risk) and proposals seeking to tie compensation to ESG metrics.

Institutional investors have set specific expectations for ESG disclosure on, for example, board and C-suite diversity, diversity-related data, sustainability, and climate-related risk. Management teams and directors should be prepared to respond to those perspectives.

Set expectations for the CEO speaking out on social or political issues. A number of lead directors we spoke to (but not all) felt that CEOs should be speaking out on issues that reflect a company’s values. In those cases, one lead director said, “the board should be kept informed. It doesn’t have to be a formal conversation every time, but I think it would behoove the CEO to have some conversations with at least a set of directors, if not the full board.”

And, as another lead director noted, “Remember that saying nothing is saying something.”

Patrick A. Lee is a senior advisor with the KPMG Board Leadership Center.

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Getting the People Side Right: Five Questions to Ask to Protect Your M&A Deal

We are in a period of intense business model transformation. Many enterprises are looking to reflect new consumer and competitor realities—and they need to act fast. Mergers and acquisitions (M&A), and other transactions, offer one strategic path to rapid change, so it’s unsurprising that our research shows that 57 percent of business leaders anticipate an increase in deal activity in 2021 and 2022.

Deals, however, are not without their challenges. About half will not be completed, with an even higher number failing to deliver the promised value. There are many reasons for this, but Mercer research released in May reveals a striking fact: 47 percent of deals that fail do so primarily due to a lack of strategic planning and execution rigor related to people risks. The report, Delivering the Deal: The Unrealized Potential of People in Deal Value Creation, was based on data sourced from PitchBook or collected through a survey that captured the insights of over 750 experienced deal leaders from Fortune 1000 companies or private equity professionals.

People as a Revenue Driver, Not Just a Cost Center

The pandemic hammered home how crucial an agile and resilient workforce is to the bottom line, yet many businesses fail to translate the importance of people to deals. Why the disconnect?

Traditionally, when envisioning a deal’s cost and revenue synergies, most leaders think of people only on the cost side—forgetting that it’s people who will ultimately bring any new revenue-driving strategy to life.

For example, if your deal thesis depends on cross-selling the products of two merged companies to increase revenue, you must ensure you have salespeople with the right skill sets, incentives, and understanding of how they need to act differently to deliver your vision. Without this, nothing will change, and your plans for generating new revenue will suffer.

Based on our experience supporting nearly 1,400 deals per year worldwide, we have seen the effects of this people disconnect. For example:

We stepped in to develop a culture, communication, and change-integration plan and talent retention strategy for a multibillion-dollar deal threatened by employee turnover caused by misaligned leadership and diversity approaches.
We executed a rapid change management and culture alignment effort in three weeks across 40 countries when the stock value of an acquiring organization was under pressure due to the failure to produce promised synergy targets.
We developed a new workforce geographic strategy when one company’s deal team did not realize until formal due diligence that the deal hypothesis for a $500 million acquisition did not accurately reflect local works council and dismissal-charge issues.

These examples demonstrate the impact people have on delivering revenue-related deal value and the need to apply the same rigor to people as to other deal aspects. As one business leader told us in our research, “In a deal, people cannot be left to chance. Failure to address pain points in your people strategy can have catastrophic consequences.”

Here are five questions that boards should ask management during any M&A activity to avoid deal failure:

Are the people opportunities and impacts defined in the deal hypothesis? When examining the benefits of a potential merger, a business leader who thinks of people only as costs is unlikely to anticipate how people might impact theorized revenue synergies. It is critical to move beyond headcount reductions and strategically anticipate how people will need to change their behaviors and what skills are required to deliver this new organization. Too frequently, it is assumed that people will “figure out” what they need to do post-close. But to extract value from the deal, you need to develop an initial people hypothesis and rigorously test and refine that hypothesis into a pragmatic execution plan.

With what degree of rigor are the people-related impacts represented in the financial modeling? Nearly half of executives told us in our study that workforce impacts were not quantified or built into financial models. This is a significant omission because, in most instances, what is not modeled will not be proactively acted on. Fully understanding and anticipating what is needed from the workforce must be built into your financial model if you’re to deliver as promised to stakeholders.

How are we assessing people impact during quality of earnings (Q of E) diligence? A seller’s goal is to maximize the company’s financial attractiveness. Frequently, decisions are made to improve the short term without concern for the longer-term consequences. Workforce adequacy and human resources (HR) operations are two areas prone to this thinking. If a seller cuts back on HR delivery, it may destabilize the workforce. The short-term impact on earnings will be positive (lowered labor and function support costs), but the post-close impact will be lasting and negative. A rigorous look at people even during Q of E diligence will create a foundation for deal success.

How does talent factor into target identification? A good understanding of what talent a potential acquisition brings is just as important as understanding the product portfolio or customer base. Yet, this is often neglected. Creating a process to capture some level of understanding of talent assets when evaluating targets is critical, as this becomes a key input to the initial deal thesis. It is also important for this evaluation to not only be a static assessment of today but also consider the future skills needed to deliver value.

Do we have a people advisor who can provide on-the-ground execution support? After examining the issues above, you then need a strategic partner focused on all things people. This means an advisor who not only offers strategic advice but also has the on-the-ground resources to execute your vision. By selecting a partner who specializes in talent and applies the same rigor of thought and execution to your deal’s people aspects as you do, you can ensure the people-related elements align to deliver the desired deal value.

Robustly factoring in the people impact, from target identification to deal thesis formation to financial modeling and Q of E diligence, and working with an experienced partner on deal execution can protect the bottom line and realize maximum value from your most important asset—your people.

Jeff Black is partner and global and North America mergers and acquisitions advisory services leader at Mercer.

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