There is always a warning—but the call is not always heeded.
When it comes to companies, especially in the United States, taking environmental, social, and governance (ESG) issues seriously, that sentiment couldn’t be more apt. The world has irrevocably changed, and US companies that fully embrace and engage on ESG will remain players in the global market. If US companies don’t get on board with ESG, their equities could be worth less than anyplace else in the world.
Take cybersecurity as an example: It was a threat. Companies knew this and discussed it. It wasn’t until data breaches hit like a magnitude 10 earthquake that companies grasped the severity of the threat and the change required, and took action. Initially, many companies created a board seat for a cybersecurity expert, with the onus landing on that person to know all and see all. But when it came to implementation, cybersecurity became an investment issue that necessitated broader board education and different committees taking responsibility for different pieces of cyber-risk oversight.
ESG is at this crossroads now. Stakeholders’ calls for action are louder and more urgent in their demands for change, increased disclosure, and greater transparency. Boards can no longer continue to only discuss ESG or rely on a solely performative approach.
Embedding ESG starts with the three standing committees on a board. Each committee brings its own concerns and governance charter to incorporating ESG into its processes, and when ESG is effectively integrated, this will lead to the next-level mind-set that is required of boards today.
The Nominating and Governance Committee: ESG and People
The nominating and governance committee, simply put, is focused on people. So, ESG from a nominating and governance perspective needs to focus on questions that employees are raising, such as on the return-to-office policy and on conducting employee surveys that provide answers that make sense in the face of the Great Resignation—a component of the “Great Corporate Renegotiation”.
Questions for the nominating and governance committee include, for example:
What investment are we making in our employee culture—beyond affinity groups?How does working remotely support the company in achieving Scope 1 and 2 carbon emission goals? How is that being tracked, analyzed, and disclosed publicly?Have strategies for recruiting and retaining talent shifted to include historically Black colleges and universities and public universities and colleges?How does our company value and promote women and people of color?What is our board composition strategy? How does it align with Nasdaq listing requirements when it comes to board diversity, for example?
A shift in the mind-set of directors on this committee needs to resonate throughout the board, including through asking integrative questions and showing broad support for setting diversity targets during financial and supply-chain discussions.
In today’s landscape, investors see high resignation rates as a risk indicator, triggering deeper analysis of the risk of volatility in growth and performance projections. Considering the questions posed here, as well as others, will strengthen the board’s oversight of the social and environmental components of ESG.
The Compensation Committee: Put Your Money Where Your ESG Is
The compensation committee has its own role in this equation. It is responsible not only for determining who gets paid and how much but also for achieving any targets that have been set. After the last two years—of the pandemic, as well as the racial reckoning following the murders of George Floyd and Ahmaud Arbery and the $12 million wrongful death settlement for Breonna Taylor’s killing—diversity, equity, and inclusion (DE&I) are not “nice to have.” They are “must haves.”
No longer can companies get away with simply presenting as though they have good governance around equity and race, gender, and sexual orientation. They need to show what they are doing to hit targets and grow a diverse, stable workforce from the front lines to their executive leadership teams.
The compensation committee needs to wed compensation to DE&I targets. When hiring a compensation company to advise it, the committee must check and see if that company has experience bringing DE&I into short- and long-term compensation and then ask, “Whom are they benchmarking our company to?”
If a company is paying an executive for achieving DE&I targets, they should be benchmarking against where the company is going (e.g., Best Buy) versus what they have been doing (e.g., Blockbuster).
The Audit Committee: From Bottleneck to Breakthrough
Finally, the audit committee is responsible for looking at the history of intangible assets, such as a company’s reputation, and determining how to budget the management of those risks in accordance with ESG concerns. Is ESG embedded in internal capital allocation models? Was ESG explicitly included in the company’s last financial materiality assessment? How is the company tracking and reporting this data?
Companies need to invest in creating and tracking their own data, and they need to do so in a way that withstands financial valuation analysis at critical times including during merger and acquisition transactions or when they seek financing externally from banks and investors.
In today’s competitive environment, when a board needs to assess the value of an acquisition target, it’s now a prerequisite to view the assessment through the ESG lens. It begins with the board identifying where the target company aligns with the acquiring firm’s corporate strategy and then identifying alignment in how the acquisition target has integrated and embedded ESG in investments and capital allocation decision processes. Target acquisition companies that are not aligned from an ESG viewpoint will face a discounted value.
Essentially, the audit committee can be a bridge from what was done yesterday to what needs to be done today to consistently moving forward in order to embed resiliency through good governance.
Pay Heed or Pay the Price
The world has changed forever since March 2020. Were there warnings from a financial, social, racial inequity, and public health perspective? Yes, and most went unheeded until the pause button was hit, and we were left to ask: Who are we as a nation? As a people? As a corporation?
The world is demanding answers to pressing questions, and pressure is coming from all sides. Corporations that respond at pace and scale with the global landscape will be invested in by the people within, by the community without, and in the financial capital marketplace. Those that don’t, won’t. Embedding ESG meaningfully and effectively is an advantage that bolsters organizational agility even in times of crisis and will help companies successfully renegotiate their role in society and the economy.
Joyce Cacho is an experienced independent director and honoree of Savoy magazine’s 2021 Most Influential Black Corporate Directors list.
NACD: Tools and resources to help guide you in unpredictable times.
Become a member today.