ARTICLE • 5 min

Board members must drive ESG action

“The business of business is no longer merely business. Our obligation is not just to increase profits for shareholders. We must also hold ourselves accountable to a broader set of stakeholders: to our customers, our employees, the environment and the communities in which we work and live”*

Stakeholders are demanding more transparent, comparable, and reliable non-financial information on companies’ environmental, social, and governance (ESG) risks and performance, raising the pressure to meet expectations on sustainability and long-term value.

Before awarding capital, ESG performance is being increasingly scrutinized by investors — EY estimates that 98% of investors now evaluate non-financial disclosures – creating a sense of ESG urgency.

To address this shift, direction needs to come from the top: boards of directors must lead the way in building a culture of good corporate citizenship while working out how to square this with the pressure to deliver short-term earnings.

Keen ESG oversight by boards is required to deliver total shareholder return and sustainable value creation. To keep boards accountable, leading institutional investors and proxy advisors are taking a firm stance with policies and voting practices that favour voting against board members, chairs, or committees who fail in this respect.

It is vital that board members reflect on whether they understand the types of disclosures that their investors seek, and respond with an established and compelling ESG narrative.

Boards who are not responsive to the market’s move towards increased transparency and disclosure may find themselves on the defensive, losing the opportunity to control the narrative. This can have a lasting effect in damaging a company’s carefully built brand and reputation.

All the while, board members must also consider the wide range of other stakeholders including employees, creditors, consumers, governments, the environment, as well as the long-term interests of the company.

Building a culture of good corporate citizenship and robust ESG credentials can’t be established too soon as the larger and more mature a business, the harder it is to change. And as ESG reporting becomes more important, those that fail to act will no doubt be left behind.

So how can board members drive ESG action within an organization?

In thinking about how to act on the ESG urgency and oversee ESG matters, boards need to consider whether they have the right composition to do so.

Oversight should ideally be performed by directors from diverse backgrounds, with the right skill sets. Many institutional investors and proxy advisory firms already expect boards to at least provide clear disclosure on the ESG skills reflected amongst their ranks. Furthermore, investors are increasingly demanding board diversity, including for gender, ethnicity, race, and age.

In cases where corporate directors and/or board members have insufficient expertise, experience, or background to grasp ESG factors relevant to their business, further education or retaining specialist advisors is suggested.

Boards should work to adopt a stakeholder materiality assessment with both internal and external stakeholders. This protocol determines which factors are the most relevant to their organization, and will assist directors in taking those ESG factors into account.

The materiality assessment should include a gap analysis to identify which ESG areas need particular attention. These should be weighed, and their impact on the organization and its stakeholders considered. Weighing the various ESG metrics and their expected impact will dictate a course of action, and this decision-making process ought to be disclosed as part of regular ESG reporting.

Once boards of directors have taken responsibility for overseeing ESG metrics, according to a materiality assessment and in line with a standardized ESG reporting framework, KPIs are to be identified and incorporated into compensation plans to incentivize desired behaviour.

Investors are pushing for ESG metrics to be acknowledged alongside traditional KPIs in executive compensation. So, linking ESG metrics to executive pay presents an opportunity to demonstrate an organization’s commitment to ESG priorities and action.

Boards often have good intentions of incorporating ESG practices into business models, but these must be compared to market expectations. The goal is to bridge the gap between stakeholder expectations and current ESG tracking and disclosure. Expectations can be found by examining the voting guidelines of those institutional investors and proxy advisory firms that have recognised the importance of ESG reporting.

A review of the latest proxy voting guidelines and principles of some of North America’s largest proxy advisory firms and institutional investors by law firm Norton Rose Fulbright highlighted the importance of adequate ESG adherence and reporting. Investors are explicitly urging companies to integrate information on their ESG performance into their annual reports and financial filings using recognized reporting standards.

Boards therefore should consider implementing a well-recognized and standardized ESG framework.

The World Economic Forum’s Stakeholder Capitalism Metrics is an industry-agnostic ESG Framework with 21 core - and 34 expanded - metrics to provide a universal standard for ESG reporting. Developed in conjunction with the big four professional services firms – Deloitte, EY, KPMG and PwC, this widely adopted framework creates a comprehensive system of corporate ESG disclosures on governance, planet, people, and prosperity.

Socialsuite helps companies report on their progress against this framework. Socialsuite’s ESG solution helps both private and publicly listed companies quickly commence corporate ESG reporting and demonstrate ongoing disclosure of their ESG progress.

*https://www.weforum.org/agenda/2021/01/klaus-schwab-on-what-is-stakeholder-capitalism-history-relevance/ - Klaus Schwab's, 'Stakeholder Capitalism’

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