ESG and the Board’s Governance Role

Global research indicates that companies in North America are less committed to environmental, social, and governance (ESG) engagement than those in Europe and Asia-Pacific. For boards seeking to improve their ESG engagement, what steps should they take? Below are 10 steps boards should explore. 

Engage stakeholders. Boards should consider employee, customer, supplier, investor, and other stakeholder interests in the context of maintaining financial vibrancy, sustaining the organization’s strategy and business model, and delivering long-term shareholder value. Interactions with key stakeholders are opportunities to learn about their respective interests and concerns and build relationships based on trust. A company’s commitment to all of its stakeholders and its commitment to its shareholders are not to be viewed as mutually exclusive; rather, both are integral to the purpose of generating sustainable long-term shareholder value.

Set the context for the ESG agenda with organizational purpose. Directors should develop a shared view with executive management regarding the organization’s purpose, including the promises for which its brand stands. Purpose focuses on why the organization exists and how it benefits the markets it serves. It frames the narrative to the public. 

Integrate ESG considerations with strategy and capital allocation. Boards are stewards of capital, and ESG initiatives are under increased financial pressure as CEOs and investors focus more sharply on risk and reward. Ultimately, directors must view ESG considerations the same way they view everything else that involves the allocation of capital and the future (e.g., understand the strategic opportunity and purpose, inquire as to the risks, and measure and monitor return on capital). 

Assess board ESG capabilities. The board chair and committee chairs should periodically evaluate the board’s expertise with respect to environmental and social matters and the organization’s changing needs to set a context for planning board succession and onboarding new members. Board refreshment is about maintaining currency with respect to knowledge, experience, and perspectives in the boardroom.  

Evaluate the board’s ESG oversight process. ESG-related opportunities and risks, supported by data and metrics, should be included within the scope of the board’s overall oversight process. To that end, it may make sense for directors to review the board committee structure (including the need for a separate ESG- or sustainability-focused committee) to ensure coverage of ESG priorities while also retaining a whole board view of the full picture with respect to ESG strategy and reporting. Based on the review’s results, committee charters should be revised accordingly. 

Set board reporting protocols. To set the foundation for ESG oversight, the board should establish the content and frequency of the ESG reports it is to receive from the company. The board should receive periodic briefings regarding management’s assessment of material ESG issues and the company’s current ESG market ratings and rankings as well as their implications. Directors also need to work with management to define the board’s involvement in significant decisions regarding environmental and social matters, including company positions on sensitive social and political issues.  

Integrate ESG matters into risk management. As Martin Lipton, a noted author, pointed out, ESG “is… a collection of… disparate risks that corporations face, from climate change to human capital to diversity to relations among the board, management, shareholders, and other stakeholders.” The board should ascertain that these risks are added to the scope of the enterprise risk management process, with incorporation into enterprise risk assessments, integration of risk with strategy-setting and performance management, and—if critical to the enterprise—periodic reporting to the board.  

Pay attention to ESG external reporting. High-quality and transparent ESG reporting to the public is a board priority. It is recommended that directors do the following: 

• Establish an understanding and reach agreement with management on the nature and extent of the board’s review of draft ESG sustainability reports prior to issuance. 

• Engage management regarding the effectiveness of the company’s disclosure controls and procedures, including the role and composition of its disclosure committee as well as the interactions of that committee with management’s ESG committee structure, if any. 

• Inquire as to whether the company’s ESG storyline is resonating in the market and impacting the company’s valuation. 

• Understand management’s preparations for new regulatory requirements (e.g., the US Securities and Exchange Commission’s forthcoming climate change disclosure enhancements in the United States) affecting the nature, extent, and timing of ESG disclosures. 

• Request periodic comparisons of the organization’s ESG reporting relative to its peers to ascertain whether there are potential deficiencies to be corrected. 

Finally, some companies are disclosing the board’s oversight role with respect to ESG matters. 

Focus on sponsorship and accountability related to compensation. The board should agree on the senior executive designated with responsibility for ESG and understand how the organization is driving a collaborative focus on the ESG priorities essential to the organization’s long-term success. Desirably, ESG performance measures are integrated with financial and operational performance monitoring to avoid becoming an appendage that would likely receive curt treatment in the C-suite. Performance expectations and the related metrics linked to incentive compensation plans are the means to ingraining accountability for results and commitment to progress within the culture. It also makes sense for the board to set agenda time for the dedicated ESG sponsor to discuss the company’s progress toward ESG targets in the context of the company’s overall strategy. 

Consider help from outsiders. Board governance sets the tone for effective corporate stewardship of environmental and social issues. To that end, the board may want to consider the need for engaging outside experts, as well as the importance of educating directors, on selected ESG topics. 

These 10 steps are not intended to suggest a fixation on ESG in the C-suite or boardroom, as there are certainly other fundamental issues that must be managed. Rather, the point is that leaders have a fiduciary responsibility to address the opportunities and risks posed by ESG matters as they ensure the long-term viability and well-being of their companies. Accordingly, they should focus on appropriate sustainability objectives while keeping an eye toward delivering expected financial results. In this context, board governance sets a constructive, balanced tone for effective corporate stewardship over environmental and social issues. 

Jim DeLoach is managing director of Protiviti. DeLoach is the author of several books and a frequent contributor to NACD BoardTalk.