In light of accelerating concerns about climate change and sustainability, economic inequality, worker safety and racial inequity, companies have faced increasing calls to answer to a variety of stakeholders—stakeholders other than shareholders. These concerns are often collected under the heading of environmental, social and governance issues, sometimes adding in “employees” as a separate “E” category. How should companies that aim to be good corporate citizens identify relevant components of EESG?  How does EESG align with existing Caremark compliance efforts? How should we think about incorporating EESG oversight into the board’s organizational structure?  Is this another job for the already burdened audit committee? This article, Caremark and ESG, Perfect Together: A Practical Approach to Implementing an Integrated, Efficient, and Effective Caremark and EESG Strategy, co-authored by former Delaware Chief Justice Leo Strine, observes that “boards and management teams are struggling to situate EESG within their existing reporting and committee framework and figure out how to meet the demand for greater accountability to society while not falling short in other areas.” Strine and his co-authors offer a framework for doing just that.

Caremark and EESG. The authors begin by drawing a line from Caremark duties to “implement and monitor compliance programs to ensure that the company honors its legal obligations”—which the authors suggest is actually rooted in the “much older requirement that corporations conduct only lawful business by lawful means”—to the newer concept of EESG (the acronym preferred by Strine). According to the authors, if a company decides to “respect” all of its key stakeholders—“do more than the legal minimum toward its employees, its consumers, the environment, and society as a whole”—by implementing robust EESG policies and holding itself accountable to those objectives, “it will simultaneously satisfy legitimate demands for strong EESG programs and promote compliance with law.” That is, “as a matter of practical business strategy, if a company strives to be an above-average corporate citizen, then it will also be much more likely to simultaneously meet its minimum legal and regulatory duties. In this way, EESG and ordinary compliance should be seen as interconnected and be accomplished in an integrated one-step process.”

Shareholder primacy and stakeholder capitalism. The authors next discuss the tension between “shareholder primacy”—aka Milton Friedman’s “shareholder preeminence theory” that took hold in the late 1970s, which maintained that “corporations should, within the limits allowed by law and ethics, focus on the best interests of their stockholders”—and the more traditional view that preceded it—a type of stakeholder capitalism that “saw the firm as a social institution that should not just seek profit for stockholders, but also treat society and other corporate stakeholders like workers with respect.”  In recent years, the authors point out, several chinks have appeared in the armor of shareholder primacy: the “need for a series of high-profile corporate bailouts, wage stagnation, rising inequality and economic insecurity,” putting “pressure on the shareholder primacy concept.” Perhaps in  response to these societal concerns, “many business leaders, institutional investors, and policymakers have again gravitated toward the view that corporations should serve the interests of all their stakeholders, not just those who own the company’s stock….” The prime example cited here is the Business Roundtable’s 2019 “statement of purpose,” which recognized the significance of stakeholder interests.  These societal problems were exacerbated by the impact of COVID-19, particularly with regard to concerns about employee welfare, which, although they may have been sparked by the pandemic, at another level, may well reflect broader concerns that have been marinating for a while—about the essential value of previously overlooked elements of the workforce, about physical risk allocation, about economic inequity and, to some extent, even about social justice.

What is the legal basis for acting to benefit stakeholders? The authors observe that the debate over shareholder primacy often overlooks “the first principle of corporate law: corporations may only conduct lawful business by lawful means.”  The authors contend that, “[p]recisely because of this statutory mandate, corporate fiduciaries are imbued with substantial discretion to manage their corporations in an ‘other regarding’ manner. Like a human citizen, corporations can consciously choose to avoid ambiguous grey areas of conduct that risk violating the law. Like a human citizen, a corporation can decide that its reputation for aboveboard conduct, for acting in a manner that does not skirt the law and that shows respect for society, is valuable, and based on that business judgment, a corporation can also embrace a culture that gives primacy to ethical practices, even when such practices might not generate the most profit.” [emphasis added]  In support, the authors cite eBay Domestic Holdings, Inc. v. Newmark, 16 A.3d 1, 33 (Del. Ch. 2010) (“When director decisions are reviewed under the business judgment rule, this Court will not question rational judgments about how promoting non-stockholder interests—be it through making a charitable contribution, paying employees higher salaries and benefits, or more general norms like promoting a particular corporate culture—ultimately promote stockholder value.”)

EESG aligns with legal compliance efforts. The requirement to conduct only lawful business underscores the authors’ “central point”—that “a corporation’s plan to fulfill its legal compliance obligations should not be viewed as separate and distinct from the corporation’s plan to operate in a sustainable, ethical manner with fair regard for all the corporation’s stakeholders. Rather, when viewed through the correct prism, there should not be two plans for these related objectives, because the objectives are not in fact meaningfully distinct; there should be just one integrated scheme.”  For example, the authors point to the environmental prong of EESG.  In that context, they contend that regulatory “[c]orporate compliance programs that effectively addressed these environmental risks have thus better-positioned their companies to confront emerging demands to meet the ‘environmental’ prong of EESG for action going beyond the legal minimum.”  Similarly, with regard to employees as stakeholders, the authors maintain that “the responsibility to provide employees with safe working conditions, an environment that is tolerant toward diverse beliefs and backgrounds, and fair wages and benefits overlaps with important compliance duties.” Conduct with regard to employees “has also been a focus of Caremark cases and actions by regulators.”

Framework for analyzing EESG. The authors suggest that the “most important foundational question corporate directors and managers need to be able to answer to be an effective fiduciary is this one: ‘How does the company make money?’” As a starting point, the question compels directors to examine closely what the company does and ultimately leads directors to consider where the company’s activity “rubs up” against its stakeholders (as Strine phrased it at SRI).  The question plays out into a useful framework for identifying key elements of EESG most germane to each company:   

“For a manufacturing company, this means understanding the company’s products and how they’re made. Doing so necessarily requires one to think about who will use the product and for what purposes, and the corresponding benefits and risks of doing so. Answering that question requires directors to think about the corporation’s production processes and who they affect and in what manner. This includes the safety of their workers and the environmental impact of the business.

“The same is also true when asking how the product gets sold. What are the marketing practices that the company uses? Does the corporation gather more consumer information than necessary to make the sale? Is the company reselling that information to others? Is the corporation telling its consumers that it does so? Is the company protecting customers’ data?

“Permeating the question of how the corporation makes money, of course, will be the issue of what human beings are involved in the production and sales process. Do they have safe working conditions? Does the company pay them fairly and give them quality benefits? Is the company keeping workers at a ‘full-time part-time’ hour level to avoid giving them benefits? Is the corporation using contracted labor? Does the company require its contractors to extend to their employees the same standards the company requires for treatment of the company’s own employees? To what extent does the company attribute its success to its workforce as a whole as opposed to just top management? And is the company matching that thinking to the company’s compensation system?”

The result of this analysis, according to the authors, “is an understanding that the legal regimes likely to be most salient for the company are identical to the EESG issues that have the most salience,” positioning directors “to best shape an effective compliance system. Happily, it is also how best to shape an effective EESG plan.”

The authors advocate that companies and their boards build on the analysis above, applying their business judgment, to identify the most material sources of business and their impact. (Notably, however, the authors insist that the “less material a source of cash is, the more intolerant the company should be of conduct that is legally, ethically, or socially problematic.”) For material business lines, the company and its board should “carefully address the relevant regulatory regimes that constrain the company’s conduct, consider the reasons why that is so, and identify the stakeholders whose interests the law seeks to protect. Relatedly, managers and boards should undertake the same inquiry in addressing reputable EESG criteria and their application.”  The authors then advise companies to integrate the results of these related inquiries, maintaining that the “concerns addressed by law and EESG standards will tend to track.” For example, the law may already require the company to track and aggregate some information, and information gathered for compliance with a voluntary EESG standard may be “a safeguard for legal compliance.”

Organizing effective board structures.  The authors believe that many companies do not have organizational compliance structures that are “well thought out,” with the result that these companies may fail to “identify and address key areas where the company could negatively affect stakeholders and society—and run afoul of the law.” First, companies will need to determine the expertise necessary “to implement the company’s compliance and EESG plan, the allocation of responsibility among the company’s management team, and, correspondingly, the organization of the board to oversee management’s implementation of the adopted plan.”  It is well-recognized that employees with diverse sets of skills are typically necessary for companies to thrive, but “the same kind of sensible deployment of expertise has not characterized how American corporations have addressed risk management, compliance, and EESG.” 

In most cases, the audit committee is the board committee responsible for oversight of compliance and risk management. But that is problematic in many cases, the authors say, both because of the increase in complexity and time required to address the committee’s core responsibilities in accounting and financial compliance and because risk and compliance issues often arise in areas requiring special non-financial expertise, such as  “environmental, food safety, data security, drug efficacy, plant and production safety measures, privacy protections, etc.”  Companies may want to consider appointing directors with substantial industry and educational expertise in these other topics as applicable.

The authors contend that it would be “much more effective and efficient to make sure that committee-level responsibility for risk management and compliance is thoughtfully allocated among the board’s committees, rather than solely vested in the audit committee. With such a thoughtful allocation should come an alignment of officer-to-board-level reporting relationships, which has the added value of ensuring that the directors get to know and regularly communicate with a broader range of corporate executives” and receive “management-to-director communication on a regular basis on all the material, industry-relevant areas of risk and compliance. And it does so in a way that allows the managers and directors best equipped to identify and deal with risks in the first instances the best chance to do so.”

The authors advocate that allocation of responsibility among committees should track “the skills needed to do the task well and mirror the way the task is allocated at the management level,” based on board expertise and functional purpose. Most companies, the authors suggest, will need to create “at least one committee that has risk management, compliance, and EESG functions addressing some critical non-financial areas of concern, such as environment for an energy company or product safety for a pharmaceutical or food company. This allocation could also come with responsibility for attendant areas of concern, such as a concern for cybersecurity and consumer privacy for companies that collect sensitive information from their customers.” 

To avoid a proliferation of committees, the authors also suggest revisiting the functions of some of the mandated committees, such as the compensation committee, whose responsibility should be enlarged beyond executive comp to also include workforce issues, such as worker safety, discrimination and fair pay and benefits. What’s more, “[c]ross-fertilization by a set of strong committees well populated with relevant expertise and with the time to do the job well sets up the whole board to function much better than loading too much on to the audit committee (the traditional approach) or setting up a bifurcated process whereby audit does compliance and risk management, and the nominating and corporate governance committee is given some vague mandate to oversee EESG.” 

“With careful thought,” the authors conclude, “corporate leaders can position their companies to better identify and address known and emerging risks; adopt goals for responsible corporate behavior toward workers, other stakeholders, and society; and establish standards and policies designed to promote and measure the attainment of both EESG goals and legal compliance.”

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