One topic that directors were asked about in the PwC 2020 Annual Corporate Directors Survey was ESG. Although 55% of directors surveyed considered ESG issues to be a part of the board’s enterprise risk management discussions, 49% saw a link between ESG issues and the company’s strategy and 51% recognized that ESG issues were important to shareholders, directors were “not convinced that they’re connected to the company’s bottom line. Only 38% of directors say ESG issues have a financial impact on the company’s performance—down from 49% in 2019.” And only 32% thought that the board needed more reporting on ESG-related measures. Notably, 51% thought that their boards had “a strong understanding of ESG issues impacting the company.” As you may discern from its title, this study from the NYU Stern Center for Sustainable Business, U.S. Corporate Boards Suffer From Inadequate Expertise in Financially Material ESG Matters, begs to differ.
The Stern Center analyzed the credentials of the 1188 Fortune 100 board directors, based on company bios and Bloomberg bios. The study “found that very few sectors and very few companies were adequately prepared at the board level for issues that were already affecting their performance.” While on an initial examination, the study found that 29% of those directors had relevant ESG credentials, on a deeper dive, the Center found that 21% of the directors’ experience was in the “social” category—clustered around health and diversity issues—but in each of “environment” and “governance,” only 6% of directors had relevant credentials. As it turned out, the absence of board expertise was often in an area of ESG that could be considered critical to that business; for example, the study cited a property and casualty insurance company that had “no environmental expertise on the board in a year experiencing $100 billion in damage caused by climate change-heightened extreme weather events.” According to the study, “without board members who have a strategic understanding of the issues, the board will not know the questions to ask or even understand that the potential risks might exist.”
The study first examined the level of directors’ expertise in each of the three ESG categories. In the “social” category, the study found that, with two exceptions, a negligible percentage of directors had credentials in areas of potentially material impact for companies, such as human rights, human resource development, benefits and safety. However, 5% of directors had “workplace diversity” credentials—such as involvement with boards or initiatives focused on women’s representation or increasing minority leadership—the highest percentage seen across all ESG topics. In the social category, the second largest percentage was board members with health care experience (3.5%), with most of these directors serving on health care company boards. Credentials here included generally board memberships with medical facilities or occupations as physicians, medical researchers and academics.
With regard to “governance,” the study found that “very few” directors had credentials in “ethics, transparency, corruption, and other material good governance issues,” and only eight had expertise in cybersecurity. Likewise, only 2.6% of the directors in the study had accounting oversight credentials and only 1.0% of directors had expertise with regulatory bodies such as the SEC or FCC.
What qualifies as a “relevant credential” may be somewhat subjective, and some may question the determinations made in the study. Examples of “credentials” included “[b]oard membership on large environmental organization boards which work with business, such as WRI,” and “youth education programs that brought students directly into the company through internships,” but did not include service on “youth education related boards…or small land trust/conservation related boards… when they had no bearing on the business of the company.” However, with regard to accounting oversight credentials, the bar was rather high: the study included only those with “exhibited leadership in this area, such as being a trustee of the International Financial Reporting Standards Board or a member of the Federal Accounting Standards Advisory Board.”
In the “environmental” category, the study found “very little director expertise.” Only 1.2% of directors had expertise in energy and land/conservation—the highest showings in this category—with backgrounds in renewables, nuclear power and utilities (energy) and service on conservation boards (land/conservation), as well as some public policy and/or regulatory experience. The study observes that, although energy is an important issue for most companies, generally only energy companies had directors with energy expertise. Notably, the study found that, in general, a number of industry sectors that faced material environmental challenges “did not reflect that materiality on their boards.”
The study also looked at various industry sectors, concluding that some industry sectors with material ESG issues had “very little relevant expertise on their boards.” The study found the industry sectors with the highest percentage of board members with relevant ESG credentials were the health care (55%), utilities (50%), consumer staples (46%) and telecommunication services (46%) sectors. Nevertheless, even in health care, where 53% had credentials in the “social” category, the study asserts that only five had health-related credentials. In addition, in that sector, “despite the significant environmental footprint (energy, water, waste) and governance issues (opioids, biotech, drug access) zero board members had environmental credentials and just 4% (two) had governance credentials.” The study found that the industry sectors with lowest percentage of directors with ESG relevant representation were consumer discretionary, media(12%) and retailing (13%), and industrials, transportation (18%). Although the transportation sector faces “significant environmental challenges,” the study found that only one board member had environmental credentials, and in the insurance sector, which has material environmental risk exposure, only 6% of directors had relevant environmental credentials. Similarly, in the media sector, which “has growing issues around data privacy and cyber security, among other material governance issues, only one person of 42 had governance credentials.”
The study also drilled down into recent major ESG-related challenges: COVID-19 and racial inequity, looking at a subset of 45 Fortune 100 companies to assess their responses during summer 2020. Of those companies, 41 issued a statement following the death of George Floyd and, while many made donations, the study contends that few were adequate in responding to stakeholder demands to change “how the business does its business.” While some companies “took actions to enhance diversity, equity and inclusion (DEI) efforts…, very few made their current performance and targets public and none publicly enlisted an accountable third party to provide oversight. This is a board failure. Without transparency on current demographics and targets, progress is likely to be minimal and corporate reputations will be at risk.” The study attributed the problem in part to a paucity of Black directors, resulting in an inability by boards to “personally understand the depth of the problem.”
With regard to COVID-19, the key issues related to the treatment of workers and the equitable sharing of sacrifice across the organization—how “companies treated workers on the one hand, e.g. layoffs, furloughs, sick leave policies, and bonuses for workers and how they treated their C-suite, board and shareholders on the other, e.g. compensation cuts for the C-suite and board members, reduction/suspension of dividends and/or share buybacks.” Although a couple of automakers were highlighted for shared sacrifice across the company, more generally, the study found that “compensation cuts for board members were nonexistent, cuts for the C-suite were rare and generally confined to salary (not options and bonuses), dividends continued, and share buybacks were reduced by some companies, but definitely not all.” On the other side of the equation, apparently “layoffs and furloughs were common, bonuses for frontline workers expired in early summer and sick leave policies related to COVID were limited or difficult to uncover.” The study noted that just locating the information was difficult and urged more transparency.
What to do? As reported in Bloomberg, the Center’s director recommended that boards “have to first understand and pinpoint ESG risks, prioritize them and then bring on the expertise.” Expertise does not necessarily mean climate change scientists or cyber security technicians, but rather board members who have a strategic understanding of the issues. Adding more diversity may help: according to PwC, women directors are more “likely to say that climate change and human rights should be part of business strategy.” Board refreshment may also help: the study makes the observation that “[m]ost boards have a preponderance of former CEOs sitting on their boards. Those CEOs were in charge 10-20 years ago when ESG issues were not regularly considered as material and they bring that mentality to the boardroom.”
Under pressure from institutional investors, environmental groups and climate activists, consumers and even employees, many companies have sought to demonstrate their bona fides when it comes to sustainability. In 2020, in his annual letter to CEOs, Laurence Fink, CEO of BlackRock, the world’s largest asset manager, announced a number of initiatives designed to put “sustainability at the center of [BlackRock’s] investment approach.” According to Fink, “[c]limate change has become a defining factor in companies’ long-term prospects.” What’s more, he made clear that companies needed to step up their games when it comes to sustainability disclosure. (See this PubCo post.) Similarly, State Street Global Advisors has announced that, in 2022, it plans to start voting against the boards of big companies that have underperformed relative to their peers on ESG standards, particularly financially material sustainability issues, and cannot explain how they plan to improve. SSGA believes that directors have a significant role to play in promoting action on ESG issues, but still exhibit some “ambivalence” about their roles in ESG oversight. During engagements, SSGA wants to “understand how boards are developing ESG-aware strategies, as well as how they are overseeing and incentivizing management to consider and measure performance of financially material ESG issues.” With this heightened focus on sustainability, how can boards best oversee ESG? To help demystify sustainability for directors, SSGA has developed a framework intended to provide a roadmap for boards—where to begin—in conducting oversight of sustainability as a strategic and operational issue. (See this PubCo post.) Likewise, consultant Protiviti offers ten questions about ESG reporting that boards should consider with their management teams. (See this Pubco post.)