Boards’ Priorities and Investment Plans for ESG Risk Evolve with the Market

by Amy Rojik

The risk landscape has expanded rapidly in recent years. Alongside ongoing economic volatility and rising interest rates, evolving ESG risks have prompted boards to reassess their priorities and investment plans.

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We surveyed more than 200 directors in the Spring 2023 BDO Board Pulse Survey and identified three notable trends in ESG risk: 

  1. While ESG risk remains high on boardroom agendas, there are mixed perspectives on the materiality of environmental threats.
  2. Going into proxy season, directors saw human capital management (HCM) as a top shareholder issue that impacts financial performance and capital markets.
  3. As the scope and cost of cyber threats rise sharply, boards are maintaining or increasing their investment in cybersecurity governance more than any other significant risk area. 

Directors perceive climate challenges as one risk among a broad risk landscape 

Despite a pattern of extreme weather events and commitments to reduce emissions, fewer boards are prioritizing climate-related risks than in recent years. The latest board survey data shows a recent shift in focus from climate risk toward other ESG risk areas such as HCM, amid an ongoing talent shortage and broader inflationary pressures. This shift suggests that some of the social and governance aspects of ESG may be more easily identifiable and measurable compared to environmental aspects.  

Our survey found that only 23% of directors say investment in reducing their companies’ carbon footprint to satisfy net-zero commitments will provide the most long-term value, while 27% of directors expected that shareholders would focus on environmental issues this proxy season. However, almost nine out of 10 directors say they plan to either maintain (68%) or increase (22%) investment in ESG this year, so there’s little backslide in terms of budget despite the shift in focus.  

And that approach seems to align with shareholder priorities. In an early look at the 2023 proxy season meeting results through May 31st, Georgeson found that for the Russell 3000, ESG proposal activity increased with approximately 324 proposals going to a vote (including 10% of those relating to anti-ESG proposals), with an allocation of 14% to “E” (6.3% passing), 38% to “S” (2.4% passing), and 48% to “G” (11.8% passing). Furthermore, the research platform AlphaSense found that while mentions of ESG during earnings calls declined during Q2, historical proxy statement disclosures that address ESG-related matters have continued to increase into 2023. 

Also, many companies have already taken steps to devote resources to ESG, especially for assessing climate-related risk and preparing for impending ESG-related disclosure requirements. Data from BDO’s 2022 Fall Board Pulse Survey shows that many companies had already made headway in selecting appropriate ESG frameworks and standards for ESG reporting (49%) and establishing ESG goals and objectives (45%).  

Boards should still consider the materiality of ESG impacts to their business and ensure ESG disclosures are compliant with current regulations. Pending regulatory changes related to climate risk domestically and globally require close monitoring. Boards and management teams who take a proactive approach to embedding ESG into their longer-term strategy can establish a competitive advantage and better prepare for opportunities and final regulatory requirements.  

As one example, the SEC’s proposed Scope 1, 2, and 3 emissions disclosures and attestation requirements, if required in the final regulation, will demand significant resources to meet regulatory compliance and reporting in the future. Specifically, companies may struggle to develop climate risk estimates and forecasts or assess the materiality of climate-related risk over the near, mid-, and long term. However, by adopting practices and policies to reduce emissions or employ carbon offsets, companies can also take advantage of a range of tax credits and incentives. 

Amid talent and skills shortages, compensation and human capital management remain a significant risk  

Our survey found that 92% of directors say talent shortages pose some or a significant risk to their businesses, and 14% consider talent acquisition and retention the single greatest business risk for the next year. Many companies seek to leverage efficiencies and automation this year to help mitigate recruitment and retention concerns, with 39% planning to increase investment in workplace technology and digital transformation. 

Companies also face ongoing shareholder and regulatory scrutiny of board composition. Two-thirds of directors anticipate shareholders will focus on board diversity this proxy season. We interpret this broadly as a focus both on diversity, equity, and inclusion (DEI) aspects as well as specific skills sets and experience needs within the board (e.g., cybersecurity, technology, AI, industry, etc.). Additionally, the SEC’s universal proxy card ruling gives shareholders more input on director nominations and re-elections. Nomination and governance committees should seize this opportunity to closely review companies’ HCM policies and board refreshment practices to help strengthen governance practices.  

Per the SEC’s rulemaking agenda, the agency could also introduce new requirements related to employee well-being and hiring and development practices. Additionally, there have already been recent SEC regulations on pay versus performance disclosures and compensation recovery provisions (“clawbacks”) that put greater focus on accountability for executive compensation. As tying specific ESG key performance indicators (KPIs) to executive compensation becomes a more common practice in many organizations, compensation committees are also focusing on ESG risk metrics and ESG-linked incentives as part of evolving compensation policies.  

Cybersecurity is a chief concern 

As businesses invest in technology and expand their digital footprint, the opportunities for threat actors grow. Cyber threats continue to grow in number and sophistication — a trend that accelerated during the pandemic — so it’s not surprising that 79% of directors say a data breach poses at least some or a significant risk to their business. Boards are addressing cyber risk head on with 99% of directors expecting to maintain or increase investment in cybersecurity this year. 

Regulators are also paying close attention to cybersecurity practices and disclosures. The SEC has taken several cyber-related enforcement actions in the past 18 months after significantly expanding the Division of Enforcement’s Crypto Assets and Cyber Unit. In March 2022, the SEC proposed rules for cyber risk management, strategy, governance, and incident disclosure. Those proposed rules are in the final stage on the agency’s rulemaking agenda, in addition to other proposed cyber-related rules. 

As boards closely monitor shifts in cyber risk and regulatory requirements, they should assess the current level of knowledge and potential additional expertise needed to expand initiatives in risk mitigation and remediation while holding upper management accountable for safeguarding of cyber assets.  

Evolving ESG risk landscape requires customized strategies 

Directors differ in how they weigh the many risks to their businesses, industries, and markets. They have adopted varying risk management strategies for the year ahead. While ESG remains a primary focus, we see a greater emphasis on the “S” and “G” factors for the year ahead.  

That’s why boards almost unanimously plan to maintain or increase investment in cybersecurity, and they’re responding to HCM considerations with plans to address talent shortages, recruitment and retention, board composition, and DEI. At the same time, directors are closely monitoring material climate-related risks and related regulatory developments. We urge directors to ensure they take a wide lens and look not only at what the SEC may be doing, but also at how regulations in other jurisdictions may impact U.S.-based organizations that have foreign operations or form components of global supply chains.  

Regardless of where boards and their organizations may be in the maturity of their approach to ESG, we strongly encourage a proactive approach that requires staying current on new developments, assessing materiality of risk, and identifying opportunities, as well as ensuring that current reporting is based on thoughtful, relevant assumptions and estimates to help achieve compliance with developing regulations and standard-setting.