Board Oversight of ESG Issues

Sponsored by DFIN

CFO’s and other C-Suite executives are taking a proactive approach to ESG communication.

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ESG topics have been on a steady upswing in importance for some time, and so it should come as no surprise that ESG is now widely considered a critical business priority. More than ever, investors want information about a company’s ESG performance, employees want an awareness of and commitment to ESG to be woven into daily operations, and consumers and business partners are scrutinizing a company’s ESG behavior before making purchasing decisions.

All of this means that ESG concerns have landed on the agendas of boards across the country. For board directors, though, connecting the huge and growing list of ESG issues and priorities with operational objectives, business strategy, and assessments of organizational risk can pose a monumental challenge. One threshold challenge to enhancing board oversight of ESG issues is identifying the specific issues that a board should oversee. This is particularly dauntng because there are no one-size-fits-all answers. Most experts agree that shareholder engagement is a key element of identifying perceived risks and oversight challenges. Once a company has identified the ESG risks and opportunities relevant to its business, there are several concrete steps it can take to strengthen its board oversight of those issues.

While board oversight of ESG issues is moving into the mainstream, we are seeing more of an evolution than a revolution. DFIN’s annual update to its Guide to Effective Proxies, which devotes increasing coverage to ESG and human capital management in its 2020 edition, identified several areas in which companies are closing historic gaps and providing robust board oversight and disclosure.

  • Following are the area’s most frequently disclosed in the proxy statement: Updating board charters and governance documents, as necessary, to reflect oversight practices. Codifying the board’s role in overseeing ESG-related risks is an important step in ensuring that oversight activities do occur--and occur at regular intervals.
  • How ESG risks and opportunities factor into a company’s long-term vision, strategy, and objectives. Discussing ESG oversight is not enough. Directors should be clear that the ESG issues that the board oversees are integrated into a company’s long-term strategy. Directors should also confirm that, when possible and practicable, measurable ESG goals are established and disclosed, and progress in meeting those goals is tracked.
  • When and if ESG reporting, frameworks are used. It’s important to note that using ESG reporting frameworks is not solely a compliance exercise. Using these frameworks requires deep thinking about how ESG factors feed into strategy development to account for both risks and opportunities for executing on business goals.
  • How a company’s ESG priorities, risks, and opportunities impact business strategy. Companies should ensure that their boards are well equipped to oversee material ESG risks and opportunities. To the extent directors’ skills are aligned with those risks/opportunities, such skills should be disclosed in the proxy statement, possibly in a board skills matrix. 
  • Ways in which a company approaches ESG risk oversight. Ideally, ESG risk oversight disclosures would include the process that the board uses to review management’s enterprise risk management (ERM) assumptions, as well as a company’s materiality assessments and/or prioritization of the various risks faced by a company.
  • Disclosure of which board committees and functions engage in executing ESG initiatives and monitoring ESG risks and opportunities. Companies with outstanding disclosure practices include information on how often specific committees and functions discuss ESG issues. In addition, companies should have a mechanism in place to ensure that the board continues to be kept abreast of ever-changing risks. A strong risk oversight program is one that looks at whether the board is appropriately informed about the types and magnitude of risk within the company’s principal, “mission-critical” areas.
  • If and how ESG metrics are incorporated into compensation plans. Many investors appreciate when a board’s approach to measuring and rewarding performance is predetermined and transparent, using company-specific key performance indicators, or KPIs, that are aligned with the overall business strategy. Increasingly, companies are incorporating ESG metrics into their compensation plans.

Popular venues for companies and their boards to highlight evolving ESG disclosure practices include the proxy statement, sustainability reports, and corporate web sites.

A Glimpse into the Future

Publication of corporate ESG and sustainability reports is clearly on the rise. In 2020, DFIN found that nearly two-thirds (or 64 percent) of issuers responding to one of our surveys produced ESG reports, a significant increase over the 51 percent that reported publishing ESG reports in 2019.

In the final analysis, company executives and boards need to make sure that they understand and monitor ESG risks—even those that may appear to be only remote possibilities. Although they may be facing several new hurdles, boards that regularly update their charters, cultivate a mix of backgrounds and skills within their boardrooms, clearly articulate their ESG oversight activities, and actively monitor progress on ESG goals will be best positioned to handle whatever challenges lie ahead.

Click here for DFIN’s latest white paper “Board Oversight of ESG NOW.”

Click here for DFIN “Guide to Effective Proxies 2020 Edition” with ESG and HCM examples.