US Corporate Boards Suffer from Inadequate Expertise in Financially Material ESG Matters

MK: This is a somehow controversial piece, but feel free to enjoy my comments.

  • US Directors: 38% don’t believe ESG issues have a financial impact on the company [MK: I don’t know the real question but won’t be surprised to see that some factors are prioritized over others thus distorting the answer]. 56% of Directors complain that their investors put too much emphasis on ESG. Again, it’s unclear whether the directors complain about the focus on less important ESG factors or they’re simply lazy.

  • It shouldn’t come as a surprise that 60% of Directors believe the E (environmental / sustainability) expertise is important for the Board. E is more prominently published in annual company and special reports (ex: X5 Retail Group).

  • Reporting on S (social) through reporting and Board oversight gradually becomes the norm. This includes diversity, pay gaps and other social factors.

  • Here come the scary numbers: taking a sample of 475 Fortune 2000 companies, only 17% Board members have demonstrable sustainability (E) credentials and just 13% have robust oversight of ESG issues [MK: this I can actually believe]. And only 10% regularly review sustainability issues at Board meetings as part of the agenda. [MK: since the E-S-G balance differs between firms, and for some non-manufacturing/retailing firms E is not the key letter in ESG, the 17% figure looks artificial.]

  • A possible reason why the S (social) and E (environmental) factors can be given insufficient attention is that Boards deal with them via busy committees (compensation and governance/nomination respectively) with lots of other responsibilities. The only time E really matters is when the non-compliance risks are material and eat up in the profits of the firm. Lawsuits in themselves are part of life and are not newsworthy unless they can lead to fines.

  • MK: let me stop here and reflect a little bit. I’ll do more of it later in my special cynical writeup on ESG, but let’s be clear about the following:

o   E is the most known letter of the three thanks to Chernobyl, Greta and global climate change. At the same time, Boards are concerned about non-compliance because it may turn very expensive. It makes sense to be slightly proactive and do analysis as part of the risk management framework. There’s this slightly uncomfortable shareholder pressure requiring firms to spend a little bit of money into supporting a market-pleasing sustainability narrative.

o   It’s very easy to pretend about doing something about S and G for a long time unless a black swan (consumer tastes change, past company narratives become toxic, customer database gets stolen, etc.) emerges.

o   For financial firms an indirect exposure to their clients’ ESG practices may mean default on the loans or incorrect calculations of insurance premiums, leading to losses. One can greenwash this all they want, but the cynical fact of life is that these are simply not-so-new risks and have to be factored in properly.

  • MK: The article makes a point about the proper representation of all three ESG letters on the Board level. It’s important to mention the following:

o   One’s representation is considered “proper” if she has served in the required professional capacity for a certain period of time in another firm. I.e. a doctor (MD) serving on the Board of a medical organization is “proper”, a person with interest in the topic (say, having read ten books or even having taken some courses, but not working in the field) is not.

o   It’s sad, but most Directors don’t have even the basic Director education on the principles of corporate governance (offered by Director Associations, INSEAD or even short courses). Thus, the key trouble with the G portion is that some Directors are not fully aware of the requirements towards them.

  • The article makes some very good points (which I’d independently verify, though) about the areas where the relevant ESG skills were underrepresented on the Board level:

o   Media (12%), Retailing (13%), Transportation (18%). The last one is of particular interest to me because transportation (and my beloved aviation) has quite a negative rap about emissions and the use of energy. Still, in many companies accounting seems to matter more than carbon emissions.

o   Unsurprisingly, in addition to the obvious E exposure, retailing has a large S exposure due to the massive labour force, turnover and productivity concerns.

o   A quite recent development also mentioned in the report is the second order (i.e. indirect) impact of ESG on financial decisions: insurance companies have to factor in the E risks of their clients in their own decisions. Same goes to lending (say, Macquarie Bank (AU) won’t fund their clients’ projects without complying with the ecological standards).

  • The article goes on to suggest that for the diversity (S) firms need to have an accountable third party for oversight, and that the lack of such party is a Board failure. One point of view that the lack of representation of minorities is the sign of racism, sexism or some other -ism, hence a more diverse Board would somehow cure the problem.

o   MK: touching this topic is like running on the minefield as there are many opinions held and voiced by many groups of people. I am a firm believer in the diversity of experiences and I’m very sad that the underrepresented minorities haven’t had a chance to grow their expertise and experience in the same ways that others had. As such, there appears to be a shortage of Board candidates from underprivileged backgrounds and solving this issue should start with the lack of discrimination on the lower levels to ensure career progression (and the acquisition of the necessary experience) for everyone.

o   At the same time, I am not convinced that the literal implementation of the diversity targets on the top will lead to the best Board compositions possible (which the Boards are actually judged against). Would love to read good non-politicized reports on this.

  • A very telling example of S are the COVID-related salary / benefits cuts for Board Members/C-Suite vs employees. Board salaries weren’t cut most of the time, C-level salaries sometimes were cut 30-50-100% with share-based compensation remaining intact. Many firms chose to keep paying dividends / doing share buybacks, i.e. the shareholders didn’t get hit as well (other than with the share price fluctuation).

  • Another good point of the article is that while many Board members are ex-CEOs (which for many, including myself, seems like a logical career progression), dragging the business practices from the past (which didn’t factor in ESG as much as they do now) into the current environment and having these ex-CEOs do the oversight doesn’t seem like a super-winning proposition.

  • The article also tries to push the agenda that ESG is part of the Board’s fiduciary duty, which it’s not, at least not to the extent suggested by the article. Such agendas, in my personal opinion, are harmful to the noble cause of promoting ESG, as the decisions made out of fear (being accused of breaching the fiduciary duty is not something any Director would willingly seek) are always poor decisions.