For years, the manufacturer tried to do right by the environment. The firm disclosed the potential environmental risks of its products, and its efforts to reduce them over time. It used solar power at its factories. It even planted trees in its community. Outside ratings agencies held the firm and its board of directors out as leaders in environmental stewardship.
And then, one day, a faulty machine at the company’s factory caught fire, and the fire devastated an entire town. It was an environmental risk that neither the firm’s management nor its board of directors ever thought about. Unable to cover the damages from the fire, the company declared bankruptcy.
Modeling out environmental risks—or opportunities, for that matter—isn’t typically on the minds of most directors when they join their respective boards. But over the past year, directors have found that identifying environmental, social, and governance (or ESG) challenges has become an increasingly important agenda item. “Boards have been so focused on financials that they have to become more cognizant of these other risks, even if they are from non-revenue-generating parts of the business,” says Tierney Remick, a vice chairman of Korn Ferry’s Board & CEO Services practice.
But directors tell Korn Ferry that they find themselves are uncertain about what questions to ask, let alone what type of guidance the board should provide. “The whole concept of ESG is new, and boards are definitely still trying to figure it out,” says Joe Griesedieck, who also is a vice chairman of Korn Ferry’s Board & CEO Services practice.
The pressure to consider ESG issues comes primarily from the public, who are increasingly aware of potential problems with climate change, and institutional investors, who want to have a better grasp of whether firms have a grasp on potential issues. In its 2018 report on investor stewardship, asset giant Vanguard stated that there’s a growing consensus in the investment community that certain ESG matters can significantly affect a company’s long-term value. But Vanguard, which manages $1.6 trillion worldwide, admits that there are multiple ways firms can approach ESG, particularly when it comes to disclosure.
Whether standards will come anytime soon is up for debate. In October 2018, a group of pension funds managing a combined $5 trillion in assets petitioned the Securities and Exchange Commission to require public companies to uniformly disclose ESG information. But in March, the director of the SEC’s division of corporate finance, William Hinman, told an audience that he preferred that the market, not the government, lead the way on disclosures and other ESG-related topics.
Absent the standards, Remick recommends that directors can, at a minimum, figure out who all the company’s stakeholders are and find out what they really care about.
The other step boards can take is to incorporate ESG issues into its ordinary review of the business.
Directors who routinely question management about financial issues and strategy should also add queries about environmental and sustainability challenges. Once they get those answers, directors can advise management about how to integrate ESG-related risks into various aspects of the organization, such as strategic planning, stakeholder communications, budgets, and even incentive structures for employees.
“Investors now want to know how you run your biz but also about how non-revenue issues are being managed,” Greisedieck says. “Boards should include some time on the agenda with management on ESG, ask about how we are doing, and at least ask whether we should do more.”