It is clearer than ever before that sustainability practices can affect corporate value. That was the main thread of a panel that I led at the National Association of Corporate Directors’ 2016 Global Board Leaders’ Summit in Washington, D.C. My co-panelists Christianna Wood, director at H&R Block, and Seth Goldman, founder of Honest Tea, and I discussed the potential risks and opportunities that environmental and social issues pose to companies.
Sustainability is a broad term, and not every environmental or social issue belongs on the board agenda. But when an environmental or social issue has the potential to affect corporate revenue and earnings in the short and long term, sustainability absolutely should be on the table.
At the end of the day, it all comes down to materiality, and this is where corporate directors have a critical role to play.
Materiality is about determining a company’s priorities. As fiduciaries responsible for overseeing a company so that it not only survives but also thrives in the long term, directors have a responsibility to assess whether a company is making the right choices.
But the much harder question is: When does an environmental or social issue rise to the level of being material?
Here are some steps directors can take to drive discussions about whether sustainability issues are material to the companies that they oversee.
1.) Understand how sustainability is being integrated into your company’s efforts as a way to identify material issues.
There are a few ways to do this. Directors could point management towards the Sustainability Accounting Standards Board’s Company Implementation Guide, which provides a great starting point for companies to assess whether certain sustainability factors could be considered material for the purposes of the company’s financial filings. Directors could also integrate themselves more meaningfully into corporate efforts aimed at identifying material sustainability issues. They could provide perspectives on the connections between sustainability factors, corporate strategy, risk, and revenue.
2.) Include key issues being raised by critical stakeholders in the materiality exercise.
While a broader range of stakeholders is raising a variety of issues these days, the financial community is a particularly critical constituency to direct attention towards. As we discussed in our panel, the U.S. investor community is starting to make the connections between sustainability and the financial value of companies in their portfolios. During the 2016 proxy season, close to 400 shareholder resolutions on climate change and other sustainability issues were filed. Large investors including CalPERS, CalSTRS and State Street Global Advisors are asking their portfolio companies to put directors with climate expertise on their boards.
In addition to tracking broad sustainability trends that investors are paying attention to, prudent directors could consider opportunities to engage directly with key shareholders to get a sense of issues specific to the company and the industry. Directors could also track and engage with the broader activist and advocacy community as a risk management exercise.
3.) Weigh in on the time frame over which issues are considered to be material.
Since the board in particular is responsible for long-term corporate performance, directors play an important role in examining whether their company’s materiality process focuses on considering issues over the long or short term.
Overall, momentum is building to adopt a more long-term view to encourage companies and boards to think more broadly about sustainability and materiality. The recently released Commonsense Corporate Governance Principles, which are backed by major U.S. companies including JPMorgan Chase & Co., Berkshire Hathaway, and Blackrock, support the move to long-term thinking. And more companies including Unilever, Coca Cola, and National Grid are moving away from the practice of issuing quarterly guidance specifically to encourage investors and other stakeholders to adopt long-term thinking.
4.) Disclose details on what you consider to be your company’s material priorities.
Noting that determinations of materiality depend on whom the company considers to be its most significant stakeholders, governance experts are starting to call on corporate boards to release a statement noting critical audiences that the company is oriented towards and issues that the corporation is prioritizing. Companies like the Dutch insurance company Aegon have started to issue such statements.
The process of helping to identify the right issues is just a first step in a director’s responsibility on materiality. Directors have an important role to play in ensuring that material issues, when identified are integrated into board deliberations on strategy, risk, revenue and accountability systems. However, getting to the right issues lays an important foundation for the company and its key stakeholders to build on.
This week, NACD bridged the gap between corporate directors and the investors they represent. In conjunction with Broadridge Financial Solutions, NACD hosted a Virtual Roundtable at the Newseum in Washington, DC, bringing together leaders from the investment community with directors to discuss the disclosures and communication strategies.
Hosted by NACD President and CEO Ken Daly, the Roundtable featured investment community representatives from T. Rowe Price, CalSTRS, and Vanguard Group, Inc. They engaged in dialogue with board members from Forrester Research, Broadridge Financial Solutions, Kimberly-Clark, Legg Mason, SmartPros Ltd., and Assure Holding Corporation. With the intent to inform directors on what investors are looking for in the proxy in the upcoming year, the Roundtable discussion covered compensation, committee reports, and director qualification disclosures.
The investment managers represented at the Roundtable do not take a “check-the-box” approach based on guidance from proxy advisory firms; instead, they choose to complete their own analysis. Notably, these active shareholders emphasized quality over quantity with respect to disclosures in the proxy statement. Simply an increase in the amount of disclosures from companies only makes it more difficult for investors to uncover the valuable information in the proxy. The participating investors further suggested companies should make an effort to provide quality disclosures regarding how executive compensation matches performance, and how incentives are linked to the business strategy, for example.
The participating investors also stressed the improvements that need to be made regarding the new director qualification disclosures resulting from the SEC Proxy Disclosure Enhancement rules. They felt many companies did not fully explain how each director’s skill sets contributed to the company’s business strategy.
Lastly, the investors offered advice to the boardroom on director succession. After directors have analyzed their board’s composition in light of the company’s strategy, they find a larger challenge in recruiting directors to fill the gaps in skill sets. As a solution, Anne Sheehan of CalSTRS suggested that directors should “think of their shareholders as stakeholders.” Long-term investors have the same interests as directors and might be able to offer potential candidates whose skills complement the company’s business strategy and build its long-term value.
For background, CalSTRS is the second largest public pension fund with over $134B under management. CalSTRS is a long-term shareowner and is considered a passive investor. Their mission is to act as the steward for California state teachers’ retirement funds—ensuring that California’s K-14 professors and teachers (kindergarten through community college) have sufficient funds available when they retire. Approximately half of CalSTRS’ portfolio is invested in equities across roughly 7,000 companies. Typically CalSTRS’ investment is around 0.5 percent of outstanding stock per company.
Anne’s comments were extremely important for directors of publicly traded companies, as CalSTRS leverages corporate governance practices to add value and minimize risk to their portfolio. CalSTRS looks to directors to oversee delivery of long-term growth and value for shareholders. It does not have a political agenda; it’s all about long-term value creation.
Aside from shareholder value creation, the goals of Anne’s team are focused on creating a dialogue with companies and boards. Importantly, the majority of CalSTRS requests are resolved through dialogue.
During our meeting last week, Anne provided a brief summary of recent proxy access rules—SEC Rule 14a-11 and amended SEC Rule 14a-8(i)(8)—and what they mean for directors. While many organizations have provided detailed descriptions of these rules, Anne emphasized the following four key points:
Boards need to proactively engage in shareholder communications and dialogue. While boards need to be aware of shareholders concerns and desires, boards do not have to do as all shareholders request. Frequently shareholders perceptions are simply based on not knowing why.
The new proxy access rules level the playing field.
If a board and/or senior management disregards and/or avoids a shareholder’s request for information, proxy access is the tool of last resort.
Proxy access is seen by large investors as the “ultimate weapon” to influence a board.
Net: If your board is looking for an independent, third party to help conduct a confidential and customized in-boardroom program on strategy, the current environment, or succession planning; or for assistance conducting CEO and/or director succession planning, or exchange-mandated board evaluations, NACD’s Board Advisory Services faculty of 100 percent current directors and leading governance experts is ready to help your board advance exemplary board leadership. NACD’s Board Advisory Services (BAS) team is poised to help boards perform as strategic assets for their shareholders and senior management.