United States: How Can Boards Of Directors Make Sense Of The Current ESG Landscape?

The question whether a public for-profit company can "do good" and make money at the same time has never been more relevant. Public companies are being bombarded with messages, requests and demands around "ESG" — environmental, social and governance — matters. These come from shareholders, asset managers, special interest groups, activist investors, private equity funds, ESG rating firms, trade groups, politicians, regulators, academics and others. They take a variety of forms, including shareholder proposals, surveys and questionnaires, letter writing campaigns, proxy voting policies, investor stewardship reports, speeches, white papers, academic studies, and legislation. Topics covered (putting aside the "G" — the governance issues with which boards are likely to be familiar) are numerous and varied, including sustainability, climate change, water management, human capital management, gender pay equity, board and workforce diversity, supply chain management, political and lobbying expenditures, the opioid crisis, and gun control. Boards of directors and management of public companies need to understand the increasing importance of this ESG landscape in which the company and investors are operating, including the growing prominence of ESG investing, the company's environmental and social (E&S) profile and vulnerabilities, and the path forward for the company as it deals with particular E&S issues.

This note briefly summarizes some of the key trends of the rapidly evolving E&S landscape of which directors and company management should be aware. In addition, it highlights a corporate law framework that has particular relevance for directors of companies incorporated in states such as Delaware that follow a shareholder primacy model — that shareholder welfare is the sole goal of directors, and that other interests may be taken into account only to further that goal.

ESG Investment. Recent reports place the level of ESG-focused investment at approximately $20 trillion of assets under management. New ESG funds and ETFs are being launched on a regular basis and with increasing frequency, and studies show that millennials have a greater interest in socially responsible investing. Within this umbrella, ESG investing can take various forms, for example making investments in companies viewed as positively addressing environmental or social issues, choosing to exclude companies in certain industry sectors viewed as problematic from an ESG perspective, or integrating ESG data into an assessment of risk-adjusted returns in order to make investment decisions.

The demand for ESG investment approaches has spurred a number of traditional investors, activist funds and private equity funds to enter this space. For example, in January 2018, ValueAct Capital launched its Spring Fund to invest in companies addressing environmental and societal problems and capture the excess returns it believes will be generated thereby. Another activist investor, Jana Partners, is reported to have hired staff for a new socially responsible fund to be named Jana Impact Capital. Also, recent reports indicate that private equity firm TPG is raising $3 billion for its second social impact fund, after previously raising a $2 billion fund focused on investments with positive social and environmental impacts.

ESG Ratings. An inevitable corollary of the increase in ESG-focused investment is the demand by those investors for ESG data and the corresponding and exponential growth in the number of entrants into the business of collecting, aggregating, synthesizing and ranking that data. The challenge is that each ESG ratings provider has its own methodology, and a company may receive widely divergent ratings from different organizations. Moreover, the ESG rating agencies may use different combinations of data sources other than company disclosures, including press reports, litigation filings, internet postings and other third-party sources, even though the company may not agree with the veracity or accuracy of those data sources.

It is possible that, over time, some ratings methodologies may prevail over others and the field will narrow to two or three dominant raters, as is the case in the governance space with ISS and Glass Lewis. And ISS and Glass Lewis are attempting to protect their turf by also including E&S ratings in their reports. In February 2018, ISS announced the launch of its E&S QualityScore, which seeks to analyze company disclosure across more than 380 factors organized into four environmental pillars and four social pillars. ISS includes those scores in its annual meeting voting recommendations report, and in May 2018 expanded its E&S coverage to 4,700 companies. Recently, Glass Lewis announced that guidance on material ESG topics from the Sustainability Accounting Standards Board would be integrated into its proxy research reports and vote management application.

ESG Activism. On January 6, 2018, activist Jana Partners and the California State Teachers' Retirement System (CalSTRS) published an open letter to Apple Inc. The letter expressed their view that Apple needed to offer parents more tools to protect children and to ensure that young customers use Apple products in an appropriate manner. Citing various studies regarding potential negative consequences of children's use of smart phones, the letter linked the issue to Apple's long-term value and called on Apple to take various steps to address the issue. Days later, Apple announced that it would introduce new features and tools to assist parents in combatting children's overuse of smart phones. It remains to be seen whether other traditional activist investors, seeking to attract ESG-focused capital, launch similar ESG-themed campaigns.

ESG activism can also take the form of industrywide or issue-specific campaigns. For example, a coalition of 30 treasurers, asset managers, and faith-based, public and labor funds formed Investors for Opioid Accountability and filed shareholder proposals on board oversight of business risks related to opioids at 10 companies involved in the manufacturing or distribution of opioids. Recently, another group of investors launched a resource to evaluate and act on water risks in investment portfolios, including tips on engaging with companies and on water-related shareholder proposals.

ESG Shareholder Proposals. According to ISS data, for 2017 and year-to-date 2018, proposals relating to E&S now make up a majority of all shareholder proposals submitted to US companies, at 53.4 percent and 54.4 percent, respectively. ISS reports that the median vote results year-to-date are at a record high of 23.4 percent, but it is noteworthy that median results for some topics are significantly higher — 41.4 percent for sustainability reporting and 36.4 percent for workforce diversity. In a turning point, in 2017, climate change proposals relating to two degree Celsius scenarios received majority support for the first time, at three different companies. Other 2017 majority-supported E&S proposals related to sustainability reporting and board diversity. This year appears to have set a new record, with 10 E&S proposals receiving majority support year-to-date: two on climate change, two on sustainability reporting, three on other environmental topics, one on governance measures related to managing the opioid crisis risk and two calling on gun manufacturers to produce reports on gun safety measures.

Perhaps in recognition of these increasing levels of support, 2018 has been noteworthy for the increased withdrawal rate, with almost half of all E&S proposals submitted being withdrawn. Based on various reports and anecdotal evidence, it is likely that a large portion of the withdrawals were the result of company engagement with proponents and reaching satisfactory agreement for the company to take some action or make some additional disclosure.

Company Actions. In the financial activist space, the advice that has crystallized over the past few years is to look at your company the way an activist and/or a long-term shareholder would; anticipate and analyze the potential criticisms and be ready to respond; engage with institutional investors to learn their views and establish the board's and management's credibility with them; and communicate the company's business strategy, and the board's role in overseeing the development and execution of that strategy, clearly and coherently, to build support before an activist shows up.

It turns out that there are many parallels in the ESG space and, as described above, the lines between financial activists and ESG activists may continue to blur. As a result, a company's ESG vulnerability and profile may need to be given appropriate attention alongside traditional valuation and operational metrics.

Shareholder Primacy as a Guidepost. ESG should not be perceived as divorced from traditional economic metrics. At least for companies incorporated in states such as Delaware, that are subject to a fiduciary model of shareholder primacy — where the ultimate priority is the preservation and enhancement of shareholder welfare — boards should consider whether there is a nexus (and, if so, how strong) between specific ESG issues and the pursuit of shareholder welfare. The starting point involves consideration of ESG in light of the company's business strategy, which is the driver of shareholder value, the dominant component of shareholder welfare. Questions may include: Will addressing ESG topics allow the company to satisfy growing consumer trends and increase sales? Will addressing other ESG factors position the company to have a better workforce and decrease worker attrition and the related costs?

Even in those cases where a particular ESG matter does not fit directly within a company's business strategy, a company may need to consider whether inaction or a failure to be responsive to an issue presents risks to a company. These might include negative perceptions by consumers, regulators, employees or the public that could lead to a boycott of the company's products, regulatory intervention, active employee protest or morale decline, negative publicity, or other forms of harm to the company's ability to compete and produce shareholder value.

The rise in ESG investing presents new risks and perhaps opportunities. ESG investors' dissatisfaction with a company's ESG policies (or lack thereof) or responsiveness may have significant adverse effects. In particular, this could include loss of interest in the company as an investment or, perhaps, initiation of a public campaign, submission of shareholder proposals, or an election contest or a "vote no" campaign focused on changing the company's ESG position. On the positive side, understanding and anticipating ESG issues that may be promoted by investors might attract positive interest in the company and support from such investors.

These and many other potential questions are strategic decisions — like any other business strategy decisions — and as such are subject to board oversight. And once the board and management determine how, if at all, ESG factors align with that business strategy or are otherwise appropriate topics for action to preserve or enhance shareholder welfare, the board needs to determine the level of corporate investment appropriate in light of the expected returns (or losses avoided), how to measure success and how to incentivize management accordingly. Shareholder engagement then presents a forum to understand the concerns of investors and how they view the company, as well as to explain ESG in the context of that business strategy and the board's oversight role. It then becomes critical for the company to communicate, whether in annual reports, proxy statements, sustainability or corporate social responsibility reports, or other public statements, its approach to ESG matters as part of its overall business strategy.

Over the years there has been a debate, which continues loudly today, about whether directors can or should consider the interests of non-shareholder constituencies. The Chief Justice of the Delaware Supreme Court, Leo E. Strine, Jr., has made clear where Delaware law stands on the subject:

"[A] clear-eyed look at the law of corporations in Delaware reveals that, within the limits of their discretion, directors must make stockholder welfare their sole end, and that other interests may be taken into consideration only as a means of promoting stockholder welfare."1

ESG issues can be presented as having, and often do have, an "other, non-shareholder constituency" character. However, the context today is quite different than during the 1980s, which witnessed the rise of corporate constituency statutes that have been adopted by more than 30 states. That difference is manifested by the concentration of U.S. public company ownership in a relatively few institutional asset managers, the active and growing support from those entities (and from other equity owners) for environmental and social responsibility by public for-profit companies, and the heightened level of consciousness in the media, academia and general population regarding the demand for ESG responsibility by public for-profit companies.

To borrow a phrase from then-Justice Andrew Moore of the Delaware Supreme Court, in his 1985 Revlon decision, directors would appear to have wide latitude — and responsibility — for dealing with ESG issues to the extent they represent matters "rationally related [to] benefits accruing to the stockholders." That said, it is incumbent on directors to do their homework and apply appropriate processes to establish informed decision-making regarding that key determination — which also will enable them to defend challenges to spending shareholder money on "causes" that not all shareholders may support and to demonstrate to the "new" shareholder constituency, ESG investors, the attention paid to the subject at the board level.

Beyond that, of course, are a myriad of other important and potentially difficult decisions that may be required. These may include: Whether, when, to whom and how to engage in outreach regarding ESG issues. Choosing among ESG matters. Deciding how, how much and when to spend company resources to support selected ESG matters. How and when to communicate choices made and actions taken.

In the end, although more consequential than ever, these are board decisions just like others, requiring the exercise of business judgment in the best interests of the company and its shareholders.

Footnote

1. Leo E. Strine, Jr., "The Dangers of Denial: The Need for a Clear-Eyed Understanding of the Power and Accountability Structure Established by the Delaware General Corporation Law," 50 WAKE FOREST LAW REVIEW 761,771 (2015).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions