Concern for environmental and social issues has reached an inflection point. While traditional governance issues that have been a staple of investor advocacy and discussion (the “G” of ESG) continue to be important, environmental and social issues (the “E” and the “S” of “ESG”) have now taken center stage. Scarcely a day passes without a new ESG development, disseminated as a statistic, an investor campaign, political initiative or action by a special interest group. In response to this change, the 2019 Corporate Governance & Executive Compensation Survey, our 17th annual, closely reviews several aspects of the current ESG phenomena in addition to continuing to report on traditional governance topics. In this effort, we cover such topics as proxy access, shareholder engagement, shareholder proposals, governance practices of newly public companies, CEO pay ratio, director compensation, cybersecurity, board diversity and shareholder activism.
The topic of ESG is a complex one for companies, raising a broad range of issues. In this Survey, we strive to help companies develop their approach and framework to the issues that are relevant to them. We also provide insights on specific E&S issues, including human capital management, gender pay disparity, board diversity and corporate culture. Across all topics, our goal is to provide an overview of the current corporate governance landscape and identify best practices.
In addition to insights articles, the Survey consists of a review of key governance characteristics of the Top 100 Companies, which we define as the 100 largest U.S. public, noncontrolled companies that have equity securities listed on the NYSE or Nasdaq, measured by market capitalization and revenue. A list of the Top 100 Companies can be found in “The Survey” section at the end of this publication. The results of the Survey can also be found in “The Survey” section as well as in the insights articles contained elsewhere
THE FORCES DRIVING ESG It is instructive to identify the forces that have been driving, and that are expected to continue to drive, the ESG movement. • Institutional investors have prioritized ESG and seek to engage with companies with respect to core ESG matters • ISS and Glass Lewis have indicated that they will make voting recommendations based on particular ESG positions taken by companies 1 See Flash Report, Governance & Accountability Institute, “86% of S&P 500 Index Companies Publish Sustainability Reports in 2018” (May 16, 2019). 2 See Principles for Responsible Investment, “PRI Signatory Growth Shows Strong Momentum” (January 2019). 3 See State Street Global Advisers, “Aim Higher: Helping Investors Move From Ambition to Action With ESG Investment Approaches” (October 2, 2018). 4 See Press Release, Business Roundtable, “Business Roundtable Redefines the Purpose of a Corporation to Promote ‘An Economy That Serves All Americans’” (August 19, 2019). 5 See Institutional Shareholder Services, “Early Review of 2019 U.S. Proxy Season Vote Results” (June 5, 2019). • ESG research and ratings firms have proliferated in response to the desires of investors and other stakeholders to measure ESG performance of companies • ESG standard-setting bodies have continued to emerge, offering potential paths to greater standardization of ESG reporting • ESG activism continues to rise and has been characterized by support from special interest groups, institutional investors and employees • Although the U.S. federal government and the SEC have not been particularity active in this area, state governments and European countries have been catalysts for change
KEY ESG QUESTIONS The following are some of the key ESG questions that we think will continue to shape ESG discussions: We encourage you to use the Survey to consider how your company’s approach to ESG fits within current trends and what steps your company should take to develop its ESG practices, to benchmark your corporate governance and compensation practices against those of the Top 100 Companies, and to consider our perspectives and practical guidance on what are no longer emerging, but in fact emerged, topics. Please reach out to a member of our team to discuss any matters contained in the Survey or to learn more about the Shearman & Sterling Corporate Governance practice. 1 2 Does the company have a dedicated team that is focused on the relevant ESG matters for the company? Are ESG matters integrated into the company’s and board’s consideration of long-term strategy and enterprise-wide risk? 3 Is the board being adequately informed about how the company is handling ESG matters? Is the board equipped to properly oversee management in this area? 4 Does the company prepare ESG-related reports and does the company follow an established ESG reporting standard? Does the company integrate ESG matters into its SEC reports? Does management apply the same rigor to the preparation and review of these reports as it does to its public reporting? Does the company engage with ESG ratings firms? 5 What ESG engagement activities does the company conduct? Are directors able to engage with investors and other stakeholders on ESG matters? INSIGHTS ESG has reached global recognition with stakeholders from all corners, including investors, employees, customers, governments and other constituencies, focusing on some or many of the issues that comprise the topic. INSIGHTS ESG has reached global recognition with stakeholders from all corners, including investors, employees, customers, governments and other constituencies, focusing on some or many of the issues that comprise the topic. Shearman & Sterling LLP The Climate Changes for ESG | 5 THE CLIMATE CHANGES FOR ESG Stephen T. Giove, Richard B. Alsop, Lona Nallengara, Bill Nelson and Judy Little The focus on ESG matters has increased considerably in the past few years. Most leading companies are now devoting significant resources to developing and refining their approach to addressing, and explaining to stakeholders, the environmental, social and governance (ESG) matters that are significantly related to their business. Despite this increased focus, there is still considerable divergence in how companies define, address and disclose ESG matters for a variety of reasons. First, there are no precise boundaries as to what issues fall within the ESG rubric. No list or single source defines the scope of ESG. Second, ESG issues are not static — new ones emerge and existing ones evolve over time, which requires companies to consider how these issues will be addressed and spoken about with stakeholders on an ongoing basis. Finally, the importance of a particular ESG issue can vary considerably across companies, industries and geographies. What is important for one company may not be as important for another. For better or worse, there is no uniform solution for approaching ESG matters. As a result, each company needs to evaluate and define which ESG issues are core to its business, determine which ESG issues resonate with its stakeholders and establish a plan to address these issues and communicate them to stakeholders. On one end of the spectrum, there are companies that do not factor ESG considerations into their decision-making, do not engage with shareholders and other constituencies on ESG matters and do not make any ESG disclosures beyond those that are required to be disclosed under applicable SEC rules. These companies, for example, include customary disclosures related to climate change and environmental matters as part of their risk factor, business, regulatory and litigation disclosures and may make limited disclosures on diversity as part of director disclosures in the proxy statement. Companies on the other end of the spectrum have fully integrated ESG considerations into their strategic planning and risk management processes, have INSIGHTS dedicated ESG staffing, regularly engage with shareholders and other stakeholders on ESG matters and make sophisticated ESG disclosures, not only in SEC filings but also in specialized reports that receive significant board attention and external promotion. Most companies fall somewhere in the middle of this spectrum. Wherever a company falls on the spectrum, it is becoming increasingly difficult for a board to let the management team ignore the ESG issues that are important to the company. The increased focus of investors, customers and employees, coupled with a growing body of research demonstrating that companies that focus on sustainability and other ESG issues tend to outperform peers that do not, makes it imperative that boards direct management to engage on ESG and ensure that the board does so itself. In this article, we identify some of the common issues faced, and some of the practical next steps to be considered, by companies planning their next steps in their evolving approach to ESG.
DETERMINING ESG SCOPE One of the most difficult threshold challenges for companies seeking to establish a comprehensive approach to ESG is setting the scope of engagement. This is usually an iterative process involving a wide cross-section of management and often with board involvement. A number of factors are relevant in determining which ESG issues a company should focus on and prioritize. Determining the scope is critically important so that the company can set expectations, establish appropriate goals, plan and implement actions to achieve these goals, measure success over time and, where appropriate, publicly report on progress. Typically, a discussion of the scope of a company’s ESG efforts includes a discussion of materiality. While many ESG issues that are important to a company and its Look at Strategy and Risks One of the most important factors in determining the scope of the company’s ESG focus is analyzing which issues are important to the success of the company’s long-term business strategy and the management of the significant risks facing the company in pursuing that strategy. As noted above, this involves viewing the company’s business strategy and risk assessment through a wider lens than traditional financial materiality. Boards and management should consider how environmental, social and sustainability issues impact the company’s ability to achieve its long-term strategy. This is a complex analysis, but it is not much different than how boards tackle any new risk or problem or brainstorm on future challenges and opportunities. constituencies are not material when viewed through the traditional financial materiality lens, some of these can be critically important to a company over the long-term with implications for the company’s business in a way that does not necessarily translate neatly into short-term financial metrics. For example, the focus on a particular ESG issue by an important constituency, such as large institutional shareholders or employees, can significantly escalate the importance of the issue to the company. Additionally, clients and customers and the public generally are increasingly raising concerns that may affect a company’s ESG agenda, and ignoring these voices can result in direct financial and reputational harm. Look to Industry Each company will have unique ESG focuses based on numerous factors, such as its size, geographic location, investor base and employee composition, but industrywide trends will be important guideposts as to where a company needs to be focused. Monitoring news about industry peers and evaluating their SEC reports As it does with any new risk, the board should better understand how an ESG issue can be an obstacle to long-term objectives. First, the company must understand and prioritize what its core ESG issues are — for example: • How could climate change impact the company’s longterm prospects? • How could a better-trained workforce help grow the company’s anticipated new business lines? • How could better childcare resources in the communities in which the company operates create new opportunities?
and voluntary disclosures can be valuable tools in establishing the scope for a company’s approach to ESG. Most companies will be “graded” against objective standards by which they will also be compared to others in their industry.
Look to Shareholders An increasing number of shareholders have viewpoints on ESG issues. Nearly all of the largest institutional shareholders (and not just the public pension funds) have publicly communicated the importance of ESG to them (and their clients) and, in many cases, have prioritized certain key issues. Many institutional investors are producing detailed reports that outline their ESG investing priorities. These reports are important sources on the issues that institutional investors care about, but, more importantly, they provide an important perspective on how institutional investors think about these issues and what level of engagement they expect. As with many other mainstream issues that boards, general counsels and corporate secretaries have had to address, many ESG issues start from a kernel planted by an issue advocate that grows over time. Keeping a close eye on what is developing in the shareholder proposal cycle, watching how shareholder voting is changing and keeping abreast of the issues that advocates are speaking about will help prepare companies for the issues that may be next on the board’s agenda. Look to the Community ESG covers a broad cross-section of issues. The ones that are global in nature, like reducing greenhouse gas emissions, water management plans and workers’ rights, have widespread coverage by institutional investors and issue advocates and will be the ones employees read about in the media. It is also important to understand that some ESG issues are local. How does a company impact the communities in which it operates and where its employees live? These include living wage issues, support for public education, decisions related to property and physical plant and community-based activities. It is important to understand the role the company can play in the important issues affecting its communities and not to lose sight of local issues when evaluating its global strategy. Look to Employees We are in an era where the actions of employees can have a significant impact on decisions made in the boardroom. Employees not only care about issues that relate to the employee-employer relationship, such as the absolute levels of pay, gender pay equity, employment conditions and terms and policies regarding paid leave, but also care about the “corporate citizen” they work for. Employees are increasingly selective about where they work because they want the company they work for to, in some degree, share their values. And we see this in some of the recent “employee activism” when a company’s actions appear to veer from what the company’s employees believe are their shared values. Whether it is employees challenging their company’s unwillingness to adopt a policy that can promote board diversity or decisions to continue commercial relationships with the federal government that are viewed as indirectly supporting controversial programs, employee activism is on the rise. And it is getting more powerful. Value or mission statements do not seem to be enough for employees unless there is something behind them. Ignoring the perspective of employees could be short-sighted in the current environment. It can impact recruitment and retention and employees can often serve as a good barometer for public sentiment. Seeking the input of employees and, better still, involving employees in the company’s ESG efforts can only strengthen the company’s efforts. 8 | The Climate Changes for ESG Shearman & Sterling LLP DOES THE CORPORATE SOCIAL RESPONSIBILITY (CSR) REPORT CONTAIN A LETTER FROM THE CEO? Given the focus on ESG by a company’s various constituencies, it has become commonplace for the company’s CSR Report to contain one or more letters from senior management, including a letter from the company’s CEO 84 84 12 12 YES NO ESG ENGAGEMENT ESG engagement has become a significant focus for companies, as the largest institutional investors are lending their financial clout to calls for leadership by the largest public companies on a variety of environmental and social issues, and a growing number of institutional investors are taking ESG disclosures into account in their investment decisions. Global equity values have achieved dizzying heights over the last few decades, driven by technological innovation, and the related increase in the size and influence of companies around the world has led to a recognition that meaningful environmental, social and economic change can be fueled by the largest public companies, both because of their sheer size and the influence they will have on practices of other, smaller companies, as well as their ability to move faster and more effectively than governments. As BlackRock’s Larry Fink noted in his 2018 letter to CEO’s, “Society is increasingly looking to companies, both public and private, to address pressing social and economic issues.” And it appears companies are listening. In August 2019, the CEOs of 181 U.S. companies, many of the largest public companies in the world, issued a statement through the Business Roundtable that seeks to redefine what had been the long-held purpose of a corporation – to serve shareholders and maximize profits.1 The statement offers that while each company has its own corporate purpose, all companies are a fundamental commitment to customers, employees, suppliers and communities along with delivering longterm value to stakeholders. Reasons to Engage with respect to ESG Matters Given these lofty expectations, companies and their boards are increasingly focused on identifying material ESG-related risks and opportunities, integrating ESG considerations into their culture, long-term strategy and operational plans, and developing an effective communication program that highlights this commitment and shows progress against particular goals. At the same time, companies are increasingly recognizing that thoughtful consideration of ESG issues and implementation of an ESG strategy will produce important benefits, including improved shareholder relations, protection against shareholder activism, demonstration of risk awareness and, most importantly, a pathway to creating long-term shareholder value. Developing the Company’s ESG Message Identifying a clear message that will resonate with a company’s stakeholders is critical. One of the key considerations is the type of information that should be provided to shareholders and other constituencies. In its February 2019 report entitled “Change the Conversation: Redefining How Companies Engage Investors on Sustainability,”2 Ceres, a sustainability organization, advised companies to disclose “decision-useful information,” which for Ceres means connecting sustainability and other ESG issues important to the company to financial performance, strategy and risk management. Many investors connect their thinking on ESG issues to more traditional concepts of profitability and risk. This approach is consistent with the growing view that ignoring sustainability and other ESG issues puts short-term profitability ahead of long-term shareholder value.
Identifying the Audience Institutional investors are increasingly incorporating ESG data into their investment decisions, or communicating their expectations to companies in their portfolios. ESG disclosures are therefore naturally designed to address existing and potential shareholders. It is important, however, for companies to have a broader view of the possible audience for their actions and disclosures. In light of the broader non-financial implications of these disclosures, companies should take into account the many other constituencies that will read and evaluate this information as well. These include ISS and Glass Lewis, which have integrated ESG reporting into their proxy advisory reports, special interest groups that use shareholder proposals to target specific ESG-related issues, entities that rate the ESG actions companies undertake and entities that set ESG standards which companies can use to assess their progress and structure their reporting. Additionally, depending on the issue involved, federal, state or local governments and government agencies may take a keen interest in the disclosures. Employees, customers, suppliers and local communities are also important constituencies to consider, particularly in an era where social media can cause perceived corporate missteps or omissions to go “viral.” These factors put a premium on determining the shareholders and other stakeholders that want or should want to hear about a company’s ESG message and prioritizing the key constituencies the company needs to engage. The ESG Engagement Team How the ESG message is communicated is a key consideration. The medium and the people delivering the message are both important. The spokespeople need to have credibility, which comes from both knowledge of the issues and responsibility within the company. Knowledge includes understanding what the company and its peers are doing and the relevant best practices. Responsibility means that those who are selected to represent the company will be seen as speaking for the company. Increasingly, this is a team effort, including senior legal, investor relations and subject matter experts. In addition, there are increasing requests by investors and others for director participation on core issues. Direct Engagement Most companies are familiar with the traditional investor roadshow. Whether it is the pomp and circumstance of an annual investor day, presentations at investor or industry conferences or road trips to visit one-on-one with key investors, companies know the focus of these meetings and presentations historically have been on financial performance, business strategy and outlook for the company in the coming months and years. Similar meetings with institutional investors solely focused on companyrelevant ESG issues are becoming more and more common. Some institutional investors have built dedicated teams with real subject matter knowledge and market experience to engage substantively with companies. These meetings or roadshows, which can be in person or by teleconference, are entirely focused on ESG issues. Often, these meetings are requested by investors and other stakeholders, but companies that have a good story (or a new one) may even seek out these meetings or ESG conferences to deliver their message. These dedicated meetings require careful planning and high-level attention.
ESG RATINGS As attention to ESG matters has grown, so has the importance of having a strong ESG profile. This has led to the growing influence of ESG rating firms. ESG rating firms are third parties that evaluate and rate the performance of public companies (and some private companies) on a range of ESG standards. Institutional investors and other stakeholders are increasingly turning to rating firms to assist them as they evaluate the ESG practices of the companies. As more and more capital is directed toward ESG investing, ESG ratings are becoming more consequential. There are numerous rating services and they all use their own methodology to establish how well a company performs against their own ESG classifications. As many of the ESG issues do not provide quantifiable metrics or standardized disclosures, the interpretation of a company’s ESG “data” can be significantly different among different rating firms. Unfortunately, this has sometimes led to the same company having different ratings from different firms. Many rating firms look only to a company’s public disclosures, such as SEC filings, ESG reports or other information on the company’s website. Other rating firms supplement the company’s disclosures with other sources of public information about the company and its ESG practices such as filings with governments or other regulators, press reports and other third-party reporting. Some rating firms seek input from the companies to determine ratings so as to ensure they have all relevant information, including information that the company has not disclosed. Other rating firms only evaluate based on publicly disclosed information, with some taking the perspective that disclosing this type of information is indicative of the change that is being fostered. This last point is important to understand. As the influence of rating firms has increased, so has the desire to understand what the rating firms look at, how they collect the information and what influence a company can have on its score. This has led many companies to unpack rating firms’ methodologies to understand the important inputs in order to devise ESG practices and, more importantly, ESG disclosures to align with what the rating firm is looking at all in an effort to get a higher rating, but does not necessarily reflect change in ESG commitment or actual improvement of practices. Additionally, many companies take seriously, devoting time and resources, inquiries from rating firms seeking to understand a company’s ESG profile. For these companies, spending the time to present the full (or best) ESG profile is worth it if ultimately ratings are better. Boards cannot ignore ESG ratings either. Boards should know the important rating firms and the company’s ratings. Directors should understand how ratings were formulated, what company disclosures were used in the assessment, where the company rated poorly and what management is going to do about the rating. Furthermore, boards should probe to make sure the company is developing credible ESG practices and not focused only on increasing ratings.