Corporate governance has long anchored the environmental, social, and governance (ESG) movement. Among investors, the largest US index fund managers now see governance as more than a “compliance exercise,” looking at it as a “key component of value creation and risk mitigation,” according to the authors of an article on the Harvard Law School Forum on Corporate Governance. The CFA Institute suggests that it has evolved to become an “accepted part of investment analysis” by most chartered financial analysts (CFAs).
Sound corporate governance is rooted in rigorous accountability, as described in ISO 26000, the international standard on social responsibility. That accountability is typically traced to the board of directors and the board’s oversight of a range of company actions. In the process of steering the organization away from damaging and irresponsible impacts, board oversight amplifies the integration of ESG drivers and outcomes, helping elevate their value.
Board Oversight: Natural Checks and Balances
Expectations of boards of directors have mounted over the past two decades, with oversight responsibilities front and center. The push may be traced to 2002, when the Sarbanes-Oxley Act sharpened the board’s role in monitoring a company’s financial reporting.
Another boost came in the wake of the 2008 global financial crisis, which led to a Securities and Exchange Commission rule mandating disclosure about the board’s role in a company’s risk management oversight.
More recently, well-publicized misdeeds by a handful of CEOs have reenergized support for bolder board oversight—although the demands regularly extend beyond the actions of individual executives. Instead, the jurisdiction of board oversight ranges from executive pay and corporate culture to a company’s compliance efforts, privacy policies, and cybersecurity measures. Logistically, initiatives like these are commonly overseen by board committees, third-party experts, or in-house audit groups.
Ultimately, the value of strong board oversight manifests in “a substantive set of checks and balances as essential in carrying out effective governance,” according to Business Law Today.
Board Oversight and ESG integration
Board oversight can drive a virtuous cycle of sustainability and ESG goals. As directors identify and address ESG matters, they reinforce good governance. The benefits can spread throughout an enterprise, explain researchers at sustainability nonprofit Ceres. For example, by monitoring a company’s exposure to ESG themes like climate change, water scarcity, and human rights issues, a board may strengthen sustainability objectives while also helping company leadership navigate risks with potentially severe financial implications.
Some corporations may also find that they have no choice, as large investors increasingly urge the consideration of ESG factors. Most notably, money manager BlackRock pledged to integrate ESG analysis in 100% of its portfolios by the end of 2020. In addition, State Street Global Advisors committed to use proxy voting to seek to oust directors of companies that fail to integrate ESG analysis in both current-state and strategic planning updates. On the topic of board oversight itself, advocacy nonprofit As You Sow’s analysis of the 2020 proxy season cited 10 relevant shareholder resolutions; six asked for oversight committees tailored to certain complex ESG issues, while the remainder requested the nomination of specific experts to the board.
While shoring up corporate governance, there are potential pitfalls to adding to boards’ oversight responsibilities. Larger companies with complex structures, numerous risks, and a hesitancy to share information can overwhelm directors, write the authors of a Harvard Business Review article.
Given the growing importance of ESG performance, however, corporations would be well-advised to pay attention to their board oversight framework.