David Frost and Bosa Kosoric, McCarthy Tetrault LLP
There’s a growing trend among investors that companies should take note of: investors care about more than just the bottom line. Investors are increasingly looking at environmental and social (E&S) factors in governance and companies that ignore them do so at their own risk.
What are E&S factors?
E&S factors cover a broad range of issues, from employee health and safety to extreme weather and cybersecurity. What is material to a company will depend on the unique circumstances of that company, including its sector, corporate structure, jurisdiction and geography.
Some E&S factors will be material for nearly every business, including social factors such as occupational health and safety, employee development, data security and privacy, as well as environmental factors such as compliance with environmental laws.
While E&S concerns can produce reputational risks for companies, shareholders are increasingly bearing that risk as well. As a result, investors are leveraging their influence over companies to mitigate long-term E&S impacts on their own portfolios.
Why should companies consider E&S factors?
Companies should consider E&S factors because they are increasingly becoming the focus of investors. In particular, investors have shown an interest in tying E&S factors to both executive compensation and the re-election (or rejection) of individual directors.
For instance, from January to June 2019, Laurel Hill – a communications firm specializing in proxy solicitation – reported that nine shareholder proposals were put to a vote that would have incorporated E&S metrics into compensation decisions. Just the year before, there had not been any such proposals.
Perhaps more significantly, institutional investors are considering E&S factors. In its 2019 proxy guidelines, Glass Lewis announced that it had codified its approach to E&S factors. In instances where companies have not properly managed E&S risks, Glass Lewis may consider recommending that shareholders vote against the election of the directors responsible.
What can companies do to oversee and disclose E&S matters?
Last year, the Canadian Coalition for Good Governance (CCGG) published The Directors’ E&S Guidebook (the Guidebook), which provides guidance to companies and Boards on governance and oversight of E&S factors. The recommendations in the Guidebook were based on expertise from CCGG members and interviews with directors of companies considered to be leaders in the management of E&S governance.
In order to find themselves on the right side of investors, companies should consider implementing and following these best practices:
1. There is no ‘one-size fits all’ solution.
The E&S approach will depend on the company’s size, sector and individual circumstances. Companies should establish a principles-based approach that can adapt to change.
E&S governance is a journey, and companies need not implement each of the best practices immediately. However, it is never too early, nor is a company too small, to begin considering which E&S factors are, or may become, consequential to business strategy.
2. Begin by choosing two or three areas of development.
Every company faces material E&S factors. Choose two or three areas of development and work to develop explicit execution objectives and accountability measures.
3. Shape corporate culture by signaling from the top.
Companies should establish a clear vision for managing E&S risks. Management should signal this message to the company, including to its employees, investors and other stakeholders, and consider assigning responsibility for E&S risks to a senior leader.
4. Integrate E&S risks into Enterprise Risk Management, rather than treating them discretely.
Companies and their management teams should agree on how to assess E&S risks and be aware that the timelines to implement strategies and processes to address E&S factors can be much longer than is typical for other governance processes. Companies should ensure that E&S is fully integrated into their Enterprise Risk Management framework and that there is clear accountability within the organization.
5. Incorporate E&S factors into long-term strategic objectives.
Allocate time to review E&S priorities and hold joint focus sessions between the Board and management to assess whether the strategy captures new developments.
6. Consider E&S capabilities when recruiting new directors and officers.
If a company lacks knowledge on a particular topic, prioritize it in director or officer recruitment and/or education. Include information about E&S experience and capabilities in the proxy circular.
7. Include oversight of E&S factors in the committee structure.
For some companies, this may involve one or more dedicated committees. Charters for the committees should clearly assign accountability and risk ownership and the oversight structure should be detailed in regulatory filings.
8. Make E&S priorities a regular discussion item in meetings and in camera sessions.
Companies should also be exposed to key stakeholder groups through onsite visits and E&S factors should be included in orientation and continuing education.
9. Include E&S priorities in performance evaluation and compensation.
As one CCGG interviewee noted: “What gets measured gets managed.” Performance evaluation and compensation should capture E&S priorities and the compensation committee’s discretionary mechanism should capture qualitative impacts. In addition, disclose the link between E&S priorities and compensation to investors. If E&S factors are deliberately excluded from performance metrics, explain why.
10. Report E&S considerations and metrics to investors.
Reporting should include key considerations for governance, strategy and risk management with appropriate context and supporting information. Metrics should be clear, measurable, forward-looking and comparable.
David Frost is a Partner at McCarthy Tétrault LLP. This article was written with co-authors Bosa Kosoric (Associate) and Lauren Muirhead (Articling Student) at McCarthy Tétrault LLP in Vancouver.