Getting Ahead of the 2022 Proxy Season: Sustainability

ESG/DEI (Environmental, Social, and Governance/Diversity, Equity, and Inclusion) will be the leading theme in the upcoming proxy season by a wide margin because of a confluence of events affecting society generally: acceptance in popular and financial media of climate change as an overriding global risk and diversity and inclusion as critical areas of emphasis for business after the Me Too movement, the social justice movement, and increasing income inequality. The forces contributing to this have, of course, been at work for some time, but they have been supercharged by attitudinal changes wrought by the COVID-19 pandemic. Board members need to take notice. 

ESG/DEI at bottom asks whether a business offers both a sustainable and, for many, an ethical investment opportunity. In some sense, this is curious as sustainability by definition requires a long-term perspective, a view that some advocate is rarely the mindset of many institutional investors. However, major money management firms now see sustainability as a path to garner even more assets under management, and a myriad for- and not-for-profit firms have gotten into the business of exclusively, and noisily, advocating particular causes. Especially now that there's money to be made, a lot of it, the intensity of focus on sustainability has become definitional for modern companies.  

Sustainability has, of course, long been at the core of board functions in modern companies. It is after all central to strategic planning, R&D budgeting, M&A, and virtually all other strategic capital allocation decisions. However, in the current environment, it is vital that what has been implicit be made explicit in the board's governing documentation and publicly disclosed, prominently and repeatedly so—particularly in an era in which search engines provide the bases for numerical scoring that will heavily influence institutional investors, and shareholders increasingly bring lawsuits seeking to take directors to task for outcomes with which they disagree.  

How any particular board should specifically approach this remains to be determined at many companies. On this and virtually all other ESG/DEI issues, it matters less how or where particular oversight is lodged and what it is called than that it is explicitly addressed in some way in the board's governing documents and that the topic is prominently featured in the company's proxy statement and other external communications.  

Nonetheless, boards should do three things before their 2022 annual shareholders' meetings: 

• What To Do About It: The board and management team need to be unambiguously aligned on exactly what sustainability means to their particular company. In the timber business, for example, sustainability is a very precise term of art for the inventory turns. For miners, it addresses wasting assets. In a technology-driven era, component manufacturers operate on the assumption that a major portion of what they are making and selling will be obsolete in just a few years. Sustainability and strategy are inextricably linked, and the board and management need to work together to align on and clearly articulate what this means for their particular company. Of course, like other corporate governance topics, there is no one-size-fits-all solution. As such, where to post sustainability oversight will depend on many factors, including historical practice and perhaps even the particular skill sets of incumbent committee members. As to this and virtually all other ESG/DEI topics, companies should take steps that are relevant to and, more importantly, work for them, not check boxes on lists drawn up by the proxy rating firms or big money managers. 
• Where To Put It: Many boards housed detailed focus on sustainability in the first instance in their nominating and corporate governance ("N&CG") committees. Some boards have even renamed these committees to include explicit reference to this. That may in part be because of a sense that all ESG considerations belonged there in the first instance and in part because they more clearly do not fit with the other stock exchange-mandated committees (audit and compensation). Leaving the subject in the N&CG committee, whether or not renamed, may well make sense. However, while sustainability is clearly embedded in ESG, for some companies the N&CG committee may not be the best location and, in those situations, boards can deal with it at the board level generally. Alternatively, particularly for those most directly affected like public utilities, a separate sustainability or similarly named directorate committee may be appropriate. In this regard, many major oil companies have already created separate directorate committees on sustainability given the intensity of external focus on the effects of fossil fuels on climate change and the energy transition.  
• What To Say About It: For companies for which sustainability is an overriding strategic concern, the preparation of an annual sustainability report is already commonplace. Whether doing this or simply highlighting the company's sustainability strategy in the company's key documents (proxy statement, 10-K, and website) depends, again, on the company's circumstances. Regardless, multiple references to sustainability, including where applicable in otherwise unrelated sections of the proxy statement like CD&A, are vital, given that much ESG/DEI scoring is done by word search. For companies for which sustainability is not a direct near-term concern, or for which other concerns are more pressing, an explicit and prominent discussion of why not—and how the topic is expected to be addressed down the road—is nonetheless required in key documents, including the proxy statement. That is, regardless of a company's particular circumstances, explicit treatment is no longer optional. 

Some dismiss the current sustainability as a passing fad. That attitude is short-sighted and potentially dangerous.