MCG Talks ESG – Part 1: Big or Small, Public or Private, Manufacturing or Tech… It’s Time to Focus on ESG

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We here at MCG think it’s time to talk ESG. Your company might already have a robust sustainability program, complete with an enterprise-wide ESG policy, third-party-verified SASB and TCFD reporting, and a thoughtfully integrated CSR statement, or you might not know what all of those acronyms even stand for. Regardless of where your company, board of directors or management team falls on the spectrum of developing, integrating and disclosing your ESG strategy, we want to help. The number of resources available to companies on various ESG and sustainability topics can be overwhelming, and in this “MCG Talks ESG” series, we hope to distill some of that information down to “what you need to know” and “what you need to do now.” In this series, we plan to address how these topics apply to your company, steps you can take to build or improve your company’s ESG program, how to prepare for SEC-mandated climate risk disclosures (yes, they’re coming!), and the basics of SASB and TCFD reporting.

How does ESG apply to my company?

Before considering how ESG and sustainability topics can apply to your company in a way that aligns with your corporate strategy and enhances value, it is helpful to understand the differences between these terms. “ESG” (environmental, social and governance) matters encompass a wide variety of issues facing a company’s directors and management, from considering which board committees should have oversight responsibility for the various risks facing the company to tasking the human resources department with enhancing employee satisfaction. It is common for a company to start building an ESG program by addressing governance issues first, such as appointing an independent board chair or improving board diversity, and then moving to environmental and social considerations that align with the company’s strategy. The term “corporate social responsibility” or “CSR” refers to a company’s efforts to define its values and implement ESG initiatives that advance these values. A company’s goals related to “sustainability” typically involve efforts to manage ESG risks, obligations and opportunities, paired with a focus on enhancing stockholder value over the long term.

Regardless of how you got to this point – an institutional stockholder or private equity sponsor requested that you consider ESG issues, a group of employees suggested that you develop a CSR statement detailing your company’s covenant to society, or investors asked what your company is doing to ensure its sustainability – the first step is identifying or refining the ESG metrics that align with your corporate strategy. By focusing on a small number of specific ESG strategies that are material to your business and your various constituencies, your efforts are likely to enhance value instead of simply “greenwashing” your corporate website. There is not a one-size-fits-all approach to identifying or refining your ESG priorities, but companies should consider the following factors:

• What is your company’s profile? A large, publicly-traded manufacturing company is likely focused on carbon emissions and workplace safety, while a smaller, privately-held software technology company might be focused on increasing diversity and inclusion efforts and employee satisfaction. The nature of your business will largely drive which ESG metrics are material to stakeholders. Additional considerations such as the company’s budget for ESG initiatives and the number of people who will assist with implementation are critical to identifying the right priorities.
• What is your primary motivation for change at this time? If you are receiving pressure from institutional investors, it is helpful to consider the general consensus that these investors have reached on various issues such as board diversity, shareholder rights and employee diversity disclosures. If you are more focused on employee engagement and retention, you might be better served by implementing a diversity and inclusion program and enhancing employee training and education. A private-equity portfolio company that is considering going public should focus on readying its corporate governance policies and practices for compliance with various SEC rules and stock market listing standards and the satisfaction of institutional investor expectations.
• What is your company’s appetite for change? Some boards of directors have been focused on ESG topics for years while others are just getting started, so the breadth and depth of your initiatives need to take into account the views of not only your board, but also your senior leadership. The degree of alignment between the board and management is critical, as a program or initiative is not likely to be successful if there are widely differing goals and expectations at the leadership level.
• Who will be leading this effort? It is important to consider who will be responsible for developing and implementing an ESG program in conjunction with deciding on the appropriate action-items. If your general counsel is interested in this area and ready to lead, then perhaps a governance or disclosure effort should top your priority list at this time. Someone in the human resources department would be well-suited to spearhead an employee training initiative, while someone in operations might prefer to focus on an energy conservation project.

Why is ESG so important right now?

Public companies have been facing increased pressure to take action in the areas of ESG, corporate social responsibility and sustainability for years, but the events of 2020 and 2021 have propelled ESG issues into the spotlight for all companies. The global COVID-19 pandemic, the movement for racial justice and growing concern about the impact of climate change have resulted in heightened focus on the ability of companies to respond to these challenges with agility and integrity. Both private and public companies need to demonstrate to their employees, customers, suppliers and investors that they care about financial performance and resilience, but also issues such as employee support and satisfaction, customer retention, supply chain management and community impact.

Additionally, all companies need to be aware of the dramatic increase in “impact investing,” which has seen the dollars invested in sustainable funds and companies in the U.S. grow by over 40% in only three years to over $17.1 trillion at the beginning of 2020. According to the Forum for Sustainable and Responsible Investment, that means that one out of every three dollars under professional management in the U.S. is managed according to sustainable investment strategies. Activist shareholders are also increasingly willing to call out companies on their ESG shortcomings and lay out specific courses of action to address those risks and opportunities. Furthermore, companies should keep in mind that millennials (those born in years 1981 to 1996) now represent the largest number of potential investors and employees, and these individuals are likely to reward good corporate actors with loyalty, both in terms of where they choose to invest and where they choose to work.

While some of these ESG and sustainability concepts admittedly sound a bit esoteric and obscure, public companies are facing a situation that is anything but. Almost all public companies are currently rated on their ESG performance by a number of third parties, and some of these ratings have the potential to dramatically impact a company’s operations and performance. Proxy advisory firms such as Institutional Shareholder Services (ISS) and Glass Lewis provide proxy statement analyses and voting recommendations to institutional shareholders, and if your company’s governance profile runs afoul of the proxy voting guidelines of these firms, you can be facing a recommendation that shareholders vote against one or all of your director candidates or other proxy proposals. ISS publishes a QualityScore for almost all public companies in the areas of Governance and E&S (Environmental and Social), which scores measure the quality of a company’s disclosures on these issues and identify key omissions. Expectations for a company’s disclosures are defined by industry group and based on specific ESG risks identified in various initiatives and standards, including the Global Reporting Initiative (GRI), Sustainability Accounting Standards Board (SASB) and Task Force on Climate-related Financial Disclosures (TCFD). A company’s Governance and E&S QualityScores are now included in ISS’s proxy voting reports, and these scores will likely continue to affect ISS’s voting recommendations in the future.

ISS and Glass Lewis also make voting recommendations to shareholders when a public company receives a shareholder proposal. If a company receives a proposal in the environmental or social areas, ISS will look at (i) how the company’s policies compare to those of its peers and (ii) the company’s current level of disclosure. In 2020, 46% of shareholder proposals were in the “ESP” (environmental, social and political) area, followed by 45% in governance and 9% in compensation.[1] Nearly 49% of ESP proposals went to a vote, and average shareholder support remained consistent at 27%. Even though the vast majority of proposals were received by large-cap (S&P 500) companies, a record of 15 ESP proposals passed in 2020 and the number of proposals received by small-cap companies will only continue to increase. Even if you share the widely-held view that proxy advisory firms have an outsized influence on company policy, and you think the likelihood of your company receiving a shareholder proposal on an ESG topic is remote, it is increasingly difficult to ignore the opinions of third parties in this space. Additional examples of third-party rating agencies that have the potential to impact a company in a real way are as follows:

• MSCI ESG Research LLC is the world’s largest provider of ratings and research on various ESG topics, as their proprietary MSCI ESG rating focuses on a company’s most significant risks and opportunities in light of its industry, as well as how the company’s leadership is managing these risks.
• Sustainalytics has partnered with Yahoo Finance to provide a “Total ESG Score” that is already displayed on the Yahoo Finance page for over 1,000 companies, with the goal of displaying this score for more companies each year. This will allow retail investors and the general public to easily access and compare quantitative information on a company’s efforts in this area, potentially affecting an investor’s decisions in real-time.

What should I be thinking about next?

Once your company’s board and management understand and appreciate how ESG and sustainability topics apply to your company in a way that aligns with your corporate strategy and enhances value, it is time to identify and refine the ESG strategies that are material to your business and your various constituencies. An upcoming segment in this “MCG Talks ESG” series will discuss practical steps you can take to build or improve your company’s ESG program in order to implement your company’s ESG and sustainability priorities. We also plan to walk you through preparing for SEC-mandated climate risk disclosures and the basics of SASB and TCFD reporting.

[1] Information regarding shareholder proposals submitted during the 2020 proxy season was found in Sullivan & Cromwell LLP’s “2020 Proxy Season Review: Part 1,” July 15, 2020.