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Four Questions Directors Need to Ask About Balancing Shareholder Returns With Growing ESG Pressure

V&E's Sarah Fortt & Lauren Collins to Moderate ESG and Clean Energy Panels at WCD Conference Background Image

Women Corporate Directors’ 2021 Global Institute – A Recap of Sarah Fortt’s ESG Panel

The rise of environmental, social and governance (“ESG”) investing is forcing the directors of publicly traded companies to figure out how to accommodate increasingly specific demands without sacrificing the bottom line: shareholder returns.

While some aspects of decision-making are universal, the calculus for each company is, in the end, unique, and influenced by industry as well as corporate culture, according to participants in a panel, “Global Environmental Governance: Action & Accountability,” moderated by Vinson & Elkins’ Sarah Fortt. The discussion took place on June 9, 2021 as part of the Women Corporate Directors’ 2021 Virtual Global Institute and Visionary Awards Celebration.

It’s a message with heightened relevance this year, after oil giant ExxonMobil saw three of its board members lose their seats to an alternative slate of directors presented by Engine No. 1, a relatively small activist fund. However, Engine No. 1 was able to rally the likes of Blackrock to its side, as investors saw a financial case for greater attention and expertise on climate change at the board level.

“As outside counsel, I do recommend that my boards treat climate change and ESG as the potential tip of a spear,” said Fortt, who is in V&E’s mergers, acquisitions and capital markets practice and the visionary behind the firm’s ESG task force. The cross-functional team provides companies with end-to-end solutions for navigating non-financial risks and opportunities, including those relating to climate change, human rights, and corporate culture.

She was joined in the panel by Vanessa C.L. Chang, an independent director of Transocean Ltd., Edison International, Sykes Enterprises, and American Funds advised by Capital Group; Sonia Consiglio Favaretto, a sustainability specialist member of the health, safety and environment committee that advises Petrobras’s board; and Michele Hooper, President and CEO of The Directors Council and a member of the boards of UnitedHealth Group, Inc. and United Airlines Holdings.

Following are four of the most important questions discussed during the session.

1. To what degree is global standardization of environmental regulations something that should be sought? Should directors be paying attention to developments in jurisdictions other than their own?

Directors should be looking at regulatory advancements around the globe, the panelists agree. There won’t be a single standard with regard to disclosure of environmental practices, as what one company is concerned about isn’t the same as what concerns another; however, countries are engaging in increased dialogue on best practices for ESG disclosure requirements, and it is foreseeable that countries may model certain approaches to any requirements off of what they’ve seen successfully implemented in other jurisdictions. For example, there are many cases in which developments have “rolled across the pond” from Europe to the U.S. and vice versa. The more attention directors pay to developments in other jurisdictions, the better prepared they will be when those issues manifest in their own back yards. And the rate of rulemaking is ramping up.

For now, the standards for disclosing such practices aren’t the same as those for reporting profits, losses and other highly regulated metrics of shareholder value, but board members should pay close attention and, if appropriate, share their perspectives with government oversight agencies developing applicable rules.

2. Investors increasingly expect directors and C-suites to be prepared to engage around ESG, including environmental matters — climate change currently being the biggest and most often discussed. Does the board need a member with climate change expertise or an environmental specialist to address these matters?

Not necessarily, the panelists say. It’s again a question of what risks the company in question is facing. Directors of boards in an industry knee-deep in climate issues, such as an oil and gas company, might benefit by having a member with specific environmental expertise. Those in retail or hospitality, however, might not be facing situations urgent enough to require devoting a valuable board seat specifically to such issues. Directors looking at the range of ESG issues should think about what their company’s priorities are, and which aspects are important to them.

The priority isn’t necessarily putting a climate expert on the board, but putting the right skill set on the board. Workshops and training initiatives, or even a sustainability committee, can help fill in any gaps.

Ultimately, the most crucial consideration will be shareholder value, the panelists said. First and foremost, directors represent shareholders, and what shareholders want are good investment returns over the long term. That means ensuring there is adequate oversight of ESG issues pertinent to a company’s operations, but it doesn’t mean retooling the board to focus on those issues for their own sake and especially not at the expense of other important operational considerations critical to the company’s financial health.

3. Investors and other stakeholders are increasingly demanding more data from companies on environmental risks, goals and impacts. How important are metrics, and how involved should directors be in determining how their companies report on these matters?

Metrics are crucial, but deciding what data should be gathered and shared is tricky. As companies face growing pressure, both to make commitments and to publicize them, it’s vital for directors to ensure that any commitments match the mission, purpose and values of the company and that they are measurable and attainable. While management may be better placed to select reporting frameworks, it’s important at the board level to pressure test those choices and make sure the right ones are chosen for the right reasons. Next, directors must make sure that the company is ready to make public pronouncements. Once a goal is publicly embraced, company leaders must be ready to track, measure and achieve it.

It can come as a surprise to companies “that they set a goal and they don’t stop hearing from their investors,” Fortt noted. “There are additional expectations and additional demands.”

Companies can’t just focus on the “what” of these goals; they also need to consider the “how.” Once companies have set a goal and established a metric to track it, performance may become a material event in the eyes of both shareholders and regulators, even if the company established it voluntarily.

“Do you have investors making investment decisions based in part on that commitment?” Fortt asked. And if so, “do you have a responsibility as a board member if you become aware that the plan is not going according to plan to then update those investors?”

4. How should the board think about balancing environmental and social matters? What trade-offs exist and how should they be navigated?

In the abstract, it’s difficult for some directors to prioritize environmental or social concerns above each other, even when it’s impossible to accommodate both. For investing criteria as varied as those in the ESG umbrella, it’s crucial that directors familiarize themselves with the variables in each of the verticals, so they can rate their importance appropriately in a variety of scenarios.

When tradeoffs have to be made, rather than judging negative consequences as simply the cost of doing business, companies may now find themselves responsible for repairing the damage in some way. Those that have to prioritize environmental issues over social concerns because of the industry in which they operate, for example, might need to devise remediation programs for community fallout. In other words, the participants suggest, you have to do both.

This information is provided by Vinson & Elkins LLP for educational and informational purposes only and is not intended, nor should it be construed, as legal advice.