Board Oversight of Sustainability: Assessment and Strategic Integration

In order for directors to understand the scope of their responsibilities with respect to overseeing sustainability and determine how to best focus their energies, an assessment must be conducted of the issues, risks and opportunities that are material to the company’s operations, environment and communities.  KPMG called on boards to conduct assessments, but conceded that identifying the strategically significant ESG risks and opportunities for a company is complex, as they vary by industry and sector, and even within industries, and that there is no standard approach that companies can take.  However, KPMG recommended a two-step process described in the following paragraphs that most companies could easily use as guiding principles during the assessment stage.  The first step would be to identify and assess all the ESG and CSR issues that are material to the business and/or its stakeholders.  The second part—“material to stakeholders”—is important because it will assist the board in anticipating and understanding questions and pressures that the company may receive from the environment in which it is operating.  Admittedly, the list of potential issues is long and should generally start with the following:

• Climate change impacts
• Waste generation and management
• Water and other natural resource scarcity
• Environmental degradation
• Product and worker safety
• Supply chain management
• Workplace diversity and inclusion
• Labor practices, talent management and employee relations
• Health and human rights
• Executive compensation
• Political contributions
• Board independence, composition and renewal

This article is adapted from material in Sustainability and Corporate Governance: A Handbook for Sustainable Entrepreneurs, which is prepared and distributed by the Sustainable Entrepreneurship Project and can be downloaded here.
When assessing each issue, the company needs to analyze the likelihood and magnitude of the associated risks and opportunities and realize that weights and measures may change as time goes by and that assessment has to be a continuous process and not a one- time exercise.  In order to align the assessment with strategy, reference should be made to the issues that peer companies have cited in their sustainability reporting and to feedback from stakeholders collected during the assessment process.  While the directors do not have the time or skills to do the assessment on their own, they should nonetheless understand the steps that management is taking and use the process as a means for improving their own awareness of key economic, social and environmental sustainability issues that are engaging governments, businesses, other organizations and individuals in the worlds in which the company is operating.
The second step acknowledges that companies, regardless of their size and available resources, do best when they focus their attention on issues, risks and opportunities that are “strategically significant”.  While it is common for the initial assessment process to generate a list of six to eight issues that could affect the operating efficiency of the company, KPMG recommended that the directors themselves select and concentrate on just two or three issues that will fundamentally affect the company’s ability to remain competitive and which customers, suppliers and other stakeholders agree will be key to the company’s long-term success.  Selection is often difficult and choices will vary depending on factors such as the company’s principal basis for competing in the marketplace.  For example, a company dependent on strong branding needs to focus on issues that might adversely impact the company’s reputation and a company competing on price will be interested in initiatives that have the potential to further decrease the cost structure or provide protection from unexpected price increases in inputs.
While identifying risks is an important part of the assessment process, and many companies conduct the assessment under the broader umbrella of their enterprise risk management systems, KPMG admonished directors to make sure that management also takes into account opportunities that may lie within ESG and CSR issues and which can be leveraged by the company to compete in the future on the basis of innovation and disruption.  A few of the examples mentioned by KPMG included solutions that would thrive in a low carbon world such as products that facilitate energy storage and efficient energy use; services that support greater access to education, affordable housing and financial products that reduce income inequality; products and services that promote health and well-being and healthy lifestyle choices; and technology that accelerates the sharing economy.
Once the board has selected the most strategically significant issues, it needs to work with management to create specific goals and “commitments”, a process described further below, and establish metrics and key performance indicators that the board can use to measure progress.  The directors should also be sure that these issues are highlighted in communications to stakeholders that demonstrate how the company is integrating them into its long-term strategy for overall value creation.  Finally, the board should be sure that management is prioritizing the issues when making decisions about allocation of resources and that information regarding the issues is being disseminated throughout the organization so that different functions can develop their own systems and practices to make the best contribution to the new product and services that may be necessary in order to create a competitive advantage.
It is important to emphasize that KPMG and others recommend that boards focus on just two or three issues because directors have limited time and their attention needs to be carefully managed so that they can have the biggest impact.  This does not mean that management should adhere to the same limitations and, in fact, the board should task management with continuously monitoring a wider range of material issues using internal and external resources allocated by the board for that purpose.  Directors should expect regular reports from management on the evolving portfolio of ESG and CSR issues, risks and opportunities so that the board can, if necessary, make changes in how it goes about exercising oversight in this area.  Material, although not strategically significant at the present time, issues also need to be managed as part of the company’s enterprise risk management system and will need to be discussed and disclosed in reports to regulators such as the Securities and Exchange Commission and in stakeholder communications.
Identifying the most strategically significant ESG and CSR issues and deciding upon commitments and initiatives for each of those issues is important; however, the ability of the company to successfully address those issues and the accompanying risks and opportunities depends on making sure that the issues are embedded, or integrated, into the company’s strategy and the way in which directors, executives, employees and other stakeholders think about the company’s long-term performance.  According to KPMG, one of the best ways for the directors to oversee integration efforts is to focus on two areas: employee selection and behavior and organizational processes and routines.
With regard to employee selection and behavior, KPMG recommended that directors engage with management to understand the answers, and associated policies with respect to, the following questions:

• Are we hiring the right talent and is our selection process compatible with building an inclusive and talented workforce that reflects our business needs?
• Do we tie compensation and promotion decisions to the metrics that advance performance on the critical ESG and CSR issues that we face?
• Are we empowering people and giving decision rights to teams that can make decisions by taking into account ESG and CSR information reflecting local knowledge?
• Is our culture promoting employee behaviors that are consistent with our priorities rather than providing perverse incentives that could actually deter employees from exhibiting the behavior management and the board hope to see?

With regard to organizational processes and routines, the following questions need to be discussed and addressed:

• Do we have the right ESG and CSR metrics to monitor performance, set targets, and incentivize action?
• Are the metrics reliable, comparable over time, and credible for decision making? What are the mechanisms to help ensure these qualities?
• Have we integrated these metrics into capital allocation decisions to help determine which projects to invest in?
• Are corporate functions considering ESG and CSR issues when making marketing, procurement, recruiting and hiring, financing, and investment decisions? Are business unit leaders aligned with the corporate vision?
• How are we achieving harmonization of ESG and CSR practices across a diverse set of geographies while at the same time adapting to local culture and laws?

Another approach to framing and understanding integration efforts comes from the following series of questions regarding sustainability that Ceres suggested that directors be asking of themselves and members of the management team:

• Materiality: What are our sustainability priorities and how were they identified? Are these priorities financially relevant to investors in the short- and long-term?  Were stakeholders engaged in identifying these priorities?
• Strategy and risk management: How have the sustainability priorities been factored into the strategic plan and risk management process? How are emerging issues being identified?
• Disclosure: Have sustainability priorities and their impacts on the strategic plan been disclosed to stakeholders in a complete, comprehensive and credible manner?
• Performance: What goals have we set to improve our performance on our sustainability priorities? How do these compare with the goals set by our peers? Do these goals set us up for leadership in our industry?
• Scope: Do the sustainability goals cover our significant impact areas, including operations, supply chains and products?
• Employees: What is our strategy to build our employee base to meet our sustainability priorities?
• Compensation: Do we have the right incentives in place for management to meet sustainability priorities and goals?
• Governance: Have we established a governance structure that allows the board to oversee the management of sustainability issues and their integration throughout the enterprise?

As the directors are collecting information from the management team, the board also needs to ensure that all of the company’s executives and senior managers understand the importance of ESG and CSR to the company’s strategy and long-term performance and that they are focused on finding and implementing the best ways for their specific functional areas to contribute to the goals that the board has established for ESG and CSR.  This will require regular meetings with not only the CEO, but also the CFO, chief operating officer, chief sustainability officer and heads of marketing, risk management, human resources, investor relations and manufacturing regarding the impacts of ESG and CSR issues on their activities in order to facilitate, as the members of Nike’s Corporate Responsibility and Sustainability Committee are required to do, “the integration of these impacts into Nike’s business including innovation, product design, manufacturing and sourcing, and operations”.
Sources for this article included Taylor, Seven Steps to Implementing Board Oversight of Sustainability (February 21, 2017); ESG, Strategy and the Long View: A Framework for Board Oversight (KPMG LLP, 2017), 8-9.; View from the Top: How Corporate Boards Can Engage on Sustainability Performance (Ceres: 2015) (as cited and included in R. Sainty, “Engaging boards of directors at the interface of corporate sustainability and corporate governance”, Governance Directions (March 2016), 85, 88).
This article is adapted from material in Sustainability and Corporate Governance: A Handbook for Sustainable Entrepreneurs, which is prepared and distributed by the Sustainable Entrepreneurship Project and can be downloaded here.
Alan Gutterman is the Founding Director of the Sustainable Entrepreneurship Project, which engages in and promotes research, education and training activities relating to entrepreneurial ventures launched with the aspiration to create sustainable enterprises that achieve significant growth in scale and value creation through the development of innovative products or services which form the basis for a successful international business.  Visit the Project’s Library of Resources for Sustainable Entrepreneurs to download handbooks, guides, articles and other materials relating to sustainable entrepreneurship and keep up with the Project’s activities by following Alan on LinkedIn, Twitter and Facebook.