Julie Gorte: Sustainability-Competent Boards are Risk-Competent Boards

There’s no better way to illustrate the phrase “you don’t know what you don’t know.”

A survey of public company board members found, among other things, that 72 percent of corporate directors identified their greatest risks as strategic and disruptive factors. What stands out is that only 6 percent of those surveyed recognized that environmental and social factors are significant risk factors—even though they are among the greatest disruptors of our time.

As we write this article, Texas continues its long climb to clean up the mess left by Hurricane Harvey. Meanwhile, the southeast part of the U.S. and parts of the Caribbean are reeling from Hurricane Irma, while another hurricane, Maria, is bringing even more destruction to the eastern Caribbean. This marks the first time in history hurricane specialists remember three hurricanes threatening landfall simultaneously in the western Atlantic. These events, as well as countless others, remind us that climate change poses unprecedented dangers and whose risks are not limited to the world’s largest greenhouse gas emitters and their investors. In 2006, which was the last time the U.S. experienced an extreme hurricane season of this magnitude, nearly half the top 100 firms in the S&P 500 experienced impacts significant enough to mention in their third- or fourth-quarter 10-Qs.

Climate change isn’t the only thing that can have a significant and lasting impact on a company’s financial well-being. Companies like Unilever and Coca-Cola understand that water risk is at the heart of their business models. Massey Energy and BP made it clear that poor safety management can have a significant, even permanent negative impact on corporate financial health. These risks are as potentially strategic and disruptive as things like the impact of e-tailing on big box retailing that’s probably in every consumer discretionary boardroom these days. The fact that these are environmental and social factors doesn’t make them less risky, or less disruptive, or less deserving of director attention. The fact that many boards do not know this is something that should concern investors greatly.

A new report, Lead From The Top, from the sustainability nonprofit organization Ceres provides some much-needed wisdom for boards that need to adjust to the new normal, in which environmental and social risk management is both strategic and crucial, not peripheral and optional. Interest from shareholders and investors in these issues has grown significantly over the past few years, as evidenced by rising votes for environmental and social proxy proposals on material issues; the fact that two shareholder proposals on planning for climate change passed this year at two major oil companies; and some of the largest investors in the world, like State Street, Vanguard and BlackRock, are using proxy votes to indicate dissatisfaction with homogeneous white male boards. But if the public board directors’ survey is any indication, a lot of boards are not as concerned as a lot of investors are, despite the fact that they are there to represent the interests of shareholders.So, how do boards become competent in dealing with sustainability? Ceres’ report lays out several doable, logical steps. Briefly, these include the following:

1. Create regular opportunities to bring directors with relevant expertise onto corporate boards and include language in nominating committee charters to specifically include sustainability competence as a skill set to be included in every director search. Moreover, these searches should focus not just on expertise, but on the ability to use that expertise in the context of business strategy, financial performance, and operations.
2. Beyond just adding one or more experts in sustainability issues to the board, systematically involve and educate the entire board in sustainability issues, through, for example, requiring training for the whole board and driving regular board discussions on how sustainability impacts corporate risk, strategy and business models. This will allow the whole board to engage on these issues as a cohesive deliberative body.
3. Find ways for boards to engage directly with investors and other stakeholders on material sustainability issues, including making strategic use of external sustainability advisory councils. Engaging external groups in this way allows the board to develop a well-rounded perspective on key issues. Given the growth in investor attention to sustainability, regular investor engagement in particular seems crucial.

The days when a corporation could satisfy the wishes of shareholders to “do something” about sustainability by making philanthropic contributions are long gone. So too are the days when a corporation with a major problem in, say, workplace management could distract shareholders into thinking it was managing sustainability risks by introducing a recycling program. Tokenism and distraction worked, maybe, in the days before most investors were aware of the potential risks and opportunities posed by the various facets of sustainability, but those days are dwindling fast.

To truly represent the interests of shareholders who know that we face growing risks throughout supply chains from climate change, and that competitiveness depends on corporations’ ability to make use of any workforce, not just the 12 percent of the global population that is white and male, boards will need sustainability competence. That can be achieved by looking for directors who have it, as well as the expertise needed to provide strategic guidance and oversight to corporations, and by assuring that board deliberations include outside expertise on sustainability issues.

Julie Gorte is Senior Vice President for Sustainable Investing at Pax World Funds.