Tom O'Neil, a highly respected corporate director and advisor with broad private and public sector experience, including leadership roles in boardrooms and C-Suites shares his insights on how organizations are leaning into ESG as a high priority for both ethical and risk management priorities.
CCBJ: Tom, how does the approach to ESG compliance differ based on an organization’s size, maturity, and industry? And when should a board retain outside ESG expertise or launch an oversight committee to get involved in these initiatives?
Tom O’Neil: It is important to take a step back, unpack ESG, and understand the trajectories of those three pillars—environmental, social and governance—which have now coalesced to become a north star for most organizations. For many companies, environmental was historically seen as primarily an area of risk and governance was viewed as the capstone of a compliance program. While it was not always well defined, it has been a key focal point since the beginning of this millennium. The more inchoate pillar is the social dimension. Within the past few years that dialogue has elevated in importance. But it is through the combination of those three pillars that, collectively, they have become a north star for many organizations. They are now viewed more holistically—not to use a hackneyed phrase, but from a cohesive perspective.
Today organizations are focusing on ESG as both a strategic imperative and an area presenting risks that must be mitigated. What is heartening to me is that there has been a fast-emerging consensus that organizations that prioritize ESG can become more successful in the marketplace; it can be a competitive differentiator. So, the size of the organization, its maturity, its external stakeholders, and the industry in which it competes will all dramatically affect how the enterprise analyzes and prioritizes ESG.
Insofar as the board is concerned, the way I like to think about it is that management is always primarily responsible for developing and successfully implementing a strategy. ESG is now viewed as a key element of a strategy. Also, many companies view it as a strategic imperative – not just an “option."
The board’s responsibility is to oversee and pressure-test the strategy that the management team develops to be sure it has a strong prospect of being successful, and then to monitor and oversee its implementation. You have to differentiate between the two roles.
The social dimension is the one that has brought the holistic concept to the table. Regarding the social piece, human resources departments historically focused on the need to prioritize diversity, equity, and inclusiveness. But now, with the merging of the three pillars into a powerful guiding star, boards are leaning in to make sure that the management team is in fact doing that. And, increasingly, boards are considering benchmarking data and asking management teams to deliver on their promises.
I believe it is a new era from the perspective of governance. But many companies and organizations, in various industries, have been dealing with one or more of the three pillars for a long time.
How has the emphasis on ESG forced or incentivized boards to focus on board composition, succession planning, and differing perspectives around the table, and to consider new governance models?
In terms of the impact in the board room, it is obviously something that boards expect a management team to have well in hand. That said, when you look at a board’s oversight responsibilities, the question arises, “How can the board effectively fulfill its oversight responsibilities and therebyf its fiduciary duties?” The answer varies dramatically based on the industry, but as a general matter, it certainly is a common topic in boardrooms these days—whether the board has sufficient expertise to fulfill its oversight obligations. The two ways a board can address a gap are first, to recruit a new member and second, to consider hiring an external expert as an advisor. I am seeing both in the governance world right now. As to how a board oversees the fulfillment of the ESG strategy, the question has arisen whether a board should create a separate oversight committee. That certainly can make sense if a board is large and is a huge global public company; the concern becomes that the board does not have sufficient room on its quarterly agenda to grapple with ESG.
In many settings, it has become a best governance practice to delegate to a board committee certain oversight responsibilities. For example, audit committees historically have also taken oversight responsibility for the organization’s enterprise risk management program, including whether the process is being handled properly and whether the risks are being effectively mitigated. Similarly, in healthcare and financial services, there is a now well-established best practice of forming a compliance committee, to ensure that the board’s oversight of the compliance and ethics program is robust. In the same vein, some boards are establishing ESG oversight committees.
My own view is that because ESG is so interdisciplinary and because it’s critical that the entire board fully understand the management team’s strategy, you’re often better advised to not delegate the oversight responsibility to a board committee. But if a board decides to form an oversight committee, it’s critical—because ESG includes risks and strategic opportunities—to ensure robust communication between the committee chair and the board so that information isn’t inappropriately siloed. It isn’t acceptable for a director who is not on the oversight committee to not fully understand what the organization is doing.
Why does the board need to be surgical in its approach to ESG? Is it a question of compliance with regulations? Fulfillment of stakeholder expectations?
I would not characterize it as “surgical.” I think the better term is that the board must be “fully informed,” both factually and legally and from a regulatory perspective, as well as highly engaged, but without inappropriately performing management functions. Before ESG became such a critical area of governance focus, boards typically were better versed in one or two of the pillars, but not all three. Now, because of the lens through which these issues are being monitored and analyzed, all the major thought leaders in the governance field are doing everything they can to educate directors of private companies, public companies, and nonprofit organizations, so that they have a fundamental understanding of what it all means, and how best to address it in the context of their organization’s realities.
What goes into a board self-assessment program and how can it be used more effectively or efficiently?
That’s something I feel pretty strongly about. To set the table for that discussion, best practices in board self-assessments have varied dramatically over the past 25 years, depending on the industry and the size of the company, and whether it is private or public. In some spaces in the financial services industry, there have been very specific mandates for conducting self-assessments by boards, such as that they are performed annually to ensure that the board is dedicated to continuous self-improvement. In most other industries, while it has not been a regulatory imperative, over the past 10 years—I think it started really with the Sarbanes-Oxley expectations of audit committees and public boards— it has been moving in that direction.
If you were to do a survey today of small private and mid-cap companies, I wouldn’t be surprised if you found that many boards use questionnaires on an annual basis to guide the discussion of the entire board, to address a myriad of topics, including how well-prepared board members are for the meetings, how engaged each director is and, generally, whether they are fulfilling all their responsibilities. At the other end of the spectrum in terms of sophistication, you have boards that are addressing this topic more frequently than once a year; some boards are seeking written affirmations from their directors about their level of engagement over the entire year and pushing educational initiatives throughout the year to ensure that the directors keep pace with changing internal and external environments.
So, it’s very clear to me that the trend now is toward a more robust self-assessment process. And as is often the case, smaller and less-well-capitalized organizations look to larger, and often public, company standards for guidance and emerging best practices, and then tailor those practices to their own organization. There are outside experts who are now assisting boards as discussion facilitators and, even more importantly, thought partners on how to implement and measure the effectiveness of a new governance model. I think this is a topic that will continue to be a very, very high priority for all companies moving forward. And as I said, my own view is that it dates back to roughly the early aughts, when a spotlight was shone on the board in a number of different corporate scandals.
How have ESG demands impacted board members’ compensation?
In my experience, I would say at most indirectly. When you discuss the board’s compensation, it is usually set based on several considerations. I think that ESG demands are impacting the compensation of management teams and senior leadership teams more than directors because, as I said, it’s become a critical strategic imperative, and if it’s not fulfilled, the company doesn’t flourish and concomitantly is exposed to unacceptable risks. So, boards tend to be measuring the leadership team’s fulfillment of its ESG responsibilities, particularly the CEO when setting her salary, but I don’t find that it’s a direct consideration when you talk about annual compensation for directors. Now, hypothetically speaking, if an organization were to fail miserably in fulfilling its ESG strategy, including exposing shareholders and others to unacceptable risks, it certainly is conceivable that the board would say, “We have not fulfilled our oversight responsibilities, and therefore, that should be a material consideration when we set our own compensation.”
Published May 31, 2022.