Building climate competency into corporate governance structures

This is the second article in a three-part series about increasing the climate competency on corporate boards. Building on part one, which offered some context about investor expectations around board climate competency and the role corporate secretaries can play, the second installment takes a deeper look at specific climate issues and concerns boards could address.

Now that major institutional investors including CalPERS, New York City Retirement Funds, CalSTRS, State Street Global Advisors and BlackRock have raised the issue of board and director accountability on climate issues, corporate governance guidance is evolving to define the concept of climate competency.

A key role for corporate secretaries will be to provide boards with information about current trends and educational materials about the way they should think about and respond to climate issues raised by management, investors or other stakeholders concerned about climate risk and its impacts on business operations and strategies.

Until recently corporate governance professionals have interpreted their role as one that helps insulate the board from outside pressure, often by deflecting queries by major investors either to senior executives or a few steps down leadership hierarchy to sustainability officers. That’s counter to prevailing best practices, which encourage opportunities for board level engagement and director communication with shareholders.

For its report, View from the top: How corporate boards engage on sustainability performance, Ceres, the nonprofit that promotes sustainability initiatives among business and investors, interviewed dozens of sitting directors to explore the role of boards in enhancing sustainability performance. The report identifies two key strategies for effective board engagement that can produce tangible efforts by companies to address and mitigate their environmental and social impacts. First, sustainability should be identified and integrated in board governance systems, and second, sustainability concerns should be a subject of board actions. including providing direction to management on these issues.

While most ‘climate-exposed’ companies nowadays have staff that monitor regulatory and competitive developments related to climate change, rarely do climate issues make it onto a board’s agenda. The board chair or presiding director might take the next step toward setting targets for reducing greenhouse gas emissions from its operations by scheduling presentation to the board to elicit directors’ input.”] And yet unless this issue can break out of the usual technical silos and become a core strategic priority that helps shape long-term planning, shareholders cannot be assured that directors are serious about ensuring long-term viability of the company’s business model. 

Improving the board’s climate competency starts with adding directors who bring an awareness of climate science, an ability to grasp its business implications, and a willingness to think independently and revisit long-held business assumptions. Diversity of experience, background, skills and thinking are key to board dynamics that facilitate big-picture thinking for the long term.

Corporate secretaries can provide data to boards showing why clear disclosures related to company vulnerabilities to evolving regulations and market conditions are important to their stockholders. Furthermore, corporate secretaries can argue that clear disclosures are likely a foundation for improving their companies’ long-term strategic planning. Climate-competent directors should be able to ask the right questions of management and outside experts and get responses that will help them interpret scenarios based on the constraints of the COP21 agreement signed in Paris last fall and regulatory requirements. Boards should have the skills needed to assess information regarding carbon asset risk in their company business models and incorporate this risk analysis into strategic planning.

A key service that corporate secretaries could provide is to increase directors’ access to relevant high-quality data and to bring in experts to help them better understand that data. This would help offset the imbalance in information on firms’ climate impacts between the board and the management team, which typically has more detailed knowledge about the business. Directors often feel at a disadvantage when management is pressing a particular point of view about risk or strategic planning. With access to specialists who can help them fashion analyses based on a range of potential outcomes, climate-competent directors should feel emboldened to challenge management on points that directors feel don’t stand up to analytical scrutiny. Only then will board leadership be in a position to contribute meaningfully to long-term strategic planning, which it should press management to approach with longer time horizons in mind.

Boards, with the help of corporate secretaries, need to be able to determine where climate-associated risk issues should be addressed in their governance structures. Audit committees may be too stretched by their responsibility for financial management oversight to be able to take on additional duties related to climate risk, while the sustainability or public policy committees may be too far removed for fundamental business strategy purposes. Whatever the decision, board accountability for climate issues should be assigned and the committee that ultimately takes it on should be regularly evaluated for effectiveness.

A fundamental role for the board is to reward and motivate top executives through a well-designed compensation program. As the setting of operational and financial metrics increasingly takes projected climate impacts into account, appropriate metrics that can incentivize long-term sustainable growth will be needed. Operational metrics that reward increased production of carbon-intensive products (including those related to reserve replacement for extractive industries) may exacerbate a company’s exposure to the risk of stranded assets. Compensation committees should design pay plans that include rigorous holding and retention requirements for performance-based stock awards. Long-term incentives should be decoupled from quarterly total shareholder return targets. Effective board oversight of compensation should consider the extent to which capital expenditures are tied to assets with elevated risks associated with greenhouse gas emissions, water usage, energy efficiency, and the like. It may become advisable for compensation committee charters to be revised to require a higher climate-related skill set of committee members.

Boards should be aware of the importance of enhanced disclosure around political lobbying efforts and financial contributions by companies with the intent to influence public policy around climate impacts. This will broaden the context that directors consider when evaluating regulatory and political risk. Governance committee charters should include guidelines that align companies’ lobbying and contribution policies with their publicly disclosed sustainability plans. Lobbying efforts that are found to be inconsistent with company-stated sustainability policies may damage corporate reputations and branding, and erode public good will, and investors’ trust in company disclosures.

Investors’ growing concern about board’ climate competency is reflected in increased demand by shareholders for direct engagement with directors on related issues. These investors will increasingly hold boards to account for their decisions regarding director recruitment, executive compensation, risk management and disclosure policies. Corporate secretaries can help ensure that directors strengthen their climate competency so their engagement with shareholders on these topics can be more thorough and positive.