Category: Corporate Governance

State legislation targets company policies on ESG—how will it affect the corporate balancing act?

Over the past several years of political discord, many CEOs have felt the need to voice their views on important political, environmental and social issues. For example, after the murder of George Floyd and resulting national protests, many of the country’s largest corporations expressed solidarity and pledged support for racial justice. After January 6, a number of companies announced that their corporate PACs had suspended—temporarily or permanently—their contributions to one or both political parties or to lawmakers who objected to certification of the presidential election.  Historically, companies have faced reputational risk for taking—or not taking—positions on some political, environmental or social issues, which can certainly impair a company’s social capital and, in some cases, its performance.  These types of risks can be more nebulous and unpredictable than traditional operating or financial risks—and the extent of potential damage may be more difficult to gauge. As if it weren’t hard enough for companies to figure out whether and how to respond to social crises, now, another potent ingredient has been stirred into the mix: the actions of state and local governments—wielding the levers of government—to enact legislation or take executive action that targets companies that express public positions on sociopolitical issues or conduct their businesses in a manner disfavored by the government in power.  As described by Bloomberg, while “companies usually faced mainly reputational damage for their social actions, politicians are increasingly eager to craft legislation that can be used as a cudgel against businesses that don’t share their social views.” And many of these actions are aimed, not just at expressed political positions, but rather at environmental and social measures that companies may view as strictly responsive to investor or employee concerns, shareholder proposals, current or anticipated governmental regulation, identified business risks or even business opportunities. How will these legislative trends affect the difficult corporate balancing act?

SEC approves new PCAOB requirements for lead auditor’s use of other auditors

At the end of last week, the SEC approved the PCAOB’s updated standards for audits that involve multiple auditing firms. SEC Chair Gary Gensler said that the amended standards “will strengthen the requirements for lead auditors who supervise other auditors in an audit, helping to enhance audit quality and protect investors.”  Why were these updates necessary? According to Gensler, the globalization and increasing complexity of public company operations has meant that auditors must increasingly “rely on other auditors—working across different firms, countries, and even languages—in completing an audit. Last year,” he said, “26 percent of all issuer audit engagements used multiple auditors, and more than half of large accelerated filer audits used multiple auditors. Given the challenges that such multi-firm audits present, it is important that there be robust standards for how lead auditors supervise, communicate with, and coordinate with other auditors on the audit engagement.”  Gensler noted that the updates enhance the standards “across two broad areas. First, the amended standards specify certain procedures for lead auditors to perform when supervising other auditors. Second, they require lead auditors to prioritize their supervisory activities around higher-risk areas in the audit.”  PCAOB Chair Erica Williams observed that companies “continue to increase their global presence. As a result, the use of other auditors has become more prevalent in the conduct of an audit, which can create additional challenges for the lead auditor. Adding other auditors into the process requires careful consideration and clear communications between all auditors involved in the audit. And when miscommunication occurs or when there are misunderstandings about the nature, timing, and extent of the other auditor’s procedures, audit quality will likely suffer.” It’s worth noting that some aspects of the new amendments will affect communications with the audit committee. The amendments will be effective for audits of financial statements for fiscal years ending on or after December 15, 2024.

ESG metrics in compensation plans—a growing trend

Consultant Semler Brossy’s new report, ESG+Incentives, examines the prevalence of various ESG metrics as part of incentive compensation structures among companies in the S&P 500. Although some view ESG targets as just too nebulous to measure—how do you measure company culture?—and too amenable to “architecting” to ensure executive payouts, the use of ESG metrics as part of executive compensation plans appears to be a growing trend. The report concludes that the majority of companies in the S&P 500 now include ESG metrics, largely reflecting increased stakeholder interest in human capital and environmental issues. In 2022, “there was a nearly 23% increase in the proportion of S&P 500 companies applying ESG metrics in incentive plans, at 70% prevalence compared to 57% prevalence a year ago”—that’s a 13 percentage point increase year over year. Metrics related to human capital management were included most often as part of comp plans—used by 65% of all companies in the S&P 500, meaning that almost all companies that included any ESG metrics included HCM metrics.  And, while environmental metrics still remained scarce at only 23%, that percentage reflects a 64% increase over the 14% reported last year. The report indicates that the predominant metric overall was diversity and inclusion (46% of companies in the S&P 500); carbon-footprint metrics predominate in the environmental category, having increased by over 300% from last year.

Board refreshment: are evaluations preferable to retirement policies?

A new report from The Conference Board (together with ESG data analytics firm ESGAUGE) , Board Refreshment and Evaluations, indicates that, in pursuit of board diversity—in skills, professional experience, gender, race/ethnicity, demography or other background characteristic—companies must overcome one key impediment: relatively low board turnover.  One approach is just to increase the size of the board; another is through “board refreshment.” To that end, the report observes, companies are relying less on director retirement policies based on tenure or age—which may sometimes be viewed as misguided and arbitrary—and looking instead to comprehensive board evaluations, sometimes conducted by a facilitator, as a way to achieve board refreshment. The Conference Board advocates that companies foster a “culture of board refreshment” that removes any stigma that could otherwise attach to an early departure from the board. In any event, The Conference Board cautions that “companies should expect continued investor scrutiny in this area. Indeed, while institutional investors may defer to the board on whether to adopt mandatory retirement policies, many are keeping a close eye on average board tenure and the balance of tenures among directors and will generally vote against directors who serve on too many boards.”

What’s wrong with ESG ratings?

About a year ago, the Brookings Institution held a panel discussion regarding the role that the SEC should play in ESG investing and invited SEC Commissioner Hester Peirce to speak at the panel. It’s well known, of course, that she is not exactly a fangirl of ESG in any of its manifestations, and she came prepared to engage, armed with a voluminous speech consisting of 10 theses, footnoted to the hilt. One of her theses was that figuring out what “good” means in the context of ESG is very subjective—that’s why, she said, there’s a lot of debate over best ESG practices and that’s especially why ESG ratings firms are so inconsistent in their results. (See this PubCo post.) There may be even more to it than that.  This new paper, ESG ratings—a compass without direction, from the Rock Center for Corporate Governance at Stanford University, looks at ESG ratings and examines issues about their reliability. The authors conclude that, “while ESG ratings providers may convey important insights into the nonfinancial impact of companies, significant shortcomings exist in their objectives, methodologies, and incentives which detract from the informativeness of their assessments.” 

More prescriptive proposals, less support for 2022 proxy season

This proxy season, companies saw more shareholder proposals than in the past, a change that has been widely attributed to actions by the SEC and its Division of Corporation Finance that had the effect of making exclusion of shareholder proposals—particularly proposals related to environmental and social issues—more of a challenge for companies. As discussed in this article in the WSJ, investors are taking the opportunity to press for more changes at companies. Nevertheless, the prescriptive nature of many of the proposals, especially climate-related proposals, has prompted many shareholders, including major asset managers, to vote against these proposals. Will next season reflect lessons learned by shareholder proponents from this proxy season?

SOX at 20! Happy birthday SOX!

SEC Chair Gary Gensler may just have some paternal affection for SOX, especially on the week of its 20th birthday.   In these remarks to the Center for Audit Quality,  he recalls having “a front-row seat” for the negotiations and signing of the bill, working as Senior Advisor to the late Senator Paul Sarbanes on this legislation. The bill passed the House almost unanimously and the Senate by a vote of 99 to 0—hard to imagine that ever happened, let alone only 20 years ago.  In giving SOX its 20-year review, he discusses the significant role SOX played in restoring public trust in the financial system after the Enron and WorldCom scandals, but also offers some, let’s say, opportunities for improvement. (He also drops the hint that the SEC may be taking a “fresh look at the SEC’s auditor independence rules.”)

More independent board chairs—but not for the reason you think

Independent board chairs may no longer be absolutely de rigueur from a corporate governance perspective—even ISS has a somewhat nuanced view on the subject—but the percentage of independent board chairs has been increasing these days. So why is that?  According to a recent report from The Conference Board, it’s not, as you might have expected, because of shareholder proposals requesting a separation of these roles to shore up board independence; rather, “it’s likely driven by CEO succession events, as well as the growing workloads of boards and management.”

How are boards addressing sustainability?

With regulators in the U.S. and around the world looking hard at the possibility of imposing sustainability disclosure requirements, and investors and other stakeholders continuing to focus on sustainability in their engagements with companies—according to a PwC survey, “ESG is the topic investors most want to discuss during engagements with shareholders”—one question that arises is just what corporate boards are doing to deal with sustainability—what are their attitudes and commitments? Are they even prepared to address sustainability issues? In an article reporting on a 2022 survey by consulting firm Russell Reynolds (published on the Harvard Law School Forum on Corporate Governance), the firm tried to answer these questions. One conclusion from the survey: “Rather than having a sole ‘ESG director’ or ‘sustainability director,’ expectations are increasing for the entire board to bring a minimum level of sustainability awareness—if not expertise—to their work, using it to identify both risks and new opportunities for value creation.”

SEC cuts key provisions of proxy advisor regulations

[This post revises and updates my earlier post primarily to reflect the contents of the proposing release.]

At an open meeting last week, the SEC voted, three to two, to adopt new amendments to the rules regarding proxy advisory firms, such as ISS and Glass Lewis—which the SEC refers to as proxy voting advice businesses, or “PVABs”—terms that the commissioners seemed to think…hmmm… needed some work. The amendments to the PVAB rules reverse some of the key provisions governing proxy voting advice that were adopted in July 2020 (referred to as the 2020 Final Rules). Those rules had codified the SEC’s interpretation that made proxy voting advice subject to the proxy solicitation rules, but added to the exemptions from those solicitation rules two significant new conditions—one requiring disclosure of conflicts of interest and the second designed to facilitate effective engagement between PVABs and the companies that are the subjects of their advice. (See this PubCo post.) Under the new final amendments as adopted last week, proxy voting advice will still be considered a “solicitation” under the proxy rules and proxy advisory firms will still be subject to the requirement to disclose conflicts of interest; however, the new amendments rescind that second central condition designed to facilitate engagement—which some might characterize as a core element, if not the core element, of the 2020 amendments. The amendments also rescind a note to Rule 14a-9, also adopted as part of the 2020 Final Rules, which provided examples of situations in which the failure to disclose certain information in proxy voting advice may be considered misleading. According to the press release, institutional investors and other clients of proxy advisory firms had “continued to express concerns that these conditions could impose increased compliance costs on proxy voting advice businesses and impair the independence and timeliness of their proxy voting advice.” In his statement, SEC Chair Gary Gensler observed that many investors expressed concerns that “certain conditions in the 2020 rule might restrain independent proxy voting advice. Given those concerns, we have revisited certain conditions and determined that the risks they impose to the independence and timeliness of proxy voting advice are not justified by their informational benefits.”