Board Oversight of ESG and Diversity Risks

Article Summary

Companies across the United States are grappling with the myriad of social, environmental and economic challenges of the past few years—from the Covid-19 pandemic to heightened political and social justice concerns to extreme economic conditions. PwC’s 2021 Annual Corporate Directors Survey reveals the significant impact of these risks and sheds light on the changes boards are making in response to the dynamic environment.

Directors say six risk issues demand particular focus, which PwC divides into the categories of “ESG & Strategy” and “Board Practices.”

ESG & Strategy Issues:

1. Board ESG oversight
2. Connecting ESG corporate strategy
3. Talent management and the future of work

Board Practices Issues:

4. Board diversity
5. Board assessments
6. Board priorities

#1 Issue: Board ESG Oversight

According to the PwC Annual Corporate Directors survey, ESG is the top risk issue shareholders want to discuss with directors. But, with only 25 percent of directors reporting their boards understand ESG risks, boards first need to provide directors with education about ESG oversight.

ESG refers to environmental, social and governance issues, which leading companies increasingly see as a “business imperative.” In 2021, 52 percent of directors say ESG issues are regularly on the board’s agenda, up from 34 percent in 2019 and 45 percent in 2020.

PwC suggests boards ask the following questions to bolster ESG oversight:

• Strategy: Are ESG risks and opportunities integrated into the company’s long-term strategy? How is the company measuring and monitoring its progress against milestones and goals set as part of the strategy?
• Messaging: Do ESG messaging and activities align with the company’s purpose and stakeholder interests?
• Risk assessment: Have material ESG risks been identified and incorporated into the ERM? Has the board allocated the oversight of these risks to the full board or individual committees?
• Reporting: What is the best communication platform to use for the company’s ESG disclosures?

#2 Issue: Connecting ESG to Corporate Strategy

More boards are linking ESG to company strategy—64 percent compared to 49 percent in 2020. It’s notable that 62 percent of directors also say ESG is directly linked to their company’s enterprise risk management (ERM) discussions, up from 55 percent a year ago.

Because the board of directors is charged with taking a long view on company strategy, PwC asserts board oversight of how companies are embedding ESG issues into corporate strategy should be of utmost importance. This companion article, “ESG Oversight: The corporate director’s guide,” provides suggestions such as tying executive compensation to non-financial metrics.

#3 Issue: Talent Management and the Future of Work

The Covid-19 pandemic singularly and radically shaped the workplace, so it’s not surprising that directors ranked talent management as a top risk. According to the PwC 2021 Annual Corporate Directors Survey, nearly three-quarters of directors say their company has increased its discussion of human capital or D&I strategy at the board level—particularly among larger companies.

For companies to effectively compete in the growing “war on talent,” boards must provide oversight to ensure their companies are “employers of choice” by:

• Attracting the best talent
• Understanding how the company is differentiating itself (as an employer)
• Being involved in decisions about the company’s workforce strategy
• Ensuring the company’s workforce strategy aligns with diversity and inclusion (D&I) goals

The survey indicated a particular attitudinal shift in how directors are thinking about D&I. More than half of respondents (52 percent) say incentive plan goals should be tied to D&I metrics, up 13 points from a year ago.

#4 Issue: Board Diversity

Nearly 70 percent of directors say, in the past two years, their board has replaced a retiring director with a director who increases the board diversity.

Board refreshment remains a concern—47 percent say that at least one fellow board member should be replaced. As boards think about replacement, racial and ethnic diversity tops the search criteria for new directors (25 percent). Gender diversity ranked much lower at 12 percent—likely a reflection of positive movement in recent years.

But board diversity won’t happen on its own. The PwC 2021 Annual Corporate Directors Survey indicates a significant shift has occurred among directors, who are much more supportive of being more intentional to achieve diversity:

• 88 percent support board policies of always interviewing a diverse state of candidates (e.g. the “Rooney Rule”)
• 85 percent support a search firm policy of always offering diverse slates of candidates
• 69 percent support institutional investor engagement with companies lacking board diversity
• 64 percent even support SEC or listing agency rules requiring the disclosure of board diversity.

PwC recommends the full board should think about what its composition should look like in the future, and create a plan to get there.

#5 Issue: Board Assessments

Assessments—of the full board, committees and individual directors—are an important element of effective board oversight.

Overall, directors are pleased with their assessment processes:

• 88 percent say their board has an effective process
• 76 percent say there is sufficient follow-up after the assessment

However, 67 percent of directors say it is difficult to be completely “frank,” throughout the process, and more than half (52 percent) describe the assessment process as a “check the box” exercise.

PwC recommends that boards conduct annual director assessments, with the board chair or director holding individual meetings with each director to discuss the feedback.

#6 Issue: Board Priorities

Time is the biggest constraint for directors—too much to do in too little time. While talent management topped the risk issues priority list in the PwC 2021 Annual Corporate Directors Survey, likely due to the impact of Covid-19, time must also be allocated to the other noted issues (ESG, D&I, board practices).

Original Article Source: “PwC’s 2021 Annual Corporate Directors Survey: The director’s new playbook: Taking on change“, PwC, 2021