American Association for Physician Leadership

Strategy and Innovation

Research: Boards Still Have an ESG Expertise Gap — But They’re Improving

Tensie Whelan

May 7, 2024


Summary:

The role of U.S. public boards in managing environmental, social, and governance (ESG) issues has significantly evolved over the past five years. Despite this progress, major gaps remain, particularly in climate change and worker welfare expertise. Notably, the creation of dedicated ESG/sustainability committees has surged, promoting better oversight of sustainability issues. This shift is crucial as companies increasingly face both regulatory pressures and strategic opportunities in transitioning to a low carbon economy.





Knowing the right questions to ask management on material environmental, social, and governance issues has become an important part of a board’s role. Five years ago, our research at NYU Stern Center for Sustainable Business found U.S. public boards were not fit for this purpose — very few had the background and credentials necessary to provide oversight of ESG topics such as climate, employee welfare, financial hygiene, and cybersecurity. Today, we find that while boards are still woefully underprepared in certain areas, there has been some important progress.

Board Progress on ESG

Having ESG expertise on boards is becoming increasingly imperative. New regulations in Europe, North America, and elsewhere are requiring more robust ESG reporting and disclosure for boards. The new SEC climate rule in the U.S., for example, requires board oversight and engagement on climate topics. In addition, there are a growing number of lawsuits against companies (more than 1,500 in the U.S. alone) that have contributed to climate change, engaged in greenwashing, mistreated their employees, have human rights abuses in their supply chains, and so on.

In 2018, our review of environmental, social, or governance-related credentials of all 1,188 board members on the Fortune 100 identified 29% of directors with one or more relevant ESG credentials. In 2023 (in research undertaken with assistance from NYU MBA candidate Ozair Arfi), we found that number jumped to 43% of the 1,161 board members now sitting on Fortune 100 boards. The growth came in environmental credentials, which nearly doubled, and governance credentials, which nearly tripled. Social credentials, which was by far the best represented category in 2018, remained close to flat in 2023 (at 253 members), while maintaining its place as the area with the most board experience. One hundred and eighty members had governance credentials and 153 had environmental credentials in 2023. Many more boards have installed ESG/sustainability committees, accelerating from 22 committees in 2018 to 89 in 2023.

Major weaknesses remain, however, particularly with regard to expertise in climate and worker welfare — two material sustainability topics for most businesses. We saw board members with cybersecurity credentials jump from 8 to 50, but climate only increased from 3 to 22. Both represent material and systemic risks and opportunities, yet climate is not being considered as seriously as cybersecurity at the board level. On the social side, while diversity credentials have increased substantially from 60 to 108 (representing the largest ESG credentialed category), only seven had credentials in labor relations.

An in-depth look at two companies illustrates the positive shifts we have seen:

In 2018, McKesson, which had been sued for contributing to the opioid crisis, and has material environmental (energy, materials, water), social (access to medicines, ethical clinical trials), and governance (misleading advertising, doctor “incentives”) issues, had no board members with any relevant ESG credentials. In 2023, they had two board members with environmental credentials (in renewable energy and sustainable business), three with social credentials (in workplace diversity, health care advocacy, and civil rights) and three with governance credentials (telecommunications security, accounting, and corporate law). They had no ESG committee in 2018; they have one in 2023.

In 2018, Liberty Mutual, which sells property and casualty insurance, had no board members with climate credentials despite significant climate risk exposure, though two were affiliated with energy companies. In response to the growing strategic importance of climate change for the sector, by 2023 it had three board members with climate, low carbon transition, and renewable energy credentials. The company also now has two board members with social credentials in sustainable business and health care advocacy, but no board members with governance credentials (the lack of cybersecurity expertise stands out). In 2018, it did not have an ESG committee; today they do.

Steps to Improve ESG Governance

Whether companies are acting proactively like Liberty Mutual or reactively like McKesson, there is a growing consensus on what constitutes robust sustainability governance at the board level, summarized as follows:

Board credentials and training must include the material ESG issues confronting the sector.

If the company is in energy, they must understand climate trends. If it is in food, they must understand climate, water, biodiversity, and labor issues, and so on. Materiality matrices should help prioritize which issues to manage, and boards should be engaged in their drafting.

The board should understand upside opportunities and downside risks.

Often, board member sustainability engagement is confined to reviewing the annual ESG report and downside risks. However, board members should also understand the upside opportunities related to sustainability and what the risks and costs are with maintaining a “business as usual” approach.

The board must have a sustainability/ESG committee.

Creating a stand-alone sustainability/ESG committee will provide the board with the time and focus needed to provide oversight of business strategy issues and capital allocation related to sustainability.

Nominating, audit/risk, and compensation committees should include relevant ESG topics.

The other committees on boards are not off the hook. Nominating committees can work on recruiting board members with relevant ESG credentials as well as organize training for current members. The compensation committee can include sustainability targets in compensation — some 75% of Fortune 500 companies are doing so today. Audit/risk should review the quality of ESG reporting data and ensure appropriate assurance.

Return on sustainability investment (ROSI) KPIs must be used in addition to reporting and compliance.

Our past research finds that ESG reporting metrics are process- and output-based and generally do not drive better performance from either a financial or societal perspective. In other words, they measure whether a company has a policy, but not the outcomes of the policy. As with other aspects of the business, the board should sign off on company-wide key performance indicators on material sustainability topics (that track outcomes such as energy use reduction) as well as require the management team to track the financial benefits of embedded sustainability (e.g. lower energy costs and reduced regulatory risk). Research into the return on sustainability investment (ROSI) demonstrates that sustainability practices can drive operational efficiency, sales and marketing, risk mitigation, employee productivity and retention, supplier resiliency, and other benefits. Therefore, to drive better performance, the board should ask to review KPIs on the sustainability practices, the ROSI KPIs to track financial performance, and then have the executive team map them to the required ESG reporting metrics.

The world is beginning a transition to a low carbon economy, one where a host of environmental and social issues are driving risks and opportunities for all business leaders. To provide effective oversight of the company, board members can best meet their fiduciary duty by making sure they understand their company’s sustainability strategy and performance, and provide appropriate strategic oversight and course correction as needed.

Copyright 2024 Harvard Business School Publishing Corporation. Distributed by The New York Times Syndicate.

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Tensie Whelan

Tensie Whelan is a clinical professor of business and society and the director of the NYU Stern Center for Sustainable Business, and she sits on the advisory boards of Arabesque and Inherent Group.

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