Environmental, social and governance (“ESG”) factors now play a major role in corporate decision-making. The ESG Global Study 2022 published by the Capital Group reveals that 26% of global investors say that ESG concerns are “central” to their investment approach.1 Regulators have also taken notice, with the Securities and Exchange Commission announcing last year that it was exploring ways to develop and implement standardized disclosure rules for communicating environmental metrics.2
The question for many business leaders is no longer whether to engage with ESG causes, but how to do so effectively. This article discusses legal strategies that business owners, directors, officers and management should consider when implementing ESG initiatives.
ESG considerations can be at the heart of what your company does. If so, one way to put your ESG efforts at the center of your business is to incorporate or convert to a public benefit corporation (“PBC”). Available in most states, a PBC is a separate business form that requires a business to state in its charter document what benefit it will pursue and how it will do so. Incorporating as a PBC has the benefit of placing your ESG objective at the heart of your business model and can help with recruitment and retention. This structure also makes it clear that directors and officers can place the public interest at the heart of decision-making without fear of facing fiduciary claims. However, this form of business can come at a cost; PBC bylaws typically have mandatory reporting requirements and subject the company to potential challenges from shareholders regarding progress toward the stated public interest. Although this is an important step that may require additional start-up capital to set up appropriate reporting structures, incorporating as a PBC makes it clear that your ESG objective is just as important as research. of profits.
Organizational documents and policy statements
A less drastic but still impactful way to focus on ESG issues is to meaningfully discuss your ESG objectives in your company’s organizational documents. There are many options here, ranging from setting out specific guidelines for directors and officers, to creating director or officer positions to monitor progress, or more generally – if your jurisdiction permits, simply clearly state that consideration of ESG factors will not violate fiduciary obligations. Keep in mind that governance documents may not be easy to change, especially if your business has many owners. It may therefore be difficult to adopt a language acceptable to a required number of shareholders. However, the benefits of discussing ESG objectives in your charter documents are twofold: (1) the company will have demonstrated focus and clear commitment to ESG issues at the highest level; and (2) the company will have a structure and roadmap to implement the initiative. If it is not possible to change organizational documents (or even if you have already done so), consider developing an ESG policy statement that identifies the main objectives you hope to achieve. This statement should detail in plain language the specific ESG objective(s) you seek to achieve and should include specific metrics you will use going forward to measure progress, such as tracking diversity in hiring, emissions greenhouse gas emissions, philanthropic contributions or gender pay equity.
Supplier and vendor relations
A key component of the success of many businesses is strong relationships with external vendors, vendors and service providers. These relationships also provide a critical opportunity for a company to pursue its ESG objective by strategically choosing to partner with others who share similar values. In practice, it can be difficult to find much information about a third party’s ESG initiatives based solely on publicly available information. Opening a dialogue on these issues can lead to a surprising realization that your vendor or supplier already has ESG programs or measures in place. If not, consider what KPIs your company might want included in the next contract renewal and have open discussions about compliance costs. One thing is certain here: if you don’t discuss ESG concerns with your vendors, service providers or suppliers, they will never know that these issues are important to your business.
Pay careful attention to acquisition targets
If your business is growing through mergers and acquisitions, strategically selecting your next target can advance your ESG goals. Consider developing an ESG section in your due diligence questionnaire to potential targets or incorporating ESG topics into interviews with key personnel. Emphasizing ESG concerns in the due diligence process can help uncover hidden risks in areas such as energy consumption, supply chain management, diversity and inclusion efforts and cybersecurity.
Facing the backlash
Directors and executives may be surprised to find that implementing an ESG strategy can provoke negative reactions from investors, employees or other important stakeholders. ESG factors are now in the political crosshairs, as Texas recently passed legislation prohibiting state pension and investment funds from doing business with companies that boycott fossil fuel companies and Florida recently announced that it would consider legislation prohibiting its state pension fund from screening investments based on ESG criteria.
At the company level, if the message doesn’t resonate on a moral level, one way to deal with any backlash is to focus the conversation on the positive financial impacts of ESG initiatives. A recent meta-analysis of over 1,000 ESG studies showed that 58% found a positive relationship between ESG and financial performance.3 Another study from 2020 states that “Companies with high ESG scores on average experienced lower costs of capital than companies with poor ESG scores”.4 Additionally, defining ESG initiatives as improving corporate decision-making, ensuring pay equity, and fostering a culture of thoughtful leadership can minimize dissent and demonstrate how management is living up to its fiduciary responsibilities.
Key points to remember
ESG initiatives can cover a wide range of topics and involve various segments of your business. The key is to start with a clear plan at the highest levels of your organization to properly identify the issues and define how you will measure success. Beyond a good policy statement, think critically about how your strategic partners and alliances can advance your ESG goals, and be prepared for backlash from unexpected sources.