Gouvernance | Page 2

Sur le blogue d’Harvard, Michael W. Peregrine, Ralph DeJong et Sandy DiVarco reviennent en 10 points sur l’impact de la COVID-19 pour la gouvernance d’entreprise : « The Long-Term Impact of the Pandemic on Corporate Governance » (Harvard Law School Forum on Corporate Governance, 16 juillet 2020).

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1. The Board/Management Dynamic

The board and management should be alert to the need for clarity on lines of decision-making authority between them.

The ability of both senior leadership components to execute their duties in times of crisis requires a shared understanding of the basic distinctions between the roles of governance and of management. This is particularly the case as both seek to satisfy enhanced expectations of their conduct created by the crisis.

The Business Roundtable’s statement of governance principles [1] ascribe to the board the basic responsibility for oversight of corporate management and business strategies, consistent with the goal of long-term sustainability. It ascribes to management responsibility for establishing, managing, and implementing corporate strategies, including but not limited to the day-to-day operations of the company under board oversight and updating the board on operational status.

But the line separating what is the responsibility of the board, and what is the responsibility of management, tends to blur in times of crisis. The absence of a “bright line” separating their respective duties can be the source of much leadership-level friction. It is vitally important that the parties work diligently to establish understandable lines of authority that assure the sustainability of organizational decisions and avoid confusion.

2. Greater Board Engagement

Boards of health care entities are likely to retain for the foreseeable future a heightened level of engagement with governance responsibilities, and with management.

Disasters, such as the pandemic, call for board involvement beyond that contemplated by basic governance principles. The pandemic presents such fundamental challenges to corporate stability that the organizational response cannot be delegated to executive management as it would be in the normal course, or even with more traditional crises.

It’s a level of engagement that will be difficult to withdraw from, at least for the near term. For one reason, commerce can be expected to remain in some uproar until public health concerns have been satisfactorily addressed. The leadership, scrutiny, and perspective offered by the board will remain at a premium. For another reason, the lasting impact of the crisis on industries and individual company business models will take time to realize and address. The board will need to remain at a heightened level of attentiveness to evaluate this change. In addition, it is now clear that boards can stay well involved through a variety of “virtual” means; it is logistically easier to perform their duties.

3. Oversight of Business Resiliency

The obligation to exercise oversight of business resiliency will become a primary board focus going forward.

The evolution of the pandemic to the resumption of sustained economic activity prompts the board to pivot to its unique oversight obligation for business resiliency. This refers to concepts of oversight that focus on long-term business and cultural ‘bounce-back’ from truly abrupt disruptions of cross-industry, national, or global proportions. It is a critical board obligation under the circumstances, but one that nevertheless should be exercised with discretion to avoid unnecessary conflict with management.

Business resiliency is an essential part of the board’s risk oversight function. It is grounded in the obligation to periodically review management’s plans to recover from catastrophe and disaster, including such tasks as business continuity, physical security, cybersecurity, and crisis management.

Ultimately, this responsibility encompasses several basic categories: whether there is a plan for getting the organization back on its feet; which corporate officers are designated to lead the effort; whether outside advisors are to be consulted; what are the features of the plan; when is it to be initiated; and whether it addresses workforce health, safety, and support.

4. Enterprise Risk Management

One of the most significant governance implications of the pandemic may be its impact on the role and function of the board’s enterprise risk management (ERM) committee.

From one perspective, the pandemic may serve to elevate that committee to a role of greater significance, potentially on a par with that of the audit committee. From a related perspective, it may prompt significant board contemplation of the level of oversight expected from that committee.

The catalyst for such change is grounded in five interconnected factors: (i) the broad-based application of ERM-focused board committees; (ii) the nature and scope of the pandemic; (iii) the environment of “second guessing” on risk preparedness likely to emerge from the pandemic; (iv) the extent to which the Caremark [2]oversight standard has evolved over the past year; and (v) the lessons on risk identification disaster response that individual corporations are certain to take from the pandemic.

COVID-19 has validated the need for a vital ERM function. Perhaps more significant is the extent to which it has confirmed that cataclysmic disasters can indeed occur and may henceforth be given greater consideration in the ERM risk identification process. These factors will, in turn, place a premium on close board evaluation on the effectiveness of the current ERM program.

5. Quality and Patient Safety

A much greater level of system-wide board collaboration with management on quality of care and patient safety concerns can be expected.

The pandemic has shone a spotlight on the vital role of the board in supporting management to ensure that both that emergency preparedness and response efforts are fully coordinated, and that the impacts of a large-scale effort are analyzed from the perspective of those who are ultimately responsible for the operation of the health care enterprise.

In the past, governing boards may have considered “operational” subjects like quality of care, infection prevention, and shifts in regulatory compliance as solely the province of management and staff. Going forward, the effects of the national health emergency and the lasting influence it will have on health care operations indicate these areas are appropriate for board-level review and decision making. Oversight and inquiry to ensure that management and health care leaders have pressure-tested their plans, and considered the effect on the organization as a whole, is well within the scope of the governing board.

By way of example, the exigencies of the pandemic and the attendant stresses due to lack of health care equipment, staff, and resources have brought to the fore complex issues like rationing care and development of “crisis standards of care.” Board involvement in vetting and adopting care protocols or care priorities developed by the organization is important, as the potential risks—legal, ethical, and reputational—rest squarely with the organization.

6. Executive Compensation

Compensation Committees (and CEOs) will focus on greater discretion in executive pay programs, and on finding a new balance between salary and performance

Indeed, the lessons of the pandemic suggest that the Compensation Committee will need to address a variety of important and sometimes unique compensation concepts that may prompt a long-term expansion of its agenda.

For example, the Committee and the CEO will want to reach a new understanding on CEO emergency powers to change executive compensation during a crisis. From a talent development perspective (and to avoid losing key executives before or during a crisis), the Committee will want to review the overall retention effect of executive programs and determine when retention will be weakest.

A key pandemic lesson is the benefit of having an appropriate level of Compensation Committee discretion built into all executive compensation and benefit arrangements. This includes the flexibility in a crisis not to pay something, or to pay it later, as well as the flexibility to pay something different or additional when extraordinary circumstances intervene.

Long-standing executive pay or benefit programs should be taken off auto pilot and given a fresh look. This includes reviewing supplemental retirement plans to understand all costs under a wider range of financial scenarios, to assess long-term affordability, and to add discretion to suspend new benefits during a crisis.

Executives will be expected to conduct their work outside the traditional office setting. A mobile leadership model will have implications for paid time-off programs, productivity, availability, and performance evaluation.

With many organizations coming out of a period of executive pay reductions, and likely an absence of incentive pay awards, the Committee will wrestle with how to restore executive compensation. The Committee will have to decide whether lost amounts are restored, whether pay increases will be through salary or greater incentive opportunity, and whether restored base salaries will at least make the organization competitive for key leadership talent.

7. Scenario-based Technology Planning

More rigorous board oversight will be exercised over long-term access to key technology, equipment, and

The health care economy has long relied on the availability and effectiveness of both technology and the technicians who operate and maintain it. The pandemic and its collateral impact on technology’s adaptability has shaken that reliance with significant resulting risk implications for physician groups, providers, and similar health care enterprises.

Going forward, boards will be expected to assure that management has in place an effective emergency technology plan. Such a plan would be designed to address events and scenarios in which technology, equipment, personnel, or some combination thereof becomes unavailable, and to build a map of probabilities. Based on each emergency type, the plan would confront an operating model without historically available technology and assure access to both an off-site backup technology, and to additional technical support. Such a plan would anticipate how long the organization can effectively operate under emergency conditions. It should also identify necessary steps to obtain and implement replacement technology, equipment, and personnel— and both the time frame and cost of doing so.

The primary responsibility for scenario-based technology planning will, of course, be that of the management team. Yet with the pandemic’s lessons in mind, the board should exercise robust oversight of management’s planning (including engaging in mock “tech outages”) to help assure organizational preparedness.

8. Oversight of Workforce Culture

Employee health and safety will become a more important element of the board’s workforce culture oversight responsibilities.

It is increasingly recognized that boards have a fiduciary responsibility to exercise oversight of corporate culture. This is grounded in the perspective that a positive organizational culture can be a meaningful corporate asset in a variety of ways (e.g., influencing operational performance, talent development, and organizational reputation). One of the recognized iterations of culture is its extension to employee morale, prevention of sexual harassment, and promotion of inclusion in the workforce.

With companies moving to reopen their business locations, culture issues are also extending to the health, safety and morale of the workforce. Employee concerns in this regard, and a general awareness of the safety of the workplace, are likely to remain well after the broad application of a vaccine or other treatment for the virus. The success of the organization’s post-pandemic business model may depend in part on the sensitivity it displays to employee virus-related concerns. This sensitivity is likely to expand to general health and safety matters. An informed and engaged board can be a support and guidance resource to management’s efforts to address these matters.

9. Oversight of Compliance

Boards may recalibrate the compliance function (and their oversight of that function), to address new risks and to seek efficiencies.

From a risk perspective, this effort will be driven by the implicit recognition that the post-pandemic era will witness a broadening of governmental authority in general, and an increasingly complex national and international regulatory environment in particular.

This can already be seen through requirements relating to accessing federal pandemic relief funds; increasing concerns with the security of information technology, antitrust issues in the labor market, and evolving regulations from the Food and Drug Administration, Centers for Medicare & Medicaid Services, and others.

From a management perspective, boards may see greater efficiencies by moving away from traditional vertical “silo” reporting arrangements for compliance officers, to arrangements that seek targeted accountability for, and greater integration among, the various legal, compliance, and risk functions. Such arrangements are intended to allow for greater collaboration between officers with risk-related responsibilities and to achieve related efficiencies and cost savings without disturbing futility bypass arrangements.

10. Succession Planning

Executive, officer, and director succession planning will require far more consideration at the board

For many organizations, leadership succession policies and procedures have been too insufficient or too informal to address the breadth of related succession challenges arising from the pandemic. Going forward, boards are expected to treat succession matters with an enhanced level of attentiveness and formality, which will provide value to the organization.

For example, the Compensation Committee (or a designated executive succession committee) should work with senior leadership to create or update the executive succession plan for key leadership positions. This would likely include addressing emergency vacancies, longer-term successors, developing leadership skills and experience in future leaders, and retention arrangements for key leaders being groomed.

Other unique executive succession issues to be considered include: the return to work of recently retired CEOs and CFOs to support their successors during the crisis environment; having executives share certain tasks and responsibilities; identifying an interim successor if a previously identified successor is not ready to assume the position; the process for transitioning to the new/interim/emergency CEO; designating an experienced board member to serve as emergency or interim CEO; and more aggressive planning for director succession.

À la prochaine…

Dans un article du Financial Times (« European companies were more keen to cut divis than executive pay », 9 septembre 2020), il est observé que les assemblées annuelles de grandes entreprises européennes montrent des disparités concernant la protection des salariés et la réduction des dividendes.

Extrait :

Businesses in Spain, Italy, the Netherlands and the UK were more likely to cut dividends than executive pay this year, despite calls from shareholders for bosses to share the financial pain caused by the pandemic.

More than half of Spanish businesses examined by Georgeson, a corporate governance consultancy, cancelled, postponed or reduced dividends in 2020. Only 29 per cent introduced a temporary reduction in executive pay. In Italy, 44 per cent of companies changed their dividend policies because of Covid-19, but just 29 per cent cut pay for bosses, according to the review of the annual meeting season in Europe.

This disparity between protection of salaries and bonuses at the top while shareholders have been hit with widespread dividend cuts is emerging as a flashpoint for investors. Asset managers such as Schroders and M&G have spoken out about the need for companies to show restraint on pay if they are cutting dividends or receiving government support. “Executive remuneration remains a key focal point for investors and was amongst the most contested resolutions in the majority of the markets,” said Georgeson’s Domenic Brancati.

But he added that despite this focus, shareholder revolts over executive pay had fallen slightly across Europe compared with 2019 — suggesting that investors were giving companies some leeway on how they dealt with the pandemic. Investors could become more vocal about this issue next year, he said.

One UK-based asset manager said it was “still having lots of conversations with companies around pay” but for this year had decided not to vote against companies on the issue. But it added the business would watch remuneration and dividends closely next year.

Companies around the world have cut or cancelled dividends in response to the crisis, hitting income streams for many investors. According to Janus Henderson, global dividends had their biggest quarterly fall in a decade during the second quarter, with more than $100bn wiped off their value. The Georgeson data shows that almost half of UK companies changed their dividend payout, while less than 45 per cent altered executive remuneration. In the Netherlands, executive pay took a hit at 29 per cent of companies, while 34 per cent adjusted dividends. In contrast, a quarter of Swiss executives were hit with a pay cut but only a fifth of companies cut or cancelled their dividend.

The Georgeson research also found that the pandemic had a significant impact on the AGM process across Europe, with many companies postponing their annual meetings or stopping shareholders from voting during the event.

À la prochaine…

Dans un article intitulé « The Pandemic and Executive Pay », Aniel Mahabier, Iris Gushi, and Thao Nguyen reviennent sur les conséquences de la COVID-19 en termes de niveaux de rémunération des CA et des hauts-dirigeants. Portant sur les entreprises du Russell 3000, cet article offre une belle synthèse et est très parlante.

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Is Reducing Base Salary Enough?

While salary reductions for Executives are greatly appreciated in this difficult time and are meant to show solidarity with employees, the fact is that base salary is only a fraction of the often enormous compensation packages granted to CEO’s and other Executives. Compensation packages predominately consist of cash bonuses and equity awards. Even though 80% of the Russell 3000 companies have disclosed 2019 compensation for Executives, we have not witnessed any companies making adjustments to these figures in light of the crisis, even for companies in hard-hit industries.

Edward Bastian, CEO of Delta Airlines, has agreed to cut 100% of his base salary for 6 months, [1] which equals USD 714,000, but still holds on to his 2019 cash and stock awards of USD 16 million, which were granted earlier in 2020. [2] Another interesting case is MGM Resorts International, where CEO Jim Murren was supposed to stay through 2021 to receive USD 32 million in compensation, including USD 12 million in severance. According to the terms of his termination agreement, he would not receive the compensation package if he left before 2021. [3] However, days after he resigned voluntarily in March, MGM announced that his resignation would be treated as a “termination without good cause”, which would qualify him to receive the full USD 32 million package. [4] In the meantime, 63,000 employees of MGM have been furloughed and will possibly be fired. [5]

Furthermore, activist investors have begun to feel unhappy about some executive pay actions amid the pandemic. CtW Investment Group, an investor of Uber, urged shareholders to reject Uber’s compensation package at the Annual General Meeting since it includes a USD 100 million equity grant to the CEO. [6]

While the ride-hailing company has suffered from a USD 2.9 billion first quarter net loss in 2020 [7] and planned to lay off 6,700 employees [8] (about 30% of its workforce), its CEO Dara Khosrowshahi only took a 100% base salary cut from May until the end of 2020, [9] which totals USD 666,000, and took home a USD 42.4 million pay package for 2019.

The same investor also urged shareholders of McDonald’s to vote against the USD 44 million+ exit package, including USD 700,000 in cash severance, for former CEO Stephen Easterbrook, who was fired last year over violation of company policies due to his relationship with an employee. [10]

The investor’s efforts failed in both instances and the CEO’s took home millions of dollars while their companies are struggling.

Since the COVID-19 outbreak, a number of public companies have gone bankrupt. Nevertheless, large sums of compensation were paid out to their Executives. Retailer J. C. Penney paid almost USD 10 million in bonuses to top executives [11] and oil company Whiting Petroleum issued USD 14.6 million in bonuses for its C-suite, [12] just days before both companies filed for bankruptcy.

Another school of thought is that the practice of issuers deferring executive salary cuts into RSUs will give rise to huge payouts in the future when the market eventually recovers and share value increases. This means that Executives who deferred their base salary have made a sacrifice that ultimately will benefit them, defeating the purpose of pay cuts.

Although the economic impacts of the pandemic on businesses are still on-going, the number of pay cuts announced has slowed since the end of May. As the effects continue to unfold over the next months, we expect companies to continue to re-evaluate their executive compensation policies. COVID-19 has changed daily lives, business operations, and the economy. Even though we will only know the full extent of impact in the second half of 2020, COVID-19 will certainly change executive pay and corporate governance practices in the future.

À la prochaine…

Retour sur la tribune de Lucian Bebchuk et Roberto Tallarita dans le Wall Street Journal critiquant le soi-disant stakeholderism qui émergerait de l’après COVID-19 par Cavin Hinks dans Board Agenda du 7 août 2020 : « Stakeholderism: study finds evidence in short supply ».

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Acceleration

Where does that leave stakeholderism? It’s no secret that many have argued fundamental change would be needed for the movement to really gain traction. In the UK, at least, the Institute of Directors has set up an entirely new governance centre to specifically explore this issue.

It may also be the case that boardroom approval and governance guidelines are not sufficient to prove that stakeholderism is absent in the US or elsewhere. Policy decision making at different levels—including chief executives acting alone—may reflect a shift to new forms of corporate behaviour, regardless of board-sanctioned decisions.

When the Sustainability Board Report , a campaign group, looked as corporate statements made by the world’s largest 100 companies as a result of Covid-19, it concluded there was evidence to suggest stakeholderism had “accelerated” during the pandemic. But it was inspecting disclosures about policies relating to employees, customers, suppliers and communities rather than formal boardroom approval processes or redrafted governance guidelines.

That might suggest CEOs make decisions that reflect stakeholderism without constructing a formal board-approved shift in approach. For that matter, it might also indicate such a movement could be short-lived and swing back once the threat of Covid-19 has receded.

Campaigners hope not. Close observers might also ask how stakeholderism might be properly observed or even measured.

The discussion has a long way to go. Bebchuk and Tallarita raise important questions with some compelling evidence. But it’s not entirely clear we’ve reached a final verdict on stakeholderism.

À la prochaine…

Article à lire sur l’Harvard Law School Forum on Corporate Governance : « An Inflection Point for Stakeholder Capitalism » (de Seymour Burchman et Seamus O’Toole).

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From the Business Roundtable to BlackRock, there’s growing pressure on companies to respect all major stakeholders—employees, customers, suppliers and local communities, as well as investors. Meanwhile, a variety of innovations are effectively making these stakeholders central to long-term company success. Digital technologies, new ways of organizing work and transactions, and the shift to the service economy have forced businesses to prioritize the interests of all stakeholders—adding significant opportunities and risks.

As a result, unless the company’s survival is in question, stakeholder-centricity is becoming essential to its overall management. Even under short-term pressures such as pandemics, executives and directors will need to view the company as operating within an integrated ecosystem. Only by supporting all major stakeholders, through calibrated and balanced incentives, will companies achieve sustained success.

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Reinforcing stakeholder-centricity through compensation

Through trial and error, Acme has been fine-tuning its approach. In our work with the boards of Acme, and of other companies, we’ve found four principles for making it all work.

Emphasize the long-term. It’s impossible to attend to all stakeholders equally in the short term. Companies are constantly making near-term trade-offs while still optimizing outcomes for all over the long-run. Investments in customer experience today might squeeze suppliers or reduce profitability in the near-term, for example, but boost the value proposition and expand revenues and margins in the future.

Any pay program tied to short-term outcomes will subconsciously influence how leaders balance these trade-offs. Accordingly, Acme has emphasized an ownership culture with greater equity compensation, broad participation, and policies that promote longer employee holding periods. It also steered clear of the usual practice of overlapping three-year performance cycles, as the overlaps effectively create a series of one-year cliffs that emphasize short-term thinking. While Acme has continued to use a short-term, cash-based bonus, it reduced that element’s weight relative to the rest of executive compensation. (Although a clear minority, some companies looking to prioritize long-term, balanced stakeholder outcomes have eliminated bonuses entirely.)

Explicitly tie pay to outcomes for all stakeholders. Acme wanted to keep the cash-based bonus tied to short-term profit and revenue goals, but was concerned that these would keep employees from weighing the stakeholder tradeoffs discussed above. So the company balanced the investor-focused metrics for the bonus with stakeholder-oriented goals such as employee engagement, customer retention, and supplier satisfaction. The simple act of ‘naming’ the priorities and directly tying them to compensation boosted buy-in across the organization.

Balance metrics with discretion. Acme believed that stakeholder dynamics were too fluid to be captured in a typical bonus construct, where ‘hard’ goals were established at the beginning of the year and performance measured formulaically twelve months later. The board set specific priorities and definitions of success, but allowed for discretion in the actual assessments and payouts. They also allowed for the updating of priorities frequently to ensure continued alignment with the strategy.

Stick to your guns. Finally, and perhaps most difficult, boards need to build up the resolve to align compensation outcomes with the stakeholder model. That means letting cash-based incentive awards follow stakeholder outcomes even when short-term financials are weak. And conversely, it means pulling back on pay when stakeholder priorities weren’t achieved, even if financial performance was strong. Note that executives will still be motivated to respect investor interests, as much of their pay will be in stock.

Boards must build the credibility to diverge from the “one-size-fits-all” status quo on pay for today’s U.S. public companies. They have to stand firm in the face of external pressure from impatient investors and shareholder advisory groups to align with their guidelines, most of which are anchored in and promote a shareholder-centric perspective. Some investors won’t agree with this philosophy and decide to select out, but others will take their place if they find the company’s mission, strategy, and execution compelling and in shareholders’ interests long-term. This will require boards to be consistent, symmetrical, proportional, and transparent in their compensation decisions. If the tie always goes to the executive, or if the company applies its philosophy selectively, the board will lose credibility and struggle to operate outside the typical investor-centric norms.

Finally, to sustain and optimize incentives that align with the stakeholder-centric model, boards must be relentless about communication, internal and external. They need to dialogue continually with investors and employees. They can emphasize the mission and strategy, how they’re balancing stakeholder needs over the long-term (even as they make trade-offs in the short term), and how the incentives align.

À la prochaine…

Sur l’Oxford Business Law Blog, le professeur Luca Enriques publie une synthèse bien intéressante à celles et ceux qui cherchent à faire le point sur les conséquences de la COVID-19 sur le droit des sociétés par actions : « GCGC/ECGI Global Webinar Series – Extreme times, Extreme Measures: Pandemic-Resistant Corporate Law » (22 avril 2020).

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These are exceptional times. Almost everywhere, policymakers are taking exceptional measures. Most of these measures are in the domains of public health, public finance and public law. Among the latter, of great relevance to corporate governance are the rules broadening governments’ powers to authorize large share block purchases (eg, in Germany and Italy). Even stronger proposals are being aired, and in some cases already adopted, in the direction of injecting public funds into companies in exchange for equity (Germany), if not of nationalising businesses altogether (France).

But some incursions into private law have also been made. This is especially true with regard to insolvency (or bankruptcy) law, as documented by Aurelio Gurrea Martinez. Some of the bankruptcy law-related measures intervene to change rules that ordinarily apply in the vicinity of insolvency and are therefore at the boundary between insolvency and corporate law. For instance, a number of countries are discussing whether to review directors’ duties in the proximity of insolvency (eg, the UK and New Zealand: see Licht) or have already done so (eg, Australia, Spain and Germany). 

Similarly, some of the jurisdictions still providing for the ‘recapitalize or liquidate’ rule (which requires directors to promote a recapitalization of the company, convert it into an unlimited liability partnership or liquidate it, if net assets fall below a given threshold), such as Spain, Italy and Ecuador, have chosen to suspend its application during the crisis. Finally, in Italy rules on the subordination of shareholders loans have also been suspended.

This post asks the question of whether company law rules not specifically dealing with companies in the twilight zone should also be tweaked to face the emergency. One obvious focus are rules dealing with how general meetings must be held (see eg the UK and Italy). Such rules may be at odds with social distancing provisions wherever they don’t allow for virtual meetings or forms of collective representation of the shareholders. But one can think more broadly about how corporate law should be amended in order to avoid economic rather than viral contagion and keep companies afloat in these exceptional times. Below are some general considerations to guide policymakers’ choices in this area, followed by examples of temporary corporate law interventions for the emergency. This post concludes with some thoughts about how to prepare for a similar emergency in the future.

À la prochaine…

Billet à découvrir sur le site de Harvard Law School Forum on Corporate Governance pour y lire cet article consacré à la sortie de crise sanitaire et aux apports de la raison d’être et des critères ESG : « ESG and Corporate Purpose in a Disrupted World » (Kristen Sullivan, Amy Silverstein et Leeann Galezio Arthur, 10 août 2020).

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Corporate purpose and ESG as tools to reframe pandemic-related disruption

The links between ESG, company strategy, and risk have never been clearer than during the COVID-19 pandemic, when companies have had to quickly pivot and respond to critical risks that previously were not considered likely to occur. The World Economic Forum’s Global Risks Survey 2020, published in January 2020, listed “infectious diseases” as number 10 in terms of potential economic impact, and did not make the top 10 list of risks considered to be “likely.” The impact of the pandemic was further magnified by the disruption it created for the operations of companies and their workforces, which were forced to rethink how and where they did business virtually overnight.

The radical recalibration of risk in the context of a global pandemic further highlights the interrelationships between long-term corporate strategy, the environment, and society. The unlikely scenario of a pandemic causing economic disruption of the magnitude seen today has caused many companies—including companies that have performed well in the pandemic—to reevaluate how they can maintain the long-term sustainability of the enterprise. While the nature and outcomes of that reevaluation will differ based on the unique set of circumstances facing each company, this likely means reframing the company’s role in society and the ways in which it addresses ESG-related challenges, including diversity and inclusion, employee safety, health and well-being, the existence of the physical workplace, supply chain disruptions, and more.

ESG factors are becoming a key determinant of financial strength. Recent research shows that the top 20 percent of ESG-ranked stocks outperformed the US market by over 5 percentage points during a recent period of volatility. Twenty-four out of 26 sustainable index funds outperformed comparable conventional index funds in Q1 2020. In addition, the MSCI ACWI ESG Leaders Index returned 5.24 percent, compared to 4.48 percent for the overall market, since it was established in September 2007 through February 2020. Notably, BlackRock, one of the world’s largest asset managers, recently analyzed the performance of 32 sustainable indices and compared that to their non-sustainable benchmarks as far back as 2015. According to BlackRock the findings indicated that “during market downturns in 2015–16 and 2018, sustainable indices tended to outperform their non-sustainable counterparts.” This trend may be further exacerbated by the effects of the pandemic and the social justice movement.

Financial resilience is certainly not the only benefit. Opportunities for brand differentiation, attraction and retention of top talent, greater innovation, operational efficiency, and an ability to attract capital and increase market valuation are abundant. Companies that have already built ESG strategies, measurements, and high-quality disclosures into their business models are likely to be well-positioned to capitalize on those opportunities and drive long-term value postcrisis.

As businesses begin to reopen and attempt to get back to some sense of normalcy, companies will need to rely on their employees, vendors, and customers to go beyond the respond phase and begin to recover and thrive. In a postpandemic world, this means seeking input from and continuing to build and retain the confidence and trust of those stakeholder groups. Business leaders are recognizing that ESG initiatives, particularly those that prioritize the health and safety of people, will be paramount to recovery.

What are investors and other stakeholders saying?

While current events have forced and will likely continue to force companies to make difficult decisions that may, in the short term, appear to be in conflict with corporate purpose, evidence suggests that as companies emerge from the crisis, they will refresh and recommit to corporate purpose, using it as a compass to focus ESG performance. Specific to the pandemic, the public may expect that companies will continue to play a greater role in helping not only employees, but the nation in general, through such activities as manufacturing personal protective equipment (PPE), equipment needed to treat COVID-19 patients, and retooling factories to produce ventilators, hand sanitizer, masks, and other items needed to address the pandemic. In some cases, decisions may be based upon or consistent with ESG priorities, such as decisions regarding employee health and well-being. From firms extending paid sick leave to all employees, including temporary workers, vendors, and contract workers, to reorienting relief funds to assist vulnerable populations, examples abound of companies demonstrating commitments to people and communities. As companies emerge from crisis mode, many are signaling that they will continue to keep these principles top of mind. This greater role is arguably becoming part of the “corporate social contract” that legitimizes and supports the existence and prosperity of corporations.

In the United States, much of the current focus on corporate purpose and ESG is likely to continue to be driven by investors rather than regulators or legislators in the near term. Thus, it’s important to consider investors’ views, which are still developing in the wake of COVID-19 and other developments.

Investors have indicated that they will assess a company’s response to the pandemic as a measure of stability, resilience ,and adaptability. Many have stated that employee health, well-being, and proactive human capital management are central to business continuity. Investor expectations remain high for companies to lead with purpose, particularly during times of severe economic disruption, and to continue to demonstrate progress against ESG goals.

State Street Global Advisors president and CEO Cyrus Taraporevala, in a March 2020 letter to board members, emphasized that companies should not sacrifice the long-term health and sustainability of the company when responding to the pandemic. According to Taraporevala, State Street continues “to believe that material ESG issues must be part of the bigger picture and clearly articulated as part of your company’s overall business strategy.” According to a recent BlackRock report, “companies with strong profiles on material sustainability issues have potential to outperform those with poor profiles. We believe companies managed with a focus on sustainability may be better positioned versus their less sustainable peers to weather adverse conditions while still benefiting from positive market environments.”

In addition to COVID-19, the recent social justice movement compels companies to think holistically about their purpose and role in society. Recent widespread protests of systemic, societal inequality leading to civil unrest and instability elevate the conversation on the “S” and “G” in ESG. Commitments to the health and well-being of employees, customers, communities, and other stakeholder groups will also require corporate leaders to address how the company articulates its purpose and ESG objectives through actions that proactively address racism and discrimination in the workplace and the communities where they operate. Companies are responding with, among other things, statements of support for diversity and inclusion efforts, reflective conversations with employees and customers, and monetary donations for diversity-focused initiatives. However, investors and others who are pledging to use their influence to hold companies accountable for meaningful progress on systemic inequality will likely look for data on hiring practices, pay equity, and diversity in executive management and on the board as metrics for further engagement on this issue.

What can boards do?

Deloitte US executive chair of the board, Janet Foutty, recently described the board as “the vehicle to hold an organization to its societal purpose.” Directors play a pivotal role in guiding

companies to balance short-term decisions with long-term strategy and thus must weigh the needs of all stakeholders while remaining cognizant of the risks associated with each decision. COVID-19 has underscored the role of ESG principles as central to business risk and strategy, as well as building credibility and trust with investors and the public at large. Boards can advise management on making clear, stakeholder-informed decisions that position the organization to emerge faster and stronger from a crisis.

It has been said before that those companies that do not control their own ESG strategies and narratives risk someone else controlling their ESG story. This is particularly true with regards to how an organization articulates its purpose and stays grounded in that purpose and ESG principles during a crisis. Transparent, high-quality ESG disclosure can be a tool to provide investors with information to efficiently allocate capital for long-term return. Boards have a role in the oversight of both the articulation of the company’s purpose and how those principles are integrated with strategy and risk.

As ESG moves to the top of the board agenda, it is important for boards to have the conversation on how they define the governance structure they will put in place to oversee ESG. Based on a recent review, completed by Deloitte’s Center for Board Effectiveness, of 310 company proxies in the S&P 500, filed from September 1, 2019, through May 6, 2020, 57 percent of the 310 companies noted that the nominating or governance committee has primary oversight responsibility, and only 9 percent noted the full board, with the remaining 34 percent spread across other committees. Regardless of the primary owner, the audit committee should be engaged with regard to any ESG disclosures, as well as prepared to oversee assurance associated with ESG metrics.

Conclusion

The board’s role necessitates oversight of corporate purpose and how corporate purpose is executed through ESG. Although companies will face tough decisions, proactive oversight of and transparency around ESG can help companies emerge from recent events with greater resilience and increased credibility. Those that have already embarked on this journey and stay the course will likely be those well-positioned to thrive in the future.

Questions for the board to consider asking:

How are the company’s corporate purpose and ESG objectives integrated with strategy and risk?

1. Has management provided key information and assumptions about how ESG is addressed during the strategic planning process?
2. How is the company communicating its purpose and ESG objectives to its stakeholders?
3. What data does the company collect to assess the impact of ESG performance on economic performance, how does this data inform internal management decision- making, and how is the board made aware of and involved from a governance perspective?
4. Does the company’s governance structure facilitate effective oversight of the company’s ESG matters?
5. How is the company remaining true to its purpose and ESG, especially now given COVID-19 pandemic and social justice issues?
6. What is the board’s diversity profile? Does the board incorporate diversity when searching for new candidates?
7. Have the board and management discussed executive management succession and how the company can build a diverse pipeline of candidates?
8. How will the company continue to refresh and recommit to its corporate purpose and ESG objectives as it emerges from the pandemic response and recovery and commit to accelerating diversity and inclusion efforts?
9. How does the company align its performance incentives for executive leadership with attaining critical ESG goals and outcomes?

À la prochaine…