ESG is of course one of the current hot button topics, in the corporate, legal, and financial world. One of the many issues surrounding ESG is the question of how ESG initiatives fit with traditional notions surrounding corporate purposes. In the following guest post, Greg Markel, Giovanna Ferrari, and Sarah Fedner of the Seyfarth Shaw law firm take a comprehensive look at the ways in which ESG fits within the basic principles of corporate governance and corporate purpose . I would like to thank the authors for allowing me to publish their article as a guest post on this site. I welcome guest post submissions from responsible authors on topics to the readers of this blog. Please contact me directly if you would like to submit a guest post. Here is the authors’ article.
ESG is an acronym and importantly a movement with a viewpoint. It is also an evolving concept which uses the first letters of three words as its name. Those words are Environmental, Social and Governance. ESG is a concept and a shorthand phrase but it is not easily defined nor is there an adequate and accepted by all definition. The movement as it has evolved to date uses the E and S of ESG as a way of referring to certain areas of high risk to the interests of corporate stakeholders and the corporation in maintaining the sustainability and long-term value of the corporation for the benefit of shareholders and other stakeholders. For the public generally these risks are also potentially very dangerous. Many of the goals of ESG are goals accepted by groups in many countries and some such as reducing greenhouse gases would benefit human beings throughout the world, if the goals are achieved.
ESG, to the extent its goals are achieved, would also assist in achieving at least a portion of the corporate purposes of many corporations. It is generally of importance to the corporation and to its stakeholders to be financially successful and in so doing benefiting all of its stakeholders and also the sustainability, long term value and profitability of the corporation. As we shall see below, many corporations have set as corporate goals benefiting all of their stakeholders along with increasing the long-term value of the corporation. The corporate interest in increasing its long-term value does not have to be inconsistent with ESG’s goals. In ESG’s name the first two letters, E and S, refer to broad areas of great and possibly existential risk both locally and in some cases to civilization as we know it. For example, the long-term value of a corporation would likely be enhanced by reducing climate change induced natural disasters in the future and if there was more general acceptance of diversity and inclusion.
The third letter G relates to the principles of corporate governance which broadly set forth the way in which corporations should be managed.
We will describe in more detail certain of the E and S risks below. We will also later address competing theories about the purpose of proper goals of corporations as well as some of the ways in which corporations may be motivated to help address some of these risks and how the basic principles of corporate governance and corporate purpose fit with ESG.
Environmental Issues : the “E” in ESG
In the 1950’s with the post-World War II prosperity of the United States and the resulting expansion of the use of cars and trucks and large airliners and the use of too much coal and other energy sources, air pollution gradually was recognized as an increasing problem. Specific fixes were tried to address air pollution with modest success. Years later some scientists started to recognize that the problem went beyond occasional smog and in fact there was fundamental climate change going on that was caused by use of fossil fuels and inadequate waste disposal. At first climate change was rejected by many people as not being real or a real threat. Over time the ever-increasing number and severity of natural climate related disasters experienced by much of the population of the United States and other countries have resulted in increased public and investor belief in the serious risks associated with climate change to mankind and its entities like corporations. Concerns also have arisen over pollution of water resources and waste disposal as well as more widespread serious droughts and floods, forest fires and bouts of unseasonable weather. Add in the warming of oceans and threats to species that inhabit them. Greenhouse gases became a term of art for some developing environmental problems. These all were and are environmental concerns. These and similar issues relate to potential damage to the environment in which human beings live and these issues are included in the “E” in ESG. One of the reasons the E is such a risk is that it is not clear how repairable the climate is once damaged. Many supporters of ESG are as or more concerned with the effects of climate damage on future generations as they are with the effect of these risks currently.
Social Issues: The S in ESG
During recent decades, serious concerns have increased over the treatment of an injury to various groups who were disadvantaged due to race, country of origin, gender, disabilities, sexual orientation unfair treatment of workers and excessive economic disparity, which has resulted in increased numbers of incidents, some of which were violent. Such incidents have been supported or opposed by various groups with a wide variety of viewpoints. The differing viewpoints have every right to be expressed but this should be done hopefully without violence and without contributing to the increasing polarization on political issues so detrimental to a well-functioning democracy. Some of these protests have been useful in identifying, attempting to discourage and organize opposition to some abuses that have existed for some time. Corporations have within their options the ability to try to contribute to ameliorating some of the problems and hopefully make rational efforts to support peaceful and suitable solutions to social issues and encourage productive discourse on the issues.
Where ESG comes in
In general, the position of supporters of S in ESG would be against discrimination, supportive of diversity and inclusion, a reduction in inequality of pay and improved working conditions. Working conditions do come up under S and have for many years caused concern among some workers at some companies and resulted in strikes, and discontent. These issues and many others are part of the “S” in ESG. We would argue that Free discourse, a government based on the rule of law and the freedom of expression are issues that also come up under S. The S in ESG is more problematical than the E because it is inherently often dealing with political issues. Some issues are not controversial. For example, the murder of George Floyd is likely to be condoned by almost no one and taking measures to avoid such atrocities would be supported by almost everyone. But what those measures should exactly be might be controversial and arguably should be addressed by governments, not determined by corporations or individuals. There is, of course, under our constitution, the right of corporations and individuals to speak out on and to organize in support of principles they believe in. However, the ability to legislate is for governments. In the United States that should mean through the methods of a democracy including the right to vote BROADLY RECOGNIZED (capitalized for emphasis) rather than unfairly restricted by local, state or national governments. What then is the proper role for ESG on social issues? It is to organize support for goals which those involved believe in and to speak up about issues they care about. A number of these S concerns are also part of what would be to some extent addressed by the modernization of the concept of corporate purpose which is addressed in the next section.
Corporate Purpose and Identifying Relevant Stakeholders
The origin of the concept of corporate purpose goes back centuries to when businesses were designed to provide means to support the needs of their owners and the owner’s family. The natural progression of expanding the family business to make more money to support the family over time and improve their standard of living and to have sustainable, sometimes relatively large, profits from that business that exceeded the need of the family, over time was accepted in the United States and many other countries as appropriate as long as laws and regulations were not violated.
As multiple owners of a business became common through the sale of shares of stock in a corporation, there is little to suggest that business owners gave much thought to the idea that a corporation was in existence for the benefit of anyone other than its owners. As academics began to think more broadly about the purpose of a corporation in the middle of the 20th century, the predominant view was that of Milton Friedman of the University of Chicago, who strongly espoused the view that the sole purpose of a corporation was to maximize its profits and its value. This frequently cited principle became known as “Shareholder Primacy”. This theory was largely unchallenged for a number of years except by income tax increases.
The Business Roundtable is an organization composed of nearly 200 CEOs of large public companies. In August of 2019, 181 of those CEOs signed a statement of corporate purpose which was considered revolutionary at the time in that it rejected Shareholder Primacy and broadened significantly the notion of “corporate purpose”. The statement of the Business Roundtable is quoted below:
Americans deserve an economy that allows each person to succeed through hard work and creativity and to lead a life of meaning and dignity. We believe the free-market system is the best means of generating good jobs, a strong and sustainable economy, innovation, a healthy environment and economic opportunity for all.
Businesses play a vital role in the economy by creating jobs, fostering innovation and providing essential goods and services. Businesses make and sell consumer products; manufacture equipment and vehicles; support the national defense; grow and produce food; provide health care; generate and deliver energy; and offer financial, communications and other services that underpin economic growth.
While each of our individual companies serves its own corporate purpose, we share a fundamental commitment to ALL of our STAKEHOLDERS (emphasis added) We commit to:
- Delivering value to our customers. We will further the tradition of American companies leading the way in meeting or exceeding customer expectations.
- Investing in our employees. This starts with compensating them fairly and providing important benefits. It also includes supporting them through training and education that help develop new skills for a rapidly changing world. We foster diversity and inclusion, dignity and respect.
- Dealing fairly and ethically with our suppliers. We are dedicated to serving as good partners to the other companies, large and small, that help us meet our missions.
- Supporting the communities in which we work. We respect the people in our communities and protect the environment by embracing sustainable practices across our businesses.
- Generating long-term value for shareholders, who provide the capital that allows companies to invest, grow and innovate. We are committed to transparency and effective engagement with shareholders.
- Each of our stakeholders is essential. We commit to deliver value to all of them for the future success of our companies, our communities and our country.
It is of course the case that there were, prior to 2019, corporations which, despite the prevalence of Shareholder Primacy as the accepted purpose of corporations, treated their employees well and otherwise lived up to their own concept of ethical behavior including through using corporate funds to support various charities.
The Business Roundtables version of corporate purpose was a step forward towards achieving a recognition on the part of large corporations that there should be more to their corporate goals than simply maximizing profit for shareholders. The Business Roundtable Manifesto (the “BRM”) was and is, in retrospect highly compatible with the state of mind that is essential if progress is to be made in convincing more corporations to adopt the principles of ESG
ESG and Corporate Purpose Can be Kept in Harmony
As is obvious from the discussion above, ESG is more difficult to define than corporate purpose because the concepts of ESG are many, newer, not uniformly adopted. still evolving and have a larger variety of persons determining their direction. What ESG asks of a particular corporation will vary greatly from company to company depending on its characteristics, including its size, wealth and the attributes of its controlling shareholders. Corporate Purpose is by definition something that will vary from corporation to corporation but the two major types of the concept either largely adopt the Business Roundtable’s BRM or stick fairly closely to Shareholder Primacy. Those adopting the BRM by and large were and are consistent with at least some of the goals of ESG. Corporate Purpose and ESG can be harmonized.
ESG is a concept that is consistent with the BRM notion that a corporation in fulfilling its corporate purpose should not merely attempt to increase its sustainable long term value creation, but while making some efforts to do so, should also consider the interests of all its stakeholders and its ethical duties to society. These ethical duties include that a corporation should support measures that reduce any adverse effects to society and stakeholders caused by the activities of corporations, particularly with respect to such existential risks as climate change, racial or gender discrimination or unfair treatment of employees or unreasonable, unfair or excessive economic imbalances. Application of such ESG like principles, if reasonably considered and approved by the board and management with procedures consistent with corporate governance principles including the duty of care, the duty of loyalty and the duty of oversight, is not only sensible business strategy, but also is very likely to foster and assist corporations in building long-term sustainability, long-term value-creation and fairness. A board and senior management would arguably be fulfilling the fiduciary duties owed by them to the corporation, its shareholders and to all stakeholders if they follow the principles of ESG, the principles of the Business Roundtable version of Corporate Purpose and the basic principles of corporate governance.
By reasonably harmonizing sustainable, long-term value creation for investors along with the reasonable expectations of other stakeholders including employees, management, customers, suppliers, communities and the environment, in part through reasonably defined ESG initiatives, boards and management will both be complying with their fiduciary duties to the corporation and duties to stakeholders and fostering the sustainability of society.
The Role of Government Entities
In the 1970’s and increasingly until today, substantial public opinion in many countries started to become more organized in addressing environmental and social issues. One important way of addressing these issues is through laws and regulations emanating from various governmental bodies and agencies. This would seem consistent with the proper role of government particularly in a constitutional democracy. While governmental action has been and is extremely important to address E and S concerns it seems clear that governmental action by itself has not been, and is not likely to be, sufficient to fully protect future generations from E and S risks, particularly given the increase in political polarization and legislative gridlock in a number of countries including the United States. The concept of ESG in this regard is that at least many corporations could and should supplement the efforts of governments with their own efforts to promote behavior by others and by each corporation itself that is consistent with sustainability in promoting remedies for Environmental and Social risks. While there is overlap between the goals of corporations under the precepts of ESG and a modern corporate purpose with governmental laws and regulations, neither alone appears to be sufficient to cure the problems created by these risks. While governments could theoretically do all that is necessary, the polarization of views on political issues in a number of countries suggests that sufficiently strong joint efforts by governments of many political strains and historical background that can solve all the all the E and S issues that fixing are not just around the corner. But with governments, corporations, the ESG movement and individuals working together perhaps progress can be at least hastened.
In connection with the suggestion that a tripartite approach may enhance progress, We note that Corporations are required to obey laws and regulations but are not required to try to ameliorate the issues and risks included within E and S except where laws and regulations require them to adopt or abandon certain relevant practices in their own business activities. In democracies, public appeals and voting trends may have a substantial effect on laws and government policies. As to corporations, some will undoubtedly follow ethical or societal obligations as they see them without being required to do so. However, others will not. In a later section we will consider non-governmental economic incentives for corporations to support, at least in some ways and to some extent, ESG.
Before going much farther we should consider the role of the SEC in connection with ESG disclosure requirements. In May of 2022 the SEC came out with proposed regulations on disclosures in SEC filings and other public venues of ESG data and other information. The disclosure requirements proposed were extremely demanding in many respects and quite likely very burdensome and expensive to comply with. Concerns were raised that the number of disclosures required and the detailed information involved made it quite possible that it would lead to errors and might lead to litigation for corporations with the SEC and with private plaintiffs. Thousands of comments were received by the SEC on the proposed rules and the publication of final adopted rules has been delayed at length while the SEC presumably is considering at least some of the comments on their initial proposal. While there may well be some scaling back of the proposal, most observers believe there will be, as is common with the SEC, substantial disclosure required in the final regulations applying to corporations relating to their own ESG efforts. We believe that if the SEC were to overstate disclosure requirements there will be extensive litigation over their authority to initiate such regulations. In any case, we strongly recommend to clients that once the final rules are in place, they be carefully reviewed with the assistance of attorneys specializing in the area, and that care be used to assure the accuracy of any disclosures made. It may well be that these disclosures turn out to play a substantial part in the type and scope of future litigation brought by the SEC, private parties and in class actions relating to environmental, social and securities laws and regulations and corporate governance issues as well as the SEC’s authority and jurisdiction.
Motivating Corporations to Play a More Important Role in Supporting ESG
There are many in senior positions in large corporations (demonstrated by the 181 members of the total membership of 200 of the Business Roundtable that signed the BRM) who share many of the ethical and societal values of ESG including the notion that corporations should consider the interests of all stakeholders as part of their corporate purpose and who do not accept the Shareholder Primacy notion that the sole purpose and only permitted purpose of a corporation is to increase shareholder value. However, it is questionable whether either ESG or Corporate Purpose can be mandated by government agencies. Given the polarization of political parties and of countries it is doubtful if any attempt to cause an action by government mandating ESG or corporate purpose principles would succeed nor is it clear that even if it did that it would survive legal attack. What does seem clear is that the SEC will issue regulations on ESG disclosure that will be strictly enforced.
However, as we will see in the next section, in a free market economy some financial firms do have some ways of influencing the actions of other corporations with respect to ESG. Most important is the growing number of people and entities with the ability to direct investment funds that they own and/or manage to those corporations which they perceive as being “ESG friendly”.
A recent phenomenon is the anti ESG movement. While it is too early to meaningfully describe all its methods and the amount of its influence, there are clearly political factions which have the goal of defeating ESG’s goals and restraining its progress. This is a movement which must be watched. It has introduced legislation in a number of states designed to push back on the ESG movement. The ultimate success of this movement is not yet possible to estimate and because it is early in it evolution not much detail can be supplied at this point.
Influence of Large Institutional Investors
In recent years, some very large institutional investors such as Blackrock, Vanguard and State Street have made it clear that one of the factors they consider, in deciding what corporations’ stock they should invest clients funds in, is the ESG friendliness of the policies of a corporation. These three investment firms together have approximately $17 trillion of customers money to invest and have each invested trillions of dollars already for their investor clients in the stock of public companies which they view as ESG friendly. These 3 firms and a number of other financial firms that advise on or make investments for their clients have adopted the level of a corporation’s ESG compliance and support (“ESG friendliness”) as a factor in investment decisions as have some individual investors. Another force today influencing ESG acceptance in the equity markets is the marketing of ESG ETFs. These ETFs are investment funds that invest at least primarily in entities which are viewed as ESG friendly corporations. This alternative does give investors the ability to determine what portion of their investment funds are to be used in part to support ESG.
The cumulative effect of these various types of financial firms (who are also major investors) having adopted ESG performance as a factor in determining what company’s shares to buy, is that public corporations and necessarily their boards and management have, in addition to doing what they believe is the right thing to do, a very strong incentive to be supportive of their ESG efforts in order to bolster their stock’s market price. Because of the policies of several financial firms to favor supporting ESG friendly investments, a company can increase demand for its equity (and thereby raise its market price). Moreover companies perceived to be ESG friendly companies are likely to have greater access to capital than they would otherwise have and some of this capital may be at a more attractive cost than financing is for corporations that are not viewed as ESG friendly. Promoting ESG friendly investments and potential investments are strong incentives that can be created by financial firms and other investors to encourage a corporation and its Board to consider supporting ESG
Basic Principles of Corporate Governance
The “G” in ESG stands for Governance. The ultimate authority to make decisions for a corporation is the board of directors unless the issue has been delegated to senior management by the board. In carrying out decision making, corporate law imposes on boards fiduciary duties of loyalty, care and oversight in making decisions to act or to decline to act on a reasonably informed basis after due consideration of relevant information and appropriate deliberation. This means that directors must also take steps necessary to be able to reasonably rely on a viable system for receiving relevant information on important and material issues and risks. Board members must consider and reasonably believe that the information provided and to be provided by that system is adequate for them to reasonably conclude that they have the information required to make decisions for the benefit of the corporation to the extent that such information is reasonably available. Directors, in using such information, should use their business judgment for the benefit of the corporation to decide to take, or refrain from taking an action and they should devote sufficient time to the consideration of such information once received. They should obtain, where helpful, advice from appropriate internal or external experts. Board members also have a duty of loyalty that requires them to act in the interests of the corporation rather their personal interests.
In our experience, it is often advisable for boards of corporations to delegate to a committee with the time and where possible expertise to evaluate the short and long term risk from environmental and social issues to the corporation, the effect of potential actions with respect to such issues on long term profitability, as well as the benefit or risk creation for its shareholders and other stakeholders likely to accrue as a result of a decision to act or not act. Of course board decisions should be made after carefully weighing the risks and rewards of any action.
Increasing long-term value or profit included as a part of a corporation’s purpose and objectives is entirely consistent with the board’s fiduciary duties. Moreover, without some substantial consideration by a board to include in its corporate purpose as one goal, increasing the long term profitability of a corporate entity, it is difficult to see why in most cases third parties would buy shares or provide financing. In other words, by failing to consider long term profitability, a board might in some circumstances be violating its fiduciary duties because such an approach would be counter to the duties of care and loyalty to promote the long term sustainability and/or long term increase in the value of the corporation. Moreover a company that is not attractive to investors may well lose some of its ability in the long run to effectively support ESG.
As noted above, a corporation in fulfilling its corporate purpose should not only attempt to increase its sustainable long term value to its shareholders but in doing so it should also consider a recognition of its ethical and corporate purpose duties to society and to all stakeholders. A board and senior management will be fulfilling fiduciary duties owed by the board and management to the corporation, its shareholders and is also fair to its stakeholders if it follows basic principles of corporate governance and supports both its corporate purpose, which should, we submit, include the interests of all stakeholders and the goals of sustainability, and ESG.
The twin goals of long-term value creation for investors with the reasonable expectations of other stakeholders including employees, management, customers, suppliers, communities and the environment are not and will no easily both be achieved and the pressures on a board to achieve both goals are likely to put substantial pressures on boards. By using their business judgment, board and management can try their best to achieve reasonably defined ESG initiatives and an enlightened corporate purpose, and thereby boards and management will both be complying with their fiduciary duties to the corporation and their duties to stakeholders and fostering the sustainability of the corporation and society.
Shareholders Voting and Proxy Firms
The board of directors or senior management which reports to the board, have decision making authority for a corporation. Shareholders have the right of voting on who sits on the board and generally other major issues such as, for example, mergers and acquisitions and dissolution of the corporation.
In an important sense the board serves at the pleasure of shareholders, because they are elected by shareholders. While incumbent boards are frequently re-elected by shareholders, board members can be replaced if they have incurred the displeasure of other board members, shareholders, activist investors or proxy firms. Another reason board members and/or management lose their position is some perceived failure of performance by the corporation to perform up to expected levels.
Public companies in the United States annually hold shareholders meetings, as well as additional special meetings. A proxy statement must be distributed to shareholders prior to such meetings. A proxy statement gives information about financial status and results and the matters to be voted on by shareholders. The matters to be voted on include the election of board members and important corporate events such as a proposed acquisition or dissolution. Thus by voting their shares either directly or through a proxy firm, shareholders have a say in the election of board members and indirectly can thereby influence the actions of a board. Shareholders can also make proposals that management can agree to present to all shareholders for a vote. Proxy firms such as ISS and Glass Lewis often advise investors on how to vote. Per the Harvard Law Forum, these firms and, particularly ISS tend to support ESG initiatives in advising on shareholder proposals. Similarly these proxy firms advise on candidates for board elections and may favor board members who are perceived by the proxy firms as ESG friendly. Once again, we see here in the influence of proxy firms on voting, something that effectively is an additional incentive for the board and management to be at least reasonably ESG friendly”.
Measuring ESG Support
It is beyond the scope of this article to explain in detail the various data frameworks which in fact rate a corporation’s record in meeting standards of ESG compliance. The available frameworks are several, they do not have identical standards and formats and the focus of the type of data required varies. Thus rating systems designed to assess the ESG efforts of corporations are not entirely uniform. The ratings produced none the less are often referred to by investors and investment firms to measure ESG friendliness for use in investment evaluations and decisions. Two of the more established provider of frameworks are the Climate Disclosure Standard Board and the International Sustainability Board. Undoubtedly the ratings, sometimes used by investors for investment decisions, also are watched carefully by corporations because they may have some effect on the level of investment in their stock.
Data and Ratings
Corporations who claim to be ESG friendly should check their compliance with standards and frameworks and accurately represent their records of such compliance in any disclosures. This is important not only because it is the right thing to do, but also, they can be reasonably sure that the SEC and other regulators and organizations will be watching.
The challenges facing directors loom large, in part because of failures of previous generations to deal adequately and consistently with E and S issues. It is hard to overstate the value of selecting directors who are both people of good will and have exceptionally good judgement to face the future issues relating to E and S.
Hopefully such people will not be lost to corporations because of other entities rigidity, lack of judgement, overweening pride or by the risks of coping with litigation or poorly thought through regulation