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Editor’s Note: Workspan Daily will be publishing a monthly executive compensation column from Willis Towers Watson for the benefit of our readers and to encourage further discourse on topics vital to compensation professionals.
In the latest in a series of round table discussions with board members on ESG, human capital and risk, Willis Towers Watson explored how boards of United States companies are adapting to and thinking ahead of a rapidly changing business, regulatory and cultural environment.
Willis Towers Watson met with a new group of 12 board members representing 32 companies across 14 industries. We asked questions similar to those addressed in prior round table discussions:
- How are your boards thinking about and governing risk?
- How are your boards thinking about and acting on ESG issues?
- Are your boards adding ESG metrics to incentive plans?
- How do people factor into addressing ESG issues?
The most interesting and promising finding from the discussion was the degree to which board members view risk and opportunity as linked together. Multiple examples were given of situations where addressing social or climate risks led to competitive advantage in the market for products and talent. A company’s positive labor practices, for example, may help win a deal where customers increasingly care about how the products they buy are made and sourced. Companies are always seeking competitive advantage, and while strong ESG performance may not induce customers to pay more, it can help win the deal where price and other factors are equal.
According to this group, their boards generally have an in-depth risk discussion alongside business strategy discussions and will often regroup for deeper dive discussions of specific risks. Some boards are moving to have a specific risk discussion at every board meeting. Some either have or are considering a separate ESG committee, while others are parsing out specific risk topics to existing committees based on the topic and committee expertise.
Board members noted that prior to the pandemic, operational risks were the primary focus. That conversation has now shifted to human capital risks. Climate and environmental risks are clearly acknowledged, but for U.S. companies, human capital risks are at the forefront.
ESG priorities vary widely between and within industries. The ESG issues that are top of mind for directors may be a case of “where you sit is where you stand.” Climate and sustainability priorities are tremendously important for some industries and less for others. Human capital issues, however, seem to transcend all industries and may be the common denominator in ESG.
Board members cited several key challenges they see in addressing ESG risks and opportunities, including:
- How to measure and quantify risk. This was identified as the biggest challenge, and key to being able to sort and prioritize risks, make trade-offs and determine where to make investments or take mitigating actions.
- Justifying ESG investments for “goodwill” purposes. How much should companies invest in actions that are good for the environment or society, but lack economic payoffs for the company?
- Different companies in different industries have radically different risk profiles and ESG priorities. This is even the case within industries. Yet pressure from investors and regulators tends to be more generic.
- Supply chains present significant challenges. How products and components are sourced, produced and shipped all affect a company’s ESG performance. Managing the process and even getting accurate information can be extremely challenging and poses significant potential risks.
Challenges, Opportunities and Innovation
Challenges, however, present opportunities for innovation, which companies are embracing. Some examples discussed at the round table included:
- One company, faced with shortening product cycles and product abandonment (and waste), developed programs for rehabilitating and recycling their products that opened new markets and generated significant economic returns.
- Another company noted that while younger consumers care about the environment, they also want instantaneous shipping, which is not environmentally friendly. This presented an opportunity to educate customers on the impact of their actions and promote more efficient — and environmentally friendly — ordering. This was a win-win for the company, the customer and the environment.
- A restaurant company board member noted that they use a lot of water, produce large quantities of grease, as well as disposable plastic utensils and packaging. They see an opportunity to simultaneously make changes, educate and win new customers.
ESG Measures in Incentive Plans
Board members noted their companies are definitely considering ESG measures for executive and management incentives. The focus is currently on human capital measures much more so than environmental measures — although this varies greatly by industry. Concern was expressed over keeping the number of measures limited.
Most companies are focused on including measures in their annual incentive and waiting to put measures in their long-term incentives until they have more experience with them on an annual basis. In general, there is far more discussion and activity around the governance of ESG than on paying for ESG.
ESG and People
Board members noted several key connections between ESG risk, opportunities and people. Meeting environmental and climate goals will require an enormous amount of innovation. It is impossible to meet the commitments that companies have made or are considering with today’s technology. Effective, sustained innovation will require great human effort, creativity, resources, diversity of thought and time. Successful innovation can also produce remarkable payoffs. A company’s culture and the quality and diversity of its people will be critical to its ability to innovate and adopt new behaviors to drive change.
Lastly, board members noted that companies are in the midst of a new war for talent. They are chasing the same scarce talent pool that tends to be younger and embraces ESG and other social values. The sense was that this generation of people is currently more concerned about “S” issues than “E” issues, but that greater focus on the E is coming soon.
The talent that companies need in order to address ESG issues will be easier to attract if they are already focusing on ESG issues.
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