Legal Strategies For ESG Initiatives
By Peter Foundas and Manleen Singh
Environmental, social and governance (“ESG”) factors now play a major role in business 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 also have taken notice, with the Securities and Exchange Commission announcing last year that it is studying ways to develop and implement standardized disclosure rules for reporting environmental metrics.2
The question now for many business leaders is not whether they should commit to 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 may cut at the heart of what your business does. If so, one way to place 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 distinct corporate form that requires a company 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 goal at the heart of your business model and can help in recruiting and retention. This structure also makes clear that directors and officers can make the public benefit a central focus of decision-making without fear of facing fiduciary claims. However, this corporate form may come at a cost; PBC statutes typically have mandatory reporting requirements and subject the company to potential shareholder challenges regarding progress toward the stated public benefit. While this is a significant step that may require additional start-up capital to implement proper reporting structures, incorporating as a PBC clearly signals that your ESG goal is just as important as pursuing profits.
Organizational Documents and Policy Statements
A less drastic but still impactful way to focus on ESG issues is to meaningfully discuss your ESG goals in your company’s organizational documents. There are many options here, ranging from setting forth specific directives to the directors and officers, establishing director or officer positions to monitor for progress, or, more broadly — if your jurisdiction allows it, simply make it clear that considering ESG factors will not violate fiduciary obligations. Keep in mind that governance documents may not be easy to amend, especially if your business has many owners, thus it may be difficult to adopt language that is acceptable to a requisite number of equity holders. However, the benefits of discussing ESG goals in your charter documents are twofold: (1) the company will have demonstrated a focus on and clear commitment to ESG issues at the highest levels; and (2) the company will have a structure and road map to implement the initiative.
If amending organizational documents is not feasible (or even if you have already done so), consider developing an ESG policy statement that identifies the main goals you hope to accomplish. This statement should detail in plain language the specific ESG goal or goals you are seeking to achieve and should include specific metrics you will use going forward to measure progress, such as tracking diversity in hiring, greenhouse gas emissions, philanthropic contributions or gender pay equity.
Supplier and Vendor Relationships
A key part of the success of many businesses is strong relationships with external vendors, suppliers, and service providers. These relationships also provide a critical opportunity for a business to further its ESG goal by strategically choosing to partner with others that share similar values. Practically speaking, it may be difficult to find much information on a third party’s ESG initiatives relying solely on publicly available information. Opening a dialogue on these issues may lead to a surprising realization that your vendor or supplier already has ESG programs or metrics in place. If they do not, give thought to what key performance indicators your business may want them to incorporate in the next contract renewal and have open discussions about the costs of compliance. One thing is certain here – if you do not discuss ESG concerns with your vendors, service providers or suppliers, they will never know that these issues matter to your company.
Carefully Vet Acquisition Targets
If your business grows through mergers and acquisitions, then strategically selecting your next target can further your ESG goals. Consider developing an ESG section in your diligence questionnaire to potential targets or incorporating ESG topics in interviews with key personnel. Placing a focus on ESG concerns in the due diligence process can help to uncover hidden risks in areas such as energy usage, supply chain management, diversity and inclusion efforts, and cyber security.
Directors and officers may be surprised to find that implementing an ESG strategy can cause backlash among investors, employees, or other important stakeholders. ESG factors are now in the political crosshairs, as Texas recently passed legislation barring the state’s retirement and investment funds from doing business with companies that are boycotting fossil fuel companies and Florida recently announced it will consider legislation banning its state pension fund from selecting investments based on ESG criteria.
At the business level, if the message is not resonating on a moral level, one way to deal with any backlash is to focus the conversation on the positive financial impacts of ESG initiatives. One 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, “Companies with high ESG scores, on average, experienced lower costs of capital compared to companies with poor ESG scores.”4 Additionally, framing ESG initiatives as improving corporate decision-making, ensuring equity in compensation, and fostering a culture of thoughtful leadership can minimize dissent and showcase how management is adhering to its fiduciary responsibilities.
ESG initiatives can cover a 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 scope 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 to deal with pushback from unexpected sources.
1 https://www.capitalgroup.com/content/dam/cgc/tenants/eacg/esg/global-study/esg-global-study-2022-full-report(en).pdf (Accessed September 2, 2022) at p. 9.
2 See SEC Statement, dated March 12, 2021, https://www.sec.gov/news/public-statement/lee-climate-change-disclosures
3 https://www.stern.nyu.edu/sites/default/files/assets/documents/ESG%20Paper%20Aug%202021.pdf (accessed September 1, 2022) at p. 4-5.
4 https://www.msci.com/www/blog-posts/esg-and-the-cost-of-capital/01726513589 (accessed September 2, 2022).
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