Until recently, I thought ESG was the power to read other people’s minds. However, as proxy advisory firms and institutional investors have grown more focused on ESG issues and ISS, for one, now features companies’ “ESG score” prominently on the first page of its reports, I have learned more than I ever wanted to know. “But Mike,” you say, “you are an executive compensation lawyer and this is an executive compensation blog. Why are we talking about ESG?”
The short answer to this question is that ESG objectives have been working their way into incentive plans, and that trend seems likely to continue. The longer answer works out like one of those logic or transitive law problems you may have had in school. Here goes:
- Because between 50-90% of annual proxy statements is devoted to executive compensation matters,* executive compensation professionals are heavily involved in drafting proxy statements.
- Because ESG scores are featured prominently in ISS’ and other investors’ reports and proxy voting guidelines, and executive compensation professionals are heavily involved in drafting proxy statements, questions from clients about improving ESG scores come to executive compensation professionals.
- Because good lawyers try to avoid saying “no” or “I don’t know” any more often than is absolutely necessary, executive compensation professionals must learn about, and be prepared to advise on, improving ESG scores.
At least that is the way it seems to have worked out for me and a few other executive compensation professionals who I know.
The first step in improving ESG scores is understanding what actions can improve a company’s score – and what actions (or omissions) reduce the company’s score. When first faced with demands for executive compensation reform and improved corporate governance on executive compensation matters beginning around 2004, and increased by say on pay voting requirements in 2011, many of us put together lengthy lists and charts of best practices and worst practices in executive compensation design and governance. If a company wanted a better executive compensation score from ISS and Glass Lewis and it did not have stock ownership guidelines, a clawback policy, and anti-hedging polices, among others, it could adopt stock ownership guidelines, a clawback policy, and anti-hedging polices, for example.
And so it is with ESG scores. To aid investors, the proxy advisory firms and various rating services grade corporate performance on ESG topics by analyzing information from a variety of sources, including NGO reports and corporate disclosures (indeed, ISS acquired oekom research about one year ago to enhance its capabilities in this area). If a company wants a better ESG score, it can compare its policies and practices to those that ISS prefers and consider whether to change some or all of them accordingly. By taking certain recommended steps and substantive actions, companies should be able to improve their ESG ratings by instituting practices that lead to better scores upon disclosure.
This is a complicated issue and we couldn’t hope to cover all of the recommended steps and substantive actions a company could take to improve its ESG score, but if a sufficient number of readers want more information, I will provide it in future blog posts.
*One could argue that these issues should not consume so large a part of one of the most important documents that companies provided to stockholders all year, but there it is.