BoardMatters Quarterly, September 2012

Environmental, social and governance data

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Average support for social and environmental shareholder proposals crossed the 20% threshold for the first time.

Forward View by Tapestry Networks

Our analysis of the 2012 proxy season shows that average support for social and environmental shareholder proposals crossed the 20% threshold for the first time last year and that shareholder proposals now ask for more disclosure on how companies are managing specific environmental and safety risks.1

What is driving the surge of environmental, social and governance (ESG) shareholder proposals and activities? And why should audit committees pay attention? To answer that, we need to look at the history and effect of governance proposals, in particular, on audit-related matters.

First, the G: from disclosure to analysis to votes

Investors have long taken governance factors into consideration. The Sarbanes-Oxley Act of 2002 (SOX) was meant to strengthen companies’ governance, internal controls and transparency. In the wake of SOX, public companies began disclosing more governance information.

Governance ratings firms used this information to further develop company governance ratings, focusing on adherence to these new standards.

These disclosures, among other areas, focused more attention on audit committee composition (e.g., whether the audit committee had appropriate financial expertise) and other matters.

Governance ratings firms — some of which were owned by proxy advisory firms that made voting recommendations — started to broaden their ratings in line with these enhanced disclosures.

Asset owners and asset managers used these enhanced ratings to differentiate companies in their portfolios and to engage more directly with companies that were slow to improve their governance structure and internal controls.

Now, the E and S

Investors now have much more access to ESG information than ever before. Ratings firms and other corporate information aggregators now analyze and synthesize more ESG data, and they aggregate and disseminate it broadly to their investor clients.

This data analysis makes it easy for investors with diversified portfolios to screen companies in a more sophisticated fashion. An EY report notes that ESG data is available for more than 5,300 companies on Bloomberg terminals. Bloomberg customers grew 50% during 2011, and the amount of data they accessed doubled over 2010.2

However, the quality and rigor of the analysis of environmental and social data greatly lags behind that of governance data. Governance ratings firms depend heavily on voluntary disclosures, making comparisons difficult.

Ratings firms must cover thousands of companies in a timely fashion, making it difficult to perform rigorous analysis on them. Vague or inconsistent company disclosures can amplify the margin for error and distort investors’ views of a company’s ESG performance.

So, what should audit committees do?

It’s uncertain whether boards regularly discuss their companies’ environmental and social communications. However, there are two ways that the audit committee can help ratings firms and investors gain a more accurate picture of their companies’ ESG performance:

  • Ensure robust and accurate reporting of ESG communication.
    Audit chairs acknowledge that their companies are communicating a vast quantity of disparate information about ESG-related issues to investors, government agencies, non- governmental organizations (NGOs) and others.

    Audit chairs acknowledge that providing different data to different organizations has an inherent risk and may be inconsistent and confusing. One audit committee chair explained, “Reports can be unbalanced or inaccurate, so boards have a role in ensuring that such reports are supportable and balanced.”
  • Strengthen internal controls around reporting of ESG information.
    Once companies define what sustainability data is important to investors and to others, they can improve their internal controls systems and processes to capture and report it.

    As one audit chair explained to us, “We had no systems to capture the [ESG-] related information that NGOs and investors were asking for. By thinking about how best to capture the information, we improved our systems, and that has made us a better company. It changed our behavior significantly.”

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1 Proxy Season 2012: Board Priorities for Shareholder Engagement: Proxy Perspectives, Ernst & Young LLP, February 2012.

2 Six Growing Trends in Corporate Sustainability, EY and GreenBiz Group, March 2012, p. 27.