In Short 

The Situation: Societal, not market, events have resulted in ESG and DEI considerations taking center stage in corporate board rooms, and will dominate the discourse this proxy season. 

The Result:  Many companies and their boards have long been committed to ESG/DEI causes, but most companies have not broadcast this fact. That will have to change as proxy rating firms and others may single out a company based on something as simple as a keyword search.

Looking Ahead:  Companies should consider bringing ESG/DEI issues to the fore in committee names, charters and, most importantly, external disclosures. 

ESG/DEI Frenzy in 2022

Investor losses resulting from stock market crashes have driven most major turns in corporate governance. In this century, director independence and audit/accounting assurance came into focus after the dotcom bubble and Enron; executive compensation and shareholder influence took center stage after the Financial Crisis.

Today's  fixation on ESG/DEI is different. It is driven by events affecting society generally:  acceptance in popular and financial media of climate change as an overriding global risk and diversity and inclusion efforts after the Me Too movement, the George Floyd murder, and increasing income inequality. These forces have of course been at work for some time, but they have been supercharged by attitudinal changes wrought by the COVID-19 pandemic.  

Major money management firms now see ESG/DEI as a path to even more assets under management and myriad for- and not-for-profit firms have gotten into the full-time business of exclusively, and noisily, advocating particular ESG/DEI causes. Especially now that there's money to be made, lots of it, the intensity of focus on ESG/DEI has become definitional for modern companies.

However, it will come as a surprise to some that serious commitments to good governance, sustainability, and inclusiveness are in fact not at all new for well‑managed companies or their boards. Rather, they are key parts of their cultures and board-management discourse. But most companies have heretofore been reluctant to brag about this. That has to change.

Things had begun to evolve in this way with the pre-pandemic focus on shareholder rights and executive compensation, including pay equity. Proxy statements and corporate websites morphed away from overly lawyered communications to more readable content with the main message delivered via graphics and in tables. In addition, big companies had begun publishing equally user-friendly sustainability, community commitment, and other reports focusing on non-shareholder constituent interests. Finally, the SEC is expected to promulgate ESG/DEI requirements  Even so, with ESG/DEI now being turbo-charged by money, companies have to turn up the volume all the way to the right for this upcoming proxy season as ESG/DEI will dominate next year's discourse.

Our Approach

We intend to publish a series of readily digestible, director-focused pieces on key ESG/DEI topics for 2022 over the weeks leading up to the 2022 proxy season.

This is the first such piece. It is about relabeling directorate committees and possibly reshuffling or at least making explicit some committee functions beyond sustainability, which we'll address separately due to the complexity and overriding importance of the topic. Before getting to the subject matter of this piece, however, three reminders, which apply to our thinking across all board topics.

  • Customize: First, despite assumptions to the contrary held by many, there are no one‑size-fits-all solutions to these issues. Concerns of miners and fossil fuel extractors are obviously very different from those of biotechs or retailers; where to put some functions will depend in part on historical practice and perhaps even the particular skill sets of incumbent committee members. Companies should take steps that are relevant to and, equally important, work for them, not check boxes drawn by the proxy rating firms, big money managers, or certainly lawyers like us.
  • Speak Up but Don't Get Carried Away: Second, while proxy statements and other governance communications have to resonate with many constituents, they are after all legal documents that will be combed over by the plaintiffs' bar—people who rake in enormous amounts of money by making mountains out of molehills and have already unleashed a broadside of class actions alleging, in essence, that companies are not walking the talk. As such, while prospectus-speak must be avoided, these materials cannot be prepared as if they were simply PR fluff, even though public and investor relations are key objectives. Having said this, much ESG/DEI rating is done via electronic searches for catch-phrases. As such, labeling and use of key catchphrases are crucial.
  • Stay in Your Lane: Finally, mostly due to the breadth and variability of the subject matter, directors must keep in the forefront of their thinking the crucial distinction between their and management's roles. Director responsibility is of course oversight and direction, not management, but many of these topics are being approached by those now dedicated full time to ESG/DEI as if they are somehow different. That is simply wrong and must be resisted—better to get a "withhold" recommendation than to attempt to drive the car from what is, and must remain, the backseat.

Renaming/Refocusing Directorate Committees

The major stock markets mandate three committees: audit, compensation, and  nominating/corporate governance. Most boards have so named their directorate committees and fashioned committee charters narrowly focused on the designated areas. However, the exchanges do not mandate particular committee names and the tenor of the times dictates that key themes be brought to the forefront.  

  • Audit: For most boards, the audit committee is the easiest from this perspective, as it has unique specifications for membership and roles set by law and stock exchange rules. As such, most boards can and should leave them pretty much as is, even in jurisdictions in which attestation of sustainability data is required.  Where compliance and enterprise risk management are officially lodged with the audit committee, boards need to say so for the reasons described below.
  • Compensation: Compensation committees have been targets of investor focus since the Financial Crisis and that can be expected to increase with the focus on DEI, and increasing pressure to tie management pay to DEI. For many, changing the committee's name to the "human resource committee" or some such moniker makes sense, as does making express reference to DEI in committee charters. The particular functions and focus of any committee will depend on the company's particular circumstances. 
  • Nominating/Corporate Governance: The N&CG committee has already begun to morph as many companies have added compliance to their charters (and, as we will discuss in a subsequent piece, ESG). Adding compliance (with corporate policies as well as laws) to the N&CG's name, and perhaps dropping the specific reference to "nominating," and charter may well make sense. Boards should decide this based on their particular circumstances. Compliance needs to be specifically called out somewhere given the potential future shift in judicial attitudes in some quarters   toward shareholder lawsuits alleging that corporate directors failed to adequately supervise before a security breach, product failure, or other adverse business event. While this may be simply repackaging, doing so could be helpful in ensuring that a duty-to-supervise complaint does not survive a motion to dismiss and is important in the ESG/DEI grading we will see this spring.

Of course, all of this is mere window dressing for most boards. But it is important window dressing in an era in which an attack may be initiated in the first instance by the results of a search engine.

Three Key Takeaways

1. Companies will need to be much more direct about ESG/DEI in the 2022 proxy season.

2. There is no universal, formulaic solution that works for all companies. Companies should make changes that work for them.

3. A director's role is oversight and direction, not management. Directors should resist pressures to go beyond that.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.