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S2_EP6 Materiality: The Key to ESG Priorities and Board Effectiveness with Anthony Goodman of Korn Ferry.

Transcript

Participants:

Michael Young | Founder | CEO of Actual Agency | Partner, Millwright Holdings

Anthony Goodman | Senior Client Partner and Head of the Board Effectiveness Practice at Korn Ferry

Michael Young:

Welcome to the Purpose, Inc., the podcast where we discuss corporate purpose and stakeholder capitalism. I'm your host, Michael Young.

My guest today is Anthony Goodman who is Senior Client Partner and Head of the Board Effectiveness Practice at Korn Ferry. There, Anthony advises public and private companies on a wide range of matters with a specialization in effective oversight of environmental, social, and governance (ESG) opportunities and risks. This Anthony's second time on the podcast and it's great to have him back. Today we have another wide-ranging and insightful conversation on the key issues boards of directors face in corporate governance, social justice, climate risk, sustainability, diversity, equity, and inclusion. And today we jump right in on the topic of activist shareholders, beginning with the recent news that Engine No. 1, the investment firm won three board seats at Exxon. And there's a lot that's interesting about this story but one of the big takeaways is how Engine No. 1 connected climate risk with underperformance for shareholders, saying that the company's failure to evolve has been to the detriment of shareholders. So not just that the company needs to be green but flipping the narrative from sustainability back to value creation. So a lot of great stuff there.

We talk about more broadly how climate has come roaring back as a key issue, the importance of materiality for boards and managing ESG priorities, why inclusion is just as important as diversity, the trend toward tying executive compensation to achieving ESG and DEI goals, and how board effectiveness has been impacted and evolved in the age of Zoom and a post-pandemic location flexible work model. As always, an incredibly thoughtful and well-informed conversation with board effectiveness expert Anthony Goodman. Anthony, thank you so much for coming back on the podcast.

Check out our previous discussion with Anthony Goodman: Leadership Matters: The Critical Role of the Board in Defining and Supporting Corporate Purpose

Anthony Goodman:

Thank you for having me.

Michael Young:

Excellent. Well, as always, a ton to talk about. And I think we should under the broad heading of this conversation, why don't we take activism head-on just given what's come out of headlines recently? So what was your take on Exxon and Shell and how are you thinking about that?

Anthony Goodman:

Yeah. This has been a sort of momentous couple of weeks in the corporate governance world. Of course, those of us who are in this space year in year out realize that 2021 was going to be the year that climate came roaring back onto the corporate governance agenda, perhaps having really been on the back burner whilst everyone was dealing with the pandemic. And boy, has it come roaring back. So you had this extraordinary vote situation. By the way, they're still counting the votes so makes the U.S. presidential election look well organized. But they're still counting the votes. But it does appear that the activist at ExxonMobil has won three board seats. They had four candidates up for the election there and they've won three of them, have been seated. So that's quite extraordinary because that activist, Engine No. 1 owns a tiny fraction, way less than 1% of the total equity. And of course, the only way that they could have won this vote is by persuading the largest institutional investors, the Blackrocks and Vanguards and State Streets, etc. to support their candidates and to support their thesis that ExxonMobil was not doing enough to arrest its poor performance in oil and gas and move to renewables and to set clear targets for reducing its emissions and heading to zero. And the company had resisted that and they've received quite the bloody nose in in response. So it is fascinating.

And what happens next will be equally interesting to watch. But I think you are seeing the rise here of something interesting which is the link between activists who've always tried to leverage small equity stakes to get control of boards in order to change strategy or change the CEO. And we've seen in general the amount of activism in Q1 of 2021 is almost equal to half of what happened in 2020. So we're definitely heading towards a busy year for activists. But you're now seeing that linked to ESG and climate change in quite a big way. Now whether this will spill over outside of the oil majors, outside of extracted industries/utilities, I think it's a bit early to say. But certainly, we'll be paying attention and I think board directors more importantly should be paying a lot of attention to this. Because clearly, if you pursue a path that your largest institutional investors do not support, they are going to use their votes ultimately to unseat you and that's going to have a lot of directors looking over their shoulder.

Michael Young:

Interesting. And I think what's also fascinating to the point of the asymmetry between the numbers and the narrative, right? So Engine No. 1, tiny, tiny, tiny fraction of equity but the narrative has clearly shifted. And so what do you think the other implications are for companies more broadly, maybe those outside of extractive industries?

Anthony Goodman:

Well, I think, look, the key really for all companies right now is to be thinking through for themselves in their own industry, what are the material ESG risks and opportunities? There are plenty of frameworks and tools and standards out there to help them do that thinking and SASB being an obvious one. I mean anybody can go to the SASB website and look up their industry and figure out what their material risks and opportunities are going to be and therefore make sure that the board is organized around those in terms of its agenda, in terms of how it's going to be dealt with in the committees, and to make sure that it is disclosing what it's doing to investors. And so I think whatever industry you're in, you need to understand what those material risks and opportunities are and get out ahead of the curve, get out there, and be telling your story in a very clear and concise manner to your investors and other stakeholders. So I think that's essential.

At some point in the future, we'll stop talking about ESG and sustainability because they'll be so integrated into what a company does and how it measures its success and how it pays its people that you won't be able to identify it as a thing in and of itself. It will just be the way you do business. But right now, it does require this additional focus, this additional disclosure, treating it in a very focused and in a special way because it's of such interest to investors and other stakeholders including companies’ employees and customers that it does require boards to say, okay, well, how are we going to deal with this when we talk about strategy, how are we going to deal with this when we talk about risk, how are we going to deal with this when we consider important aspects like human capital management, like diversity and inclusion, all of which can be seen within an ESG framework? So I think it's here to stay and directors who aren't talking about this in board meetings, who haven't identified which committee is going to do the heavy lifting, who are not telling their story are going to be vulnerable. And maybe while they're performing financially, they will be able to fly under the radar. But the minute there's any kind of underperformance, people will start paying attention to these other issues and link that to their own performance. And at that point, they're in trouble if they haven't been doing the work.

Michael Young:

Yeah. It's an interesting idea about ESG eventually disappearing. It's almost like technology in a way and digital transformation, right? It was the thing that everybody had to talk about for a while and now every organization has the digital transformation strategy. So saying we're using AI and machine learning, of course, you are. So I think it's very interesting to look ahead and think about where ESG will ultimately land. It'll just be part of the business and indistinguishable for the business. It's a really interesting point. Anthony, I want to get your thoughts on another big trend that we've seen very recently in a few announcements is linking executive compensation to achieving ESG goals. And that's not new but it seems as if there have been some recent and significant announcements on that point. So how are you thinking about that and tracking that?

Anthony Goodman:

Yeah. I mean I think, look, at the end of the day, that's where the robber hits the road, isn't it? What you pay for is what you get. And if you are taking ESG seriously and it's being integrated into the business, then it really ought to feature in how senior executives are getting paid. And so you're starting to see that. To some extent, as you say, there have always been ESG metrics that people have looked at. For instance, if you were in a manufacturing or engineering kind of company, health and safety might well have been a goal that would have been rewarded against. And I think that the same is true but we're looking at a broader suite of issues now. And again, it goes back to that materiality assessment that I mentioned earlier on because what we're trying to avoid here is people being paid to pay lip service to ESG or misdirecting them into activity that is really not required, not essential to the running of the business. And so if you've done a materiality assessment, if you understand what the material opportunities as well as risks are to your business within an ESG framework, then I think you've got some hope of identifying metrics that actually move the business. So it's not about, again, what I'm trying to avoid is this concept of adding on. So now we need to add on a whole series of metrics around ESG. Well, no, you don't. What you need to do is integrate ESG into your business and then make sure that the metrics reflect that integration so you're not adding on a whole new suite of things but you're identifying what is really important to this business and then paying people accordingly.

Michael Young:

And focusing on what matters most, the materiality piece. I do want to talk about diversity, equity, and inclusion, both on boards and within organizations. And do you distinguish between DE&I at all? Are they different? What are the priorities? How should organizations and boards be thinking about this?

Anthony Goodman:

Sure. Well, let's take this in two parts and let's talk about the boards and then let's talk about the organization. So as you know, over the last decade, there's been a huge push around diversity on boards and it started being focused around gender and now it's sort of evolving certainly in the U.S., the UK, Canada, some other countries around ethnicity and racial diversity. And if you go back to the beginning, what was that all about? It was about trying to get cognitive diversity in the boardroom. That's what investors were trying to achieve. They wanted to make sure that boards were not using group think as they made decisions, were not purely cronies of the CEO. That was a problem they're trying to solve for. But it's very difficult from the outside to have any sense of what somebody's cognitive style is. And so they came down on this idea. Well, if we got more women in the boardroom, they would be coming from different backgrounds and necessarily they would think differently than the men. And so we kind of break that monopoly of group think in the boardroom. And it's easy for us as an investor to observe outside. We can look at photos. We can look at bios. And in the current situation, we can kind of most of the time guess what someone's gender is. By the way, I footnote the fact that in the next decade that will not be possible. And so assumptions that we make about people's gender, that's going to all go away. But that's kind of what was moving the investors in the first place and now they've added this additional sense of wanting racial and ethnic diversity. And partly, it's a social justice issue, partly it's a representation matters issue. But it's also about really boosting that cognitive diversity in the boardroom.

So what is happening, but at the same time, there is a question around inclusion in the boardroom which is a lot of first-time board directors who are women, who are people of color have come into the boardroom and are not necessarily speaking up. They're not necessarily being listened to. They're not necessarily being included and boards are not getting the full value out of them being there. And so I think we're heading towards a bit of an inclusion crisis for a number of boards where that tension is going to need to be resolved in some way and it falls on board leadership. It falls on the board chair and the committee chairs really to make sure that everybody is participating and they are running the board and the committees in a way that encourages everyone to participate and contribute the skills and experiences that brought them onto the board in the first place. Now if you then pivot and look at the organization, you can think about the fact that as boards have become more diverse, in some cases ahead of where the senior management team is, they've also started to push management to diversify the organization. And so you you're seeing targets. Again, that's kind of being reflected a little bit in pay where senior executives are having metrics set around representation in their in their business or their function. But again, we have to go beyond diversity. Diversity is important and we have to have inclusion where everyone belongs in the organization and everybody's voice is heard in the organization. So I think diverse boards have a better chance of doing that and diverse organizations are going to work much more effectively if they have diverse boards. So there's definitely synergies. These things go hand in hand but I've observed that oftentimes the board gets diversified first because of the external pressure from investors and others. And it's the organizations that follow behind and how slowly they follow or how quickly they follow is really the issue.

Michael Young:

And I've heard you talk about this before, about that point of the organization and the senior leadership in the organization versus the board. So where do organizations have to look for directors? Is it is it predominantly from outside? Does that change the makeup of the board? Does that change the direction of the organization if these are outside directors brought in as opposed to an executive who's come up through the ranks and is African-American or another underrepresented group?

Anthony Goodman:

So you're talking about directors as in in the organization, not directors on the board?

Michael Young:

Yes, yes.

Anthony Goodman:

Yeah. Well, I think it is about pipeline, right? So it is about making sure that you're actually hiring people at all parts of the organization and you're developing them and you're creating career opportunities, career paths for them. We're not going to solve this problem if it's simply about the biggest companies with the largest pay packets stealing the best talent from everyone else. At the end of the day, this a societal problem as well. We've got to make sure that all companies are doing their best to ensure their workforce is diverse, that those people when they're there can have satisfying careers and are going to get the development and the mentoring and the support they need to be successful so they don't have to leave and go somewhere else. The challenge for the board is a somewhat different one which is where do they get the pipeline of board directors from? And of course, the answer is from the top levels of other organizations who've managed to create diverse populations in their senior management team. And those people are now [inaudible 00:21:02] very attractive board candidates and often are coming on the board with very little board experience. And that's fine because I think boards have realized it's easier to train someone to understand a board role than they had realized previously and to get something out of the people who come on the board pretty quickly.

Michael Young:

Interesting. Yeah. And then just more broadly on the other aspects of S and the balance within organizations and how they're thinking about climate, social, and governance. S roared to the front I think last year, right? Is that going to change? Is that going to evolve? How do you see that playing out in particular?

Anthony Goodman:

Yeah. It's a really good question. So S being the social in environmental, social, and governance. And last year, that was kind of reflected in a couple of ways. One was what are you doing for your employees during the pandemic and the concept of wellness joining health and safety as an important aspect that stakeholders were looking at in terms of the company and also how the company was treating its communities, how it was treating its supply chain, its suppliers and so on. Really being judged on that sort of social network that the company sits in the center of with all of its different stakeholders. I don't think that's going to go away. I mean, yes, look, we know climate is the number one issue. So the E is very much in everyone's minds right now. But I don't think that means that we're neglecting the S because we've got a huge challenge coming up, several challenges actually. One is we've got return to work. So as people get vaccinated, as COVID comes under control, companies are now rethinking what does it mean to be in the office, what does it mean to be in the plant, what does it mean to be an employee, and how is that going to impact our culture? And I think that the idea that we would somehow go back to the old normal of early 2020 is starting to recede. Because all the polling that I've seen shows that really for office workers, most office workers are telling their employers that they don't wish to come back to the office five days a week and in some cases, they don't want to come back at all. And so how a company is going to deal with that as they move forward. So there's a lot of thinking that needs to be done around that, a lot of implications around real estate as well. At the same time, we've got the whole social justice racial, justice movement here in the U.S. but in other countries as well following the events of last summer the merger of George Floyd, etc. and how companies are dealing with that in terms of their employees, in terms of how they relate to their communities. So I think those are big impacts and they’re long-term impacts. They're not going anywhere. So keeping a focus on that S is going to be really important.

Michael Young:

Excellent. And just to maybe the say on sustainability as a topic of interest and significance within the board, how do you think about that?

Anthony Goodman:

Yeah. This is a fascinating issue that's kind of emerged over the last year or so. Just so people understand what that is, right now investors in many markets including in the U.S. have an advisory vote on executive compensation. The shorthand for that is called say on pay. So they have a say on pay. And there's been a campaign really started in Europe to give investors a say on climate or a say on sustainability, the idea being that management would present their plans, maybe how we're going to get to net zero carbon by fill in the date and to put those plans to investors and have them be agreed so that there's a consensus around what the company is trying to achieve and it'll be easier for it to move forward knowing that shareholders are supporting its long-term plans around sustainability, around climate. And we've seen a number of companies go ahead and adopt this for themselves in Europe, companies like Nestle, Unilever. Total just had a vote on theirs in the last couple of weeks where it got over 90% support from investors. And even in the U.S., I think Moody's has adopted a say on sustainability and there are other companies looking to do the same thing. It's not cut and dried. Some of the larger investors are concerned about this proliferation of voting that takes place and the research that's got to be done behind that, the extra work for the proxy advisors, the extra work for their corporate governance teams.

And they believe that they can achieve the same thing through voting on directors. And of course, the whole ExxonMobil example we talked about earlier on is a great example where you can actually achieve a lot by voting against some directors and voting for others although it's also the case that it looks like a couple of shareholder proposals around disclosure and reporting on climate related issues have also been passed there. Again, sort of advisory but I'm guessing the board's going to have to move forward now there's going to be three people nominated by the activist on the board. So there are other mechanisms out there. But I would watch this. I think it's got some legs to it and I think over the next few years we're going to see a lot more volunteerism here from companies, putting their plans to the vote and in some cases, you're going to have activists and others putting shareholder proposals, asking for votes on those plans, knowing that that they actually have disgruntled investors who would probably vote against them. So I think it's a fascinating area and one that a year ago, we wouldn't have even had this conversation.

Michael Young:

Yeah. And you mentioned the world of work and maybe to wrap up on the topic of board effectiveness in the age of Zoom and remote work, how has board effectiveness evolved and changed over the past 16 months and where do you think it's going? And is it a return back to dinners and in-person meetings or do you think this hybrid model will continue?

Anthony Goodman:

Yeah. That's a great question. So just as we were talking about the return to work means you're not going back to the old normal of January/February 2020, I think that's true for boards as well. I don't think there are as many board directors saying that they don't ever want to show up to a board meeting again. But I think what they are saying is we need a hybrid model where when we come together in person, it's because we've got really important strategic conversations that we want to have that are just going to be so much easier when we're all in a room together. And a lot of what boards have to do that is really about consent agendas and compliance can be continued to be done virtually. So what we're hearing is boards suggesting, well, maybe we're going to keep at least one meeting a year virtual, that meeting which everyone had trouble getting to because of the weather or we're going to keep some of the committees meeting virtually so that when we get together, we have more time with all of us in a room together and those meetings are going to be much more focused on strategy, they're going to be more focused on risk, on culture, on human capital, management, understanding the bench strength of our management teams. There's no doubt that directors have missed the interaction with each other, the social interaction and they've also missed that with management. And of course, a lot of people joined boards in the last year and a bit and joined management teams and they've never met each other. So I think that that's maybe caused some boards to have a degree of dysfunctional issues where the board just hasn't really gelled and there's a little bit of mistrust of motives and so on. But I think that that will sort itself out once people are able to come together in person in a safe way. I think there's an appetite to do it. I just don't think we're going back to the old normal.

Michael Young:

Great. All right. Well, always an insightful and thoughtful conversation with you, Anthony. I really appreciate you coming back on the podcast.

Anthony Goodman:

Well, thank you for inviting me. It's a great conversation and we'll keep tracking these issues and we’ll I'm sure be talking about them again.

Michael Young:

Absolutely. Thanks again.

Anthony Goodman:

Bye, bye.

Conclusion:

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