Guidance for Engaging on Climate Risk Governance and Voting on Directors

Rob Berridge is Senior Director of Shareholder Engagement at Ceres. This post is based on his Ceres memorandum. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance by Lucian A. Bebchuk and Roberto Tallarita (discussed on the Forum here); Companies Should Maximize Shareholder Welfare Not Market Value by Oliver Hart and Luigi Zingales (discussed on the Forum here); and Reconciling Fiduciary Duty and Social Conscience: The Law and Economics of ESG Investing by a Trustee by Max M. Schanzenbach and Robert H. Sitkoff (discussed on the Forum here).

Climate change poses urgent and systemic risks to the economy and to investors, as well as serious material risks to companies. The extent of this risk, and that there is no avenue for diversifying away from it, means that investors and proxy advisory firms need reliable public information about a company’s climate-related risk oversight and its plans for transitioning to a net zero emissions future. For disclosure to be actionable and meaningful, it needs to respond adequately to the governance recommendations of the Task Force on Climate-related Financial Disclosures (TCFD), which has received strong support from investors and companies, and the Climate Action 100+ Net-Zero Company Benchmark (the Net-Zero Company Benchmark), which is backed by the world’s largest investor initiative representing more than $65 trillion in assets.

This post serves as a resource for investors and proxy advisory firms. Companies may also want to use this post to prepare for engagements with their stakeholders.

This post provides details on topics that investors and proxy advisory firms may want to consider to inform their company engagements and decisions on whether to support the election of directors responsible for climate change risk oversight. This post covers practices in governance, reporting, and lobbying around climate change-related risks and opportunities, i.e., the direction in which all U.S. public companies should be moving on their journeys to address the net zero transition. Depending on their respective internal practices, investors and proxy advisory firms may determine if voting against or making a recommendation to vote against directors is appropriate for companies that lack one or more of these practices.

A. Effective Board Oversight of Climate-Related Risks and Opportunities and Greenhouse Gas Emissions Targets

Companies should disclose independent board oversight of climate-related risks and opportunities, which includes monitoring by the board of each company’s science-based greenhouse gas (GHG) emission reduction targets.

This board oversight should be clearly reflected in a publicly available governance document on the company’s website, such as a board committee charter or—if only at the full board level—corporate governance guidelines. If a board committee has oversight, the committee should

ideally be composed of only independent directors. All committee members should have attended at least 75% of the committee’s and full board’s meetings over the past year, unless an acceptable reason for absences is disclosed in an SEC filing.

Companies should disclose the existence of an effective cross-functional senior management committee that is responsible for company-wide management of climate-related risks and opportunities. The management committee should generally report to the CEO and have a “dotted line” reporting relationship to the full board or the board committee responsible for oversight of climate change-related issues.

The cross-functional senior management committee could include members from the following corporate departments/teams: audit, human resources (including those responsible for executive compensation), investor relations, finance/treasury, marketing, government affairs, legal, operations, product development, strategy, real estate, research & development, risk management, and supply chain management/procurement.

Companies should disclose sufficient information to reveal the “climate competency” of their boards. Such disclosure could be in a company’s proxy statements or corporate social responsibility (CSR) reports, using disclosures such as board matrices and director biographies that support the experience and expertise listed in the board matrices.

No one director will make a “climate competent” board. Rather, a board should assess and be able to explain how the different directors’ experience contributes to thoughtful discussions and meaningful connections with the long-term strategy, given the unique climate risks and opportunities the company faces.

For additional resources, see Ceres’ report Lead From the Top: Building Sustainability Competence on Corporate Boards.

D. Sufficient Board and Senior Management Response to Majority-Supported Investor Votes that are Contrary to Board Recommendations

Within a reasonable time after the vote, companies should adequately address the investor concerns behind the vote and disclose the company’s response. This would apply in cases where:

  1. A director failed, at the previous board election, to receive more than 50% of the votes cast for a climate change-related reason.
  2. A climate change-related shareholder proposal received a majority of investor votes cast at the company’s shareholders meeting in any of the prior three years. The focus should be on the RESOLVED clause of the proposal, since that is what shareholders voted on. When the rigorousness of implementation is questionable, the rest of the shareholder proposal may be used to help determine what investors voted FOR.
  • For a proposal that passed at the most recent shareholders meeting, the company should disclose a plan for a timely implementation.
  • Proposals that receive a majority of non-insider votes may also warrant engagements concerning, as well as the withholding of voting support from, directors.
  • Proposals that receive between 20 and 50% may also be considered, depending on such publicly disclosed factors as the company’s outreach to investors after the vote, rationale for the degree of company implementation, and level of support for the proposal in the past.

E. Sufficient Board and Senior Management Response to Climate-Related Controversies or Failures

Companies should adequately address and disclose the reasons for—and any mitigating actions taken in response to—any climate-related controversy or failure (including a significant asset writedown related to the controversy or failure) that in the past year has resulted in or from significant or serial fines or sanctions from regulatory bodies and significant adverse legal judgments or settlements.

F. Sufficient Availability of Independent Directors to Engage with Shareholders on Climate Change Issues

Company boards should make one or more independent directors available to engage constructively with significant shareholders on climate change risks and opportunities that are financially material to the company.

Significance of a shareholder should be determined not only with respect to assets under management, but also by other factors, such as a shareholder’s recognized leadership in the climate space. For an assessment of the materiality of climate-related issues, consideration may be given to the six “Environmental” issues listed for the company’s industry in the SASB Materiality Finder.

G. Sufficient Audit Committee Oversight of Climate Risks and Disclosures

Audit committees should direct the company’s internal audit department and its independent auditors to include in their respective work scopes: (1) sufficient testing of the impacts of climate change risk on the company’s operations and (2) review of the related disclosures in the company’s audited and interim financial statements (including, for example, whether any asset valuation write-downs are appropriate), with clear disclosure of assumptions used in their testing.

In its discussion with management and the company’s internal audit department and independent auditors, the audit committee should review and discuss the critical audit matters addressed during the audit.

Consideration may be given to demand, technology, and regulatory shifts associated with climate change that could impact company accounts, including future cash flows, asset values, and retirement obligations.

The latest TCFD implementation guidance (page 8) affirms that a company’s audit committee should be among those reviewing TCFD disclosures prior to public issuance, regardless of whether the disclosures are in a financial or nonfinancial report.

II. Further Detailed Guidance Based on the Climate Action 100+ Net-Zero Company Benchmark Indicators

A. Science-Based GHG Emission Reduction Targets and Decarbonization Transition Plans

Boards should oversee the development, implementation, and disclosure of comprehensive transition plans that include science-based GHG emission reduction targets, including annual progress toward meeting these goals and independent verification. Board oversight is critically important to help drive each company’s net zero transition, aligned with the Paris Agreement goals.

B. Governance of Paris Agreement-Aligned Climate Lobbying

Company boards should themselves and/or through board committees have explicit oversight responsibility for reviewing company policies and practices to determine whether their companies lobby–directly or indirectly (through each of their trade or other associations)–for public policies that support the transition to a low-carbon economy consistent with the goals of the Paris Agreement.

If the board or committee determines that the company has lobbied (directly or indirectly) against Paris-aligned policies (or in favor of actions that would delay, negate, or obstruct such policies), it should oversee public disclosure explaining the reasons behind such misalignment, along with any mitigating steps the company is taking to address legal, financial, or reputational risks resulting from this misalignment.

  1. Companies should disclose the two TCFD “Governance” recommendations, which are detailed more fully in Section I above.
  2. Company disclosures should explain how the company has integrated climate risks and opportunities into company strategy and operations. Among other things, the company should set and disclose a strategy to meet short-, medium- and long-term targets for its scope 1, 2, and 3 GHG emissions aligned with science-based, net zero GHG emissions and the goal of limiting global warming to 1.5 Celsius by 2050 or earlier (depending on the industry).
  3. If a company’s TCFD reporting does not include disclosures for all 11 recommendations, the company should disclose a time frame for making public all of the recommended disclosures.

These disclosures, which generally cover all the Net-Zero Benchmark Indicators, should appear in a company’s annual financial reporting or a standalone TCFD report on a company’s own website.

How Investors and the Proxy Advisory Firms May Hold Boards Accountable for Inadequate Climate-Related Risk Governance

In cases where an investor or proxy advisory firm decides to escalate its engagement with a company by withholding director support, Ceres has the following additional suggestions for identifying which directors may be targeted, as well as mitigating factors:

Investors who are signatories to the Climate Action 100+ Initiative should consider focusing more attention in their company engagements with Climate Action 100+ focus companies on how company reporting aligns with both the Net-Zero Company Benchmark and the TCFD Recommendations.

Gross misalignment could also inform voting against directors.

For companies that have not taken appropriate steps, investors and the proxy advisory firms may apply this Guidance to withhold support from directors who are responsible for overseeing different elements of climate-related risk and/or for governance and overall board composition. This could include one or more of the following directors:

  • Chairs of the most relevant board committees
  • All members of the most relevant board committees
  • For situations without specified committee climate oversight responsibility, one or more of the following:
    • Audit Committee Chair (or all Audit Committee members), since Audit Committees are responsible for risk oversight;
    • Nominating/Governance Committee Chair (or all Nominating/Governance Committee members), since Nominating/Governance Committees are responsible for recommending to the full board the delegation of appropriate Board Committee oversight of relevant issues;
    • Public Affairs/Sustainability Committee (or equivalent committee) Chair (or all Committee members), since they may have relevant oversight responsibilities;
    • Independent Chair or Lead Independent Director; and/or
    • All members of the Board of Directors.
  • Directors with problematic or insufficient experience or expertise

In evaluating whether to withhold voting support for one or more directors, consideration may be given to the additional context for individual companies, including, but not limited to, the specific industry’s pace of decarbonization (as determined by leading groups such as the Science Based Targets initiative and the International Energy Agency’s (IEA) Net Zero by 2050 Roadmap) and related disclosure, geographies, and technological advances.

Additional Resources

Climate Action 100+ Net Zero Company Benchmark V1.1 (October 2021)

Climate Action 100+ Benchmark Press Release (March 2021)

TCFD Implementation Update (October 2021)

TCFD 2021 Status Report (October 2021)

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