With the coronavirus pandemic (we hope) tapering off this summer, boards are looking ahead to more normal compensation programs for 2022. They can pull back on the extraordinary measures and structures of 2020–21 and return to their long-term paths to strengthen or transform their organizations. Those paths were already a bit obscured by ongoing disruption in many industries, but then the pandemic pushed them decisively to the side. Companies can now get out of reactive mode and start to control their future again.

Still, it’s important for boards to resist the temptation to pick up where they left off in 2019. The pandemic and other developments have changed the landscape for corporate behavior and strategy. Executive compensation must adapt accordingly for companies to capture fresh opportunities and overcome new challenges.

Taking Stock

2020 was especially difficult for many boards. For their compensation programs, many resorted to new measures, goals, and performance periods, or used discretion. Others introduced special awards to promote retention or maintain motivation. Many of these approaches veered from the typical path but were deemed necessary to administer relevant and fair rewards amid the crises.

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Sustainability—both social and environmental—has quickly risen to the top of corporate agendas in recent years. This is in part because of the growing evidence that sustainable practices result in improved financial performance, and in part due to pressure from investors, employees, and the public for companies to articulate the role they play in addressing societal challenges. As one director recently told us, sustainability “has never been a higher priority for the board than it is today.”

In 2020, Russell Reynolds Associates published a study in partnership with the United Nations Global Compact examining the attributes that make executive leaders effective at driving sustainability outcomes. In this post, we study the issue from the board’s perspective, looking at how corporate directors engage with the challenges and opportunities related to sustainability, how they structure and operate the board to oversee related activities, and ultimately, how they enable sustainable in the enterprise.

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Introduction

There is a growing consensus in the global business and investment community that sustainable and inclusive capitalism is vital to society, the environment, and the economy. This paradigm shift is propelling corporate purpose to the top of the agenda for directors and investors.

The first report from the Enacting Purpose Initiative, Enacting Purpose Within the Modern Corporation, A Framework for Boards of Directors, was published in August 2020. This report builds upon that foundation by setting out how directors can work with their investors to leverage corporate purpose to address societal issues and sustain long-term value creation.

This report’s recommendations were informed by extensive dialogue with over 35 board members in the Director Steering Group and over 30 global investors and asset owners and managers in the Investor Steering Group. We remain encouraged by the common ground between investors and directors regarding the value of corporate purpose. This report lays out that common ground in order to produce actionable insights for directors seeking to deepen their collaboration with investors on corporate purpose.

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Many business thinkers have criticized corporate “short-termism” that discourages crucial long-term investments in intangible capabilities. Executive pay programs get much of the blame, as even “long-term incentives” last only three years, with the goals for each year’s tranche reset annually.

Those brief periods are understandable given that most company strategies in fast-paced markets require agile responses to near-term market developments. But then how can companies carry out long-term investments?

One answer is to realign pay programs to support the company’s larger mission and purpose, rather than a particular strategy. Boards can link a new set of incentives to progress toward achieving the mission, with an eye to promoting sustainable growth. Once executives are focused on and paid for long-term, mission-driven success, they’ll be more inclined to make the necessary investments.

These new incentives could replace existing three-year plans or become an entirely new set of incentives to complement the existing annual and three-year plans. Two incentive programs would be simpler to communicate and would minimize redundancy. But many boards might prefer a separate, third program to ease the transition from current incentive practices.

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Most boards address emergency CEO succession in some way, even if it’s just discussing the “name in the envelope” who could be quickly tapped for an interim period of time. The COVID-19 crisis underscored the importance of having a robust, formal emergency succession plan and raised questions about how prepared most organizations really are.

In this post, we highlight best practices for developing an emergency succession plan, including:

• Defining the criteria and responsibilities of an interim CEO
• Aligning on the “name in the envelope”
• Maintaining a view of relevant external talent
• Codifying the plan

Define the criteria for the interim successor

Boards historically have prioritized continuity and the likely investor reaction when selecting an interim CEO successor—someone who can give investors confidence that the company is in good hands until a permanent successor is selected. Not surprisingly, the most common interim leaders in emergency successions are the board chair, another board director, the CFO, the COO and, occasionally, a division president or general counsel.

In a crisis, the board may prioritize different criteria depending on the context and stakeholder needs: a “culture carrier” or leader with significant followership who can calm the organization and maintain continuity in the short term; an executive who is able to rally the leadership team; a highly effective communicator; or the CFO, who is closest to the financials and may be best positioned to manage through a cash crunch.

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As the global economy rebounds, companies are preparing to launch a record wave of buybacks. Buybacks have become a global phenomenon over the past 20 years, with many companies viewing them as an attractive alternative to dividends in returning capital to shareholders. They are flexible, recycle excess cash to the economy, and provide tax advantages in certain jurisdictions.

While buybacks can indeed be an effective way to distribute capital under certain circumstances—and can be used to signal to investors that their stock is undervalued – care must be taken to mitigate the downsides of buying back shares.

Common pitfalls

As tempting as buybacks may be as a quick way to return funds to shareholders, there are several pitfalls to consider.

From a strategic perspective, timing a buyback poorly can lead to losses. Companies cannot perfectly predict the market and often buy at market peaks, rather than troughs, due to overconfidence. This is also the tendency when the firm is generating excess capital. It can be mitigated by taking a long-term dollar-cost averaging approach to buybacks, adjusting the strategy based on market conditions and adopting a break-even scenario analysis.

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In recent years, the concept of “corporate purpose” has been invoked as a shorthand to address a corporation’s commitment to include stakeholder governance—and with it commitments to sustainability, diversity, inclusion, social responsibility and other ESG issues—as part of a corporate strategy that achieves sustainable long-term growth and creates long-term value for the benefit of all stakeholders.

Recognizing the importance of corporate purpose in helping guide efforts to build back better following the pandemic, a distinguished group of academics at Oxford University formed the “Enactment of Purpose Initiative.” The Initiative seeks to encourage the elemental constituencies of a corporation—directors, management, asset owners and managers, and other internal and external stakeholders—to collaborate to articulate an actional principle of purpose, which, when applied to the special circumstances of each corporation, will orient the firm towards mission-driven growth that delivers both profit and social responsibility.

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Environmental, Social, and Governance (ESG) investing has evolved greatly as a concept over the past two decades. It now reaches nearly every aspect of the corporate and investment decision-making process, and rightfully so. This growth has presented so many amazing opportunities for investors and corporations to measure and improve practices across all aspects of the E, S, and G spectrum. It has also created a host of challenges for investment professionals who are trying to answer the question: “Does ESG matter?”

Globally ISS ESG continues to see and measure improvements in corporate ESG practice:

• more companies committing to carbon goals and more biodiversity awareness;
• more awareness of inclusive Corporate Social Responsibility policies, increased gender and ethnic diversity at board and management level; and
• better board composition, shareholder rights, and increases in stewardship practices such as engagement and voting.

ISS ESG has also watched and listened as sustainability reporting continues to evolve, with different approaches developing in different global regulatory situations. While these changes have driven the availability of clean, comparable, and consistent data, challenges remain in the capture, measurement, and analysis of that data.

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The Organisation for Economic Co-operation and Development (OECD) has just issued two major new reports—The Future of Corporate Governance in Capital Markets Following the COVID-19 Crisis, and the 2021 edition of the OECD Corporate Governance Factbook—that will serve as key references for the OECD’s upcoming review and revisions to the G20/OECD Principles of Corporate Governance.

The G20/OECD Principles, since their first issuance by the OECD in 1999 and subsequent revisions in 2005 and 2015, are now recognized as the leading global standard to guide policy makers and regulators in devising effective institutional, legal and regulatory frameworks for the corporate governance of listed companies. Endorsed not only by the 38 members of the OECD but also by the G20 and Financial Stability Board, more than 50 jurisdictions worldwide now adhere to this OECD recommendation.

However, as the new OECD report on The Future of Corporate Governance in Capital Markets Following the COVID-19 Crisis makes clear, both the COVID-19 pandemic and longer-term trends suggest that governments’ corporate governance frameworks will need to make further adaptations to ensure that capital markets may serve their intended purpose of allocating substantial financial resources to support long-term investments underpinning economic growth and innovation. (more…)

Investment organizations around the world face an array of ever-changing external expectations. These expectations go well beyond traditional notions of achieving return targets or liability matching and can create important responsibilities that are broader than fiduciary duty or asset stewardship. Ripples of Responsibility provides tools for understanding and fulfilling these responsibilities. Together with our members and others, we have piloted this publication’s toolkit in workshops focused on six different domains of responsibility: economic impact at home and abroad, equity lending and stewardship, impasses in corporate engagement, racial and gender diversity of portfolio companies, climate and environmental impact, and reputation management.

The way that investment organizations navigate existing responsibilities and new expectations that arise has a tremendous effect on their long-term success.

When an investment organization fails to fulfill true responsibilities, staff can become distracted from their long-term focus, interrupting the organization’s long-term investment strategy. Consequences also can include turnover in leadership or responses by legal or regulatory authorities that narrow the discretion of leadership. Yet positive cases of investment organizations meeting evolving expectations abound: two examples are Future Fund’s efforts to ensure that external managers steward its reputation appropriately and the New Zealand Super Fund’s participation in the national response to social media firms live streaming the Christchurch atrocity. [1] [2]

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Executive Summary

How much forward-looking information do public companies disclose, including on ESG themes? Do they provide targets and KPIs on themes key to long-term value creation? In this paper, we analyze the accessibility, quantity, and time frame of forward-looking information disclosed by the 25 constituents in the S&P 500 Pharmaceuticals, Biotechnology & Life Sciences GICS industry classifications.

Using an updated version of CECP’s Long-Term Plan (“LTP”) Framework, we assess four key disclosure channels (annual reports/10-K, stand-alone sustainability reports, proxy statements, and investor day transcripts) and find that forward-looking information is dispersed, and locating it is complex and time-consuming.

In addition, the amount of forward-looking disclosure varies across the LTP Framework’s nine themes, with the most found across the themes of Competitive Positioning and Trends. We find that near-term disclosures are most common.

We conclude with a practical set of executive-ready recommendations for corporate managers focused on setting targets, increasing transparency, refreshing materiality, and providing commentary on ESG disclosures.

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Across the existing spectrum of ESG ratings, guidelines, and frameworks, higher quality environmental scores are commonly associated with technology companies while lower relative scores are typically linked to energy companies. This is not necessarily a novel statement, but it does highlight a critical inefficiency. We feel ESG-ratings agencies and, in some cases, reporting frameworks, currently miss the mark in their respective evaluation environmental impact for both sectors. Digitalization, artificial intelligence, and big data are evolutionary trends affecting every sector; however, these trends mean something inherently different for energy. Long-term success for the energy space is contingent upon developing greener technologies and adopting advanced data analytics, yet ratings agencies provide less of an opportunity for energy companies to showcase these explicit talents.

As a result, the narrative conveyed by ESG ratings data fails to outline the longer-term economic reality for most capital-intensive businesses, particularly energy. Empirically speaking, the data indicates environmental impact metrics for the energy and technology sectors are actually converging, but existing ratings data does not reflect this. As paradigm shifts within the global economy materialize, technology and energy are becoming increasingly interlaced. As big data and technological advances continue to represent a greater proportion of the overall global economy, think about the respective “inputs” the technology world will require just to keep the lights on.

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Michael Strain: Good afternoon, I’m Michael Strain, Director of Economic Policy Studies at the American Enterprise Institute, and I want to start by thanking you all for joining this discussion of shareholder capitalism. Fifty years ago last month, economist and Nobel laureate Milton Friedman published his famous essay in The New York Times Magazine arguing that the social responsibility of businesses is to increase their own profits. This view has been controversial ever since. While campaigning back in July, Joe Biden said that the idea that a corporation’s sole or primary responsibility is to its shareholders is not only wrong, but “an absolute farce.”

Adding fuel to the debate, the U.S. Business Roundtable appears to have retreated from its earlier shareholder capitalism stance by issuing a statement about a year ago that embraced the idea that corporations and their managements have a responsibility to a broader group of stakeholders, including customers, suppliers, and workers. And that’s the question that we want our distinguished panel to take up in the next 45 minutes or so: Should executives manage their companies for the benefit of all stakeholders or should they simply focus on maximizing shareholder value? But before jumping into our subject, let me tell you a little about each of our three panelists:

Cliff Asness is the founder and chief investment officer of AQR Capital Management. Besides running a highly successful investment company, Cliff has long been an active researcher who’s published peer-reviewed articles on a variety of financial topics in many publications. He is also a trustee of the American Enterprise Institute.

Marty Lipton is a founding partner of the law firm Wachtell, Lipton, Rosen & Katz, which specializes in advising major corporations on mergers and acquisitions and matters affecting corporate policy and strategy. Widely credited with having invented the poison pill as a way of protecting corporations from market shortsightedness, Marty has been a major public intellectual on the social role of corporations in serving not only their shareholders, but other corporate constituencies.

Glenn Hubbard is Dean Emeritus and Russell L. Carson Professor of Economics and Finance at Columbia Business School. Glenn was chairman of the Council of Economic Advisers under President George W. Bush and is at present a visiting scholar at AEI.

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Executive Summary

Corporate leaders and institutional investors are looking for effective, efficient, and decision-useful information about long-term business strategy, and how it connects with the most important environmental, social, and governance (ESG) issues in each sector. This need is driven by many trends in management, capital markets, regulation, and civil society, two of which stand out:

1. Growing evidence that a focus on ESG performance is strongly accretive to long-term value creation and financial performance, and that the elements of an effective ESG strategy are specific to each sector.
2. Growing recognition of how valuable it can be to effectively communicate long-term plans to investors, employees, and other stakeholders.

Long-term planning is especially important for the biopharma sector right now, as we look toward a global recovery from the COVID-19 pandemic. A sustainable, long-term response by the sector is required not only to meet the direct therapeutic and diagnostic development and production challenges, but also to create new solutions and to communicate the industry’s efforts and outcomes more effectively to all stakeholders.

In response, the Biopharma Sustainability Roundtable (BSRT) and the CEO Investor Forum at Chief Executives for Corporate Purpose (CECP) have joined forces to convene the first sector-specific Biopharma CEO Investor Forum. The Forum is planned for June 7th and 8th, 2021. This report and a companion Practitioner’s Guide were created to provide practical tools for biopharma CEOs and their teams as they prepare their Sustainable Long-Term Plan presentations for the Forum. These documents combine CECP’s Long-Term Plan Framework, honed through use at previous CEO Investor Forums, with the Biopharma Investor ESG Communications Guidance, broadly validated and supported by investors to tailor the content and perspective for the biopharma sector.

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Why do investors allocate their portfolios as they do? What causes them to change their minds and trade in their portfolios? These are critical questions in the field of macro finance. And central to answering them is understanding the role of expectations: what investors believe about future market returns and risks, how their beliefs vary with time, and how those beliefs come to influence real-world portfolio choices.

Among financial economists, there has been a growing interest in measuring investor expectations in a systematic way using surveys. However, surveys have been hindered by too qualitative a set of measures or by the lack of data showing how surveyed investors actually act on their beliefs.

In order to tackle such concerns, we have created a new research initiative on investor beliefs that combines administrative and survey data for a panel of individual investors at Vanguard. Vanguard is a well-known global asset manager; it is also large provider of investment services to U.S. retail investors. The survey, conducted every other month since February 2017, asks investors about short- and long-term expected stock market returns. It also elicits the subjective distribution of expected returns, allowing us to examine beliefs about low-probability events like a market crash. We also survey expectations on economic growth. These survey results are paired with portfolio allocation, trading, demographic and digital attention data.

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Stock-market short-termism—stemming from rapid trading and activists looking for quick cash—is, a widespread view has it, hurting the American economy. Because stock markets will not support corporate long-term planning, the thinking goes, companies fail to invest enough, do not do enough research and development, and buy back so much of their stock that their coffers are depleted of cash for their future.

This widespread view has induced proposals for remedy. One proposal is for corporate “loyalty shares,” whereby stockholders who own their stock for longer periods would get more voting power than those who trade their stock quickly. In the proponents’ vision, executives would appeal to loyal, longer-term, stockholders for votes against activists and traders and, by investing for the long run, would obtain the loyalty share votes. The longer-run stockholders, with extra votes, would elect like-minded boards and support longer-term corporate business policies. The affected companies would profit more and the American economy would prosper.

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Environmental Social and Governance (ESG) considerations now sit at the heart of good business practice, and for some companies have become a central strategic pillar.

Society needs companies to play their role in addressing challenges ranging from social mobility to climate change. This would suggest that executives should be paid based on ESG performance. But this simple conclusion may not always be correct, and simplistically adding the wrong ESG metric into executive incentives can be unproductive, and worse, counterproductive.

A new report in partnership between The Centre for Corporate Governance at London Business School and PwC reviews what market practice and academic evidence have to say about linking executive pay to ESG. There is no single right answer, but we identify the underlying reasons why a company may (or may not) include ESG in executive pay and the consequences for measure selection. And we set out the principles and decisions required to design a good, effective and enduring ESG pay metric, if that is what a board decides to do.

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Sustainable investing considers not only financial objectives but also environmental, social, and governance (ESG) criteria. Assets managed with an eye on sustainability have grown to tens of trillions of dollars and seem poised to grow further. Given this rapid growth, the effects of sustainable investing on asset prices and corporate behavior are important to understand.

We analyze both financial and real effects of sustainable investing through the lens of an equilibrium model. The model features many heterogeneous firms and agents, yet it is highly tractable, yielding simple and intuitive expressions for the quantities of interest. The model illuminates the key channels through which agents’ preferences for sustainability can move asset prices, tilt portfolio holdings, determine the size of the ESG investment industry, and cause real impact on society.

In the model, firms differ in the sustainability of their activities. “Green” firms generate positive externalities for society, “brown” firms impose negative externalities, and there are different shades of green and brown. Agents differ in their preferences for sustainability, or “ESG preferences,” which have multiple dimensions. First, agents derive utility from holdings of green firms and disutility from holdings of brown firms. Second, agents care about firms’ aggregate social impact. In a model extension, agents additionally care about climate risk. Naturally, agents also care about financial wealth.

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In our forthcoming Review of Financial Studies publication (available here), we examine the value of financial flexibility for large, publicly listed companies in the US during the initial phase of the COVID-19 crisis.

The COVID-19 shock led to a dramatic temporary decrease in revenues for many firms, because production and selling activities conflicted with social distancing practices. For some firms, production halted, because production would have led to workers being highly exposed to COVID-19. For other firms, customer demand flatlined, because the firm’s goods and/or services entailed exposure to COVID-19.

Firms differ in how their financial affairs are organized. Some firms hold large amounts of cash to help them cope with unexpected events. They also keep debt capacity and limit their exposure to debt rollover risk. These firms have financial flexibility, so that they can more easily fund a cash flow shortfall, such as the one created by the COVID-19 shock. In contrast, firms with less financial flexibility might rapidly descend into financial distress and be forced to take actions that healthy firms would consider detrimental to long-term shareholder wealth.

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A prominent securities regulator recently observed that “ESG no longer needs to be explained.” ESG is firmly ensconced in the mainstream of corporate America, a frequent topic in boardrooms, C-suites, investor meetings, and regulators’ remarks. Perhaps less obvious is that ESG has yet to be mainstreamed, as it were, in internal corporate governance and operations at the individual company level. In order to be a meaningful factor in effectuating corporate purpose, ESG—or, more accurately, EESG (including Employees as well as Environmental, Social, and Governance)—must be integrated throughout corporate affairs, not just in the boardroom.

The internal mainstreaming of EESG is the next step in its remarkable journey from activist wishlists to board and regulatory agendas. The good news is that this should not be difficult for most organizations to accomplish, so long as corporate leaders recognize that engaging with EESG considerations is not something that happens “elsewhere,” but “everywhere.” When EESG is integral to the culture and values of a company, it will naturally be incorporated in the work that is done throughout governance and operations, including strategic planning, risk management, compensation, communications, and disclosure. This approach to EESG is beneficial in a number of important ways: It is conducive to long-term value creation and responsive to investor interests; it improves efficiency and transparency while demonstrating commitment to EESG goals; and it can help forestall legal liability and reputational harm.

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