The Globe and Mail
Judging by the high-level metrics alone, Fortis Inc., the energy distribution giant, would appear to be a model of good corporate governance. Twelve of its 13 directors are independent. The chair isn’t the CEO. There’s a mandatory retirement age (72) and a term limit (12 years) to keep things fresh. Directors must be elected by a majority of votes cast—a proxy measure institutional investors like because it lets them replace directors they don’t like. Lastly, Fortis is that unicorn of publicly traded companies—a firm where women make up more than half the board. On gender, in fact, Fortis has come a long way, especially for a utility. In 2013, there was only one female director.
As for the “E” in the company’s environmental, social and governance (ESG) record, in recent years Fortis has scaled back its use of coal-fired generating plants, increased its renewable generating assets and cut its Scope 1 emissions by almost 30% (since 2018). Last year, ESG research and ranking firm Morningstar Sustainalytics gave Forits a rating of 28.8, indicating a medium level of risk among utilities. That score is comparable to several of its closest competitors. (For more about Sustainalytics and its Low-Carbon Transition Rating, see “On the road to net zero,” page 42.)
Such examples raise a question, which is not new: Does good governance deliver better environmental performance, not just because reducing a firm’s carbon footprint is the right thing to do in a climate crisis, but because hard-headed risk management demands it?
A large-scale Canadian-American-Italian study, published last year in the Journal of Accounting Research, concluded that the answer is yes. The researchers analyzed 3,293 publicly traded firms in 41 countries and concluded that “board renewal mechanisms are associated with significantly higher future environmental performance.” In particular, the study found that companies whose boards appointed more women directors and use majority voting rules to respond to activist investors tended to be more proactive when it came to the environment.
The reason? Fresh eyes.
“Think of the BlackRocks of this world,” says Alexander Dyck, a co-author of the study and a professor of finance and economic analysis and policy at the University of Toronto’s Rotman School of Management. “An indispensable item of their activism is to replace board members, because they don’t think it’s enough to create pressure on firms. They actually think they need to change the people in order to embed that new way of thinking on environmental performance.”
There’s a vast library of academic research on how, or if, corporate governance affects the way senior executives respond to wider societal pressures to do things like drive down workplace accidents, eliminate the use of child labour in the supply chain or retire polluting plants. The results haven’t always been conclusive and, in some cases, it’s not so clear which way the arrow of causation is pointing. Does good governance make companies greener, or are environmentally responsible firms simply better governed?
Take, for example, a 2012 study published in Strategic Management Journal led by sustainability management scholar Judith Walls, then a professor at Concordia’s John Molson School of Business. It found that Fortune 500 firms with poor environmental performance tended to have higher-paid CEOs and large, monochromatic boards. Written a decade before peak ESG and BlackRock CEO Larry Fink’s call for a “revolution in shareholder democracy” that could transform corporate governance, the paper zeroed in on the quicksilver question of whether boards were doing the bidding of investors or senior managers, and how to know which is the case.
With mounting concern over climate change, and an accumulation of quantifiable evidence that companies in climate-exposed sectors like property insurance are getting walloped, the more detailed results of recent research by Dyck and his colleagues strongly suggest that the era of doubt is, or should be, coming to a close.
Still, the recent boom-bust cycle of suspect ESG labelling on investment products, plus attacks by conservative politicians in the U.S. on “woke” companies, have muddied the waters. “I don’t care what [Florida Governor] Ron DeSantis has to say about it,” Dyck says. “Boards have a fiduciary obligation to pay attention to material risks. Eventually, carbon will be repriced. This is a material risk you’ve got to pay attention to. It’s a lot easier and lower-cost to pay attention to it now than down the road.”
Boards that bring on new directors—either on their own or in response to investor pressure—may also be more attuned to the opportunity side of environmental performance, such as finding emerging business lines that capitalize on macro trends like the energy transition. But to achieve that level of corporate self-awareness, boards need to inject not only new blood, but also directors with genuine climate bone fides.
“We need climate-competent boards,” argues Sarah Keyes, CEO of ESG Global Advisors, who teaches sustainable finance for the Institute of Corporate Directors. Indeed, directors with environmental expertise are a rare breed: A 2023 global survey of almost 900 directors on ESG and governance by executive search firm Spencer Stuart noted that less than 1% of 110,000 corporate directors worldwide have any sustainability experience. “Board renewal provides an opportunity for the diversification of perspectives around the boardroom table that are arguably required in this new world as we go through a low-carbon transition,” she says.
Obviously, board games and investor activism aren’t the only drivers of change. Firms must respond to regulatory changes and will also be considering how to take advantage of lucrative government programs, such as the Inflation Reduction Act, meant to stoke the green economy in the U.S. And unless executive compensation is tied to environmental performance, it won’t be a priority for CEOs and CFOs.
Governance and ESG experts also point to shifts in corporate disclosure. For years, environmental reporting was not only discretionary but also not standardized: Numerous coalitions—of large firms, accounting bodies or investor coalitions—came up with their own reporting protocols. But in January, they coalesced around two widely recognized international reporting standards that can be formally audited and therefore compared, just like audited financial statements.
Dyck and other experts predict this change will have a significant impact. “It’s important that we have this standard set of tools, and then we can compare one company to the other on the same basis and on the same level,” says lawyer Alison Babbitt, a partner and Canadian co-head of responsible business and sustainability at Norton Rose Fulbright Canada. “From a stakeholder and investor perspective, you’re getting some certainty.”
Norton Rose partner Heidi Reinhart, who also practises in this area, adds that large investors may choose to flex their institutional muscles in an entirely different way. “Not all of them are going to wage a proxy fight. But they will put their money into certain investments based on ESG criteria,” she says. “If you’re not paying attention to that, I think you will start to lose out on opportunities.”
In the final analysis, investors, boards and senior executives—however their reporting relationships are configured—will only take action on firms’ environmental track record if they can recognize a material risk approaching in the middle distance, and then figure out how to either minimize or take advantage of it. “Ultimately, it’s about the bottom line and how you make the best return for your investors and stakeholders,” says Babbitt. “Intrinsically, the risks associated with the ‘E’ and the ‘S’ actually have been proven to have that financial component.”
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