Environmental, social and governance (ESG) factors are often considered by socially conscious investors when evaluating companies on sustainability and social conscientiousness. While ESG metrics can be hard to measure, the risks surrounding them are increasing. As consumer, investor and shareholder action is increasingly focused on ESG, companies and their directors and officers (D&Os) must proactively address climate change, working conditions, cybersecurity and diversity. Failure to do so poses a significant D&O risk for companies and their insurers.
The following are ESG trends of which companies and their D&Os should be aware:
- Climate change and pollution actions—Extreme weather events—including unprecedented wildfires, winter storms in Texas and an increased number of Category 4 and 5 hurricanes—have resulted in a rise of activist and societal pressure on governments and businesses to address climate change. There is also a rise in climate change litigation, with the cumulative number of climate change-related cases more than doubling since 2015. Much of the litigation alleges that companies and their boards of directors have failed to adequately disclose the material risks of climate change. Stakeholders are demanding transparency, and it is up to companies’ boards of directors to ensure appropriate reporting and due diligence regarding climate change.
- Board diversity—There has been an uptick in diversity-related litigation following the Black Lives Matter protests in 2020, particularly in the United States. Companies may be at risk of negligence as regulation and legislation on diversity increase, with cases alleging D&Os have failed in performing their duties by having inadequate levels of diversity on the board or in management positions. Any company lacking in racial, gender and age diversity could be subject to lawsuits and questioning regarding diversity, equity and inclusion.
- Greenwashing—Greenwashing refers to a deceptive marketing practice in which companies produce misleading information to trick consumers into believing an organization’s products, services or mission have more of a positive impact on the environment than is accurate. This practice undermines companies that actually implement sustainability efforts and can make it harder for environmentally conscious consumers to make eco-friendly decisions. As stakeholders and investors take more legal action in this area, unrealistic ESG targets could become the potential subject of litigation.
- Executive pay—Conversations about management compensation and pay transparency are gaining prominence as more companies link executive incentives to ESG-related metrics. According to a study from Harvard Law School, 45% of Financial Times Stock Exchange 100 companies have an ESG target in the annual bonus, long-term incentive plan or both. However, linking ESG and pay may not be practical since there isn’t yet a consistent or rigorous view on what “good” ESG performance looks like, and there is no clear guidance for companies on a “good” ESG performance measure.
- Cybersecurity—The financial and reputational consequences of a data breach may lead to ESG concerns about the sustainability of businesses. As threats of cyberattacks become more prominent, companies should address their cyber risk-monitoring processes to ensure data is safe. While it may be hard to understand a company’s cyber risks, the investment community still expects transparency.
- Flexible work arrangements—The COVID-19 pandemic found more people than ever working from home. As vaccinations begin to take effect, flexible work arrangements are at the forefront of ESG conversations. The health and safety of employees and environmental considerations should be examined as employers decide whether or not a total return to the office is necessary.
Companies and their D&Os should identify and assess ESG concerns to ensure they aren’t subject to regulatory and legal action. For more risk management guidance, contact us today.
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