The role retail company boards should play in ESG reporting
Since the U.S. Securities and Exchange Commission (SEC) proposed rules governing climate-related disclosures by all public companies on March 21, environmental, social and governance (ESG) reporting has become a necessary part of retail corporate boards, especially in today’s green and social world.
Whether it’s understanding how the retailer is fighting climate change, how diverse the retailer’s leadership is, or what the retailer’s corporate policies are, investors, customers and even its own employees want transparency on the ESG impacts, good and bad, of the retailer’s activities. and its sustainability initiatives.
However, to fully understand the standards retail company boards must apply to navigate their ESG reporting, we must first understand what is wrong with the current system.
The state of ESG reporting today
When retailers disclose ESG reports in their annual reports, proxy advisory firms, such as Institutional Shareholder Services (ISS), take that information and essentially put it into a scoring system, where all of the retailer’s ESG efforts are scored. at level ABCD+-. Some proxy advisors, including ISS, also assess companies in terms of overall positive or negative social impact and assign them a rating. For example, just by visiting the ISS ESG Gateway, you can see that Target has a “C+” ESG rating and was found to have a positive social impact of +1.4. Walmart’s ESG corporate rating is C- and is considered to have a negative social impact of -6.2.
Proxy advisors rarely go deep into the reasoning behind corporate ratings, posing a challenge for investors trying to determine which companies are more environmentally or socially conscious. For the boards of retail organizations, this challenge is even greater. Since proxy advisors are opaque about their standards for achieving high ESG ratings, it is very difficult to know which factors are most critical. For example, Target and Walmart have relatively similar corporate diversity, compensation levels and operations, but they have very different ESG and social impact scores than ISS.
Because proxy advisor standards are so opaque, a cottage industry has formed of ESG consultants who help companies achieve higher ESG rankings. The challenge is that proxy advisors like ISS also offer such services. Many, including the SEC, have challenged this business model due to the potential for conflicts of interest. Target paid ISS to be considered for its ESG Prime certification, a time-consuming and expensive process. Walmart did not. We don’t know whether or not these payments impact ISS ratings, however, the mere appearance of impropriety should be cause for concern for boards and investors alike.
It resonates similarly with what happened more than 20 years ago between energy trading company Enron Corp. and accounting firm Arthur Andersen LLP, as Enron kept debt off its balance sheet when reporting annual financial earnings, making it the subject of a federal investigation and sparking the conversation for a new set of standards aimed at maintain financial integrity. Today’s ESG reports reflect this, as companies may try to do whatever they can to score higher and impress their investors. Shareholders and stakeholders want to see credible environmental and social change through a new set of ESG standards, but the current ESG system needs to be fixed first.
What must change?
With the current ESG rating system seemingly more focused on ratings than change, proxy advisors issuing these ratings should consider reforming their organizations to focus on either ESG ratings or ESG advice, as two operations create the challenges we see with companies trying to leverage the system for their own beneficial reviews instead of actually identifying real change in the retail industry. Just like in the Enron story, consulting firms were helping corporate boards rely on false reports, leaving shareholders to hold the bag of worthless shares and corporate valuations ultimately. .
While ISS is not the only proponent of ESG ratings, proxy advisors use their own methodologies to rank and score retailers, in which the reports produced are sometimes riddled with inaccuracies and ultimately confuse markets. These inaccuracies then consume retailers’ bandwidth as they scramble to correct the inaccuracies that appear in these reports, taking up valuable time that could be put to much better use in actually improving ESG performance.
Basically, the people at the shareholder and stakeholder level who actually want to see retailers adhere to a set of ESG standards are the losers in the current system. Instead of having the transparency of which retailers are actually responsible in terms of ESG, investors are basically in this conflict of interest system where ESG ratings mean nothing unless change happens.
The new ESG standards for retailers
When thinking about the standards that retail companies’ boards should focus on in their ESG reporting, there must be checkbox standards in every environmental, social and governance branch that the retailer reports, where any investor can publicly verify this report. Without transparency, the system will continue to harm companies that support ESG objectives while benefiting those willing to “game” with the system. Rather, a transparent system will give ESG-conscious investors a head start in understanding their investments while benefiting companies genuinely committed to doing the right thing.
Rashida Salahuddin is President and CEO of The Corporate Citizenship Project, a firm that provides objective advice on governance issues in publicly traded companies and large private enterprises.