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Aug 19, 2021

The board’s role in ESG oversight, according to Bill McNabb

‘In the next year or two, deep [board level] engagement with investors around what matters and what doesn’t will be really helpful,’ McNabb says

In recent years, definitions of ESG materiality have evolved very quickly. This rapid evolution asks more of corporate boards in terms of their oversight of ESG risks and opportunities and raises questions about board composition.

For directors whose executive careers are long behind them, are they able to have sufficient oversight of ESG – a topic that is continually changing? Do corporate boards need more environmental, human resources or cyber-security specialists? How can boards reassure investors that they have the right composition to align with their current and future strategy? What is an appropriate rate of change of board composition that doesn’t destabilize the dynamics of individual boardrooms?

In part two of our interview series with Bill McNabb, former CEO and chair of Vanguard, and current board director at Axiom, IBM and UnitedHealth Group, we discuss these questions and look at some of the governance mechanisms that boards have to ensure the right directors are in place.

Click here to read part one of our interview series with Bill McNabb, where he outlines his redefinition of total shareholder return (TSR) as talent, strategy and risk.

How well equipped is this generation of board directors to have oversight of ESG issues?

At a high level, it’s going to vary by the type of company. Boards at global Fortune 500 companies are pretty adept, and are pretty adaptive, and this has been coming for a while. So I think they’re beginning to really get their hands around it.

I see an awful lot of push from outside that ESG is a big separate thing, and that if you don’t understand it you need special directors with domain expertise and special committees. I think in most cases that’s a mistake. To really accomplish what we want to with ESG, it has to be inextricably linked to the company’s strategy and it’s got to be an integral part of a company’s mission, direction, operations and so on.

I think that in the current generation [of board directors] there’s a lot of talent who can figure that out and make those linkages. Are there sectors where one particular element could be really deep and difficult, and maybe require extra special expertise? That’s probably true.

Climate comes to mind, depending on the sector. If climate is the principal risk that you face as an organization over the next 20 years, you might want some domain expertise that you don’t have. But I think, in general, ESG is part of this longer-term drive toward sustainability. I’m using the broad definition of sustainability – not the ecological one – that ties back to a pivot from short-term thinking to longer-term thinking.

I’m often surprised that there isn’t a more pronounced discussion of board evaluation and assessment. It’s often a small section in the proxy statement, whereas if you’re trying to link your board composition to your long-term strategy, it feels that there could be more to discuss. Do you expect that it may become a bigger talking point in the future?

That’s like the $64 tn question. Where this started getting momentum was when we unveiled the first set of [Commonsense Corporate Governance Principles] – the so-called Dimon-Buffett corporate principles. Board evaluation was a big talking point at that time.

But I believe boards are just starting to grapple with this. In our book [Talent, strategy, risk: how investors and boards are redefining TSR, co-authored with writer Ram Charan and Dennis Karey, vice chair of Korn Ferry], we give a couple of examples of boards that have taken some really challenging steps to do this already, but I think it’s going to be one of the big issues over the next 24 to 36 months. What is your process? How do you think about turnover?

There’s the broader question of what does it take to be successful over the next 10 years and whether that means companies should think differently about the way they’re constructing their boards. I don’t want to be overly simplistic, but it used to be the case that for the Fortune 200, you’d get a bunch of all-star CEOs on the board. And if you’re a sitting CEO, it’s great to have a couple of former or current CEOs on your board.

I had a couple of sitting CEOs for the vast majority of my time at Vanguard and they were unbelievably good. Which is not to say that the other board directors didn’t contribute as well – they just contributed in different ways. But what you’re seeing now is that instead of having about two or three CEOs, you will get some domain expertise.

The point is that you really want to show complementary skills. Does that mean that you need a climate change expert? Not necessarily. But you’re going to need some people who think differently about some of these ESG issues, whether it’s diversity and culture or climate. To your point, you don’t get there unless you have a really good board evaluation and you’re constantly asking yourself whether everyone is hitting the mark for what’s needed going forward.

I think hard-and-fast rules get us into trouble sometimes. What I’d love to see is boards with really deeply embedded principles of how they’re going to govern themselves and what they’re looking for. When I was at Vanguard, most of the boards we looked at aged out at 72 or 73. I don’t think that’s the best practice today.

But the fear is that, if you take that away, you end up with directors with 20 to 25 years’ tenure, and questions over their independence.  I’d much rather see somebody living out a set of principles that says: We’re going to look at age on a case-by-case basis, but somewhere around 75 you have to start thinking about stepping off the board because we’re looking for an average tenure in the 10-to-12-year range.

But that’s predicated on having a really good self-assessment process. If you have that, then guiding principles – rather than hard-and-fast rules – work and they work better. We’re still thinking this through on a couple of boards I sit on. I don’t think doing [assessments] every year is all that helpful. I do think going deep every couple of years, and then maybe being a little more cursory in the off-year, could work.

In a perfect world, I’d have an outside facilitator who’s completely independent and is essentially doing a 360-degree assessment. A great question to ask when you’re starting from scratch is: Who are the board directors that we can’t live without? I’ve seen that done on a couple of boards and it’s amazing.

And it’s a tough balancing act. On the one hand, what we’re discussing may call for greater turnover of directors. But on the other, you may lose something if you change one third of your board every two or three years.

That’s where the principles come into play: there’s trust and there’s complementarity of skills. If you have those two things to begin with, you’re going to end up in a good place. But I think this is an area where investors could do a better job – and I put myself in this category – of articulating why we’d like to see how boards do this. We’d like to engage with companies about it. One board that I know of very well has an investor advisory group to talk to about future directors. So when the board is thinking about it may need, it puts these investors in a room and says, without names, what kind of profile should we be looking at? It’s been unbelievably instructive.

What can boards do through the proxy statement or off-season engagement to outline their oversight of ESG issues?

I keep coming back to this integration concept – companies have to articulate in a really clear way how deeply integrated ESG concepts are in their long-term business plan and outlook. And then they need to pick the right metrics – whether it’s quantitative or qualitative – to start engaging investors with. I think in the next year or two, deep engagement with investors around what matters and what doesn’t will be really helpful.

On reporting, we’re going to end up being very integrated in the proxy statement. I don’t want to see two sections – one with the financials and one on ESG metrics. I want to see how we’re doing overall.

Which will call for disclosure of some metrics that companies find challenging – like human capital.

And will it be perfect? No. But you know, neither is net profit after tax. We know all of the accounting conventions that you have to follow and your P&L can reflect a lot of different things. Certainly, some of these [ESG topics] are harder to measure. But something like engagement, if you do it for a long enough period of time, in a disciplined enough fashion, the directional trends are clear.

One of the boards I’m involved in is taking this so seriously, from an engagement standpoint, that we’re bringing in one of the best investors in the world who has gone deep on this topic. And we’re going to just let the board go back and forth with this investor. It’s not a half an hour – it’s a big chunk of time and a dinner. The concept was that we want to be deep on this and we want to know what the best investors in the world think about this.

You’ve had a great vantage point from which to see changing attitudes to ESG. But in your career as a board director, are there other resources that have helped you stay abreast of the latest issues?

There’s no simple answer to this one. There’s been great work done in a couple of the big governance centers over time – whether it’s the Millstein Center at Columbia University or Drexel University with the Raj and Kamla Gupta Governance Institute, both of which I’m involved with. There’s good work coming out of other academic institutions now too.

The Big Four do a lot of work with different governance centers, as well. You’d be amazed at how often these topics have been top of mind and on top of the agenda for sessions. ESG is on everybody’s mind. You have groups like NACD that are pushing the idea pretty aggressively and trying to get people on stage who know these topics. 

Another organization that I’m involved in is [Chief Executives for Corporate Purpose]. We’ve had this push for long-termism and around integrating ESG into that for several years now. We give companies a framework, and we ask them questions. Embedded in those questions are some really deep elements of ESG. We’ve had CEOs talking about it and linking to long-termism.

Is it perfect? No, because the frameworks are evolving and everyone’s style is evolving. But what we’re trying to do is to make sure that information is repeatable and then comparable. People are beginning to coalesce around certain ideas. I think that having real metrics that are linked to strategy and linked to risk and linked to long-term performance are going to emerge. Right now, we’re in this sort of feeling-out period where we’re trying to see what works, what doesn’t, what’s noise and what’s not.