When we talk about ESG – environmental, social and governance – investing, we often start with a discussion of the ‘G’ or governance. If a company has good leadership that supports policies ESG investors care about, it becomes easier to articulate why that company should be held in an ESG portfolio. Simply put, if a company does not have strong governance, it will struggle to take care of all its stakeholders (employees, customers, shareholders, and supply chain) and have a positive effect on the environment.
To better understand how Sage evaluates corporate governance, we have created “the 5 C’s” framework – compensation, composition, competency, clarity, and consistency.
- Compensation – Is leadership being properly incentivized with compensation?
- Composition – How is company management and its board of directors structured?
- Competency – Does leadership have the right credentials to run the company?
- Clarity – Are policies clear and transparent, and is there disclosure of all financially material issues?
- Consistency – Are all stakeholders considered during policy creation and are policies consistently executed?
When we think about ESG leaders, which we profile in our Highlights & Holdings series, they fulfill most if not all the above. The following are examples of companies that exemplify each of the five C’s.
Compensation
The multi-utility company Eversource Energy (NYSE: ES) is a leader in ESG compensation practices. Despite have a historically male-dominated workforce that is nearing retirement, the utilities industry has been presented a unique opportunity to recruit talent in a more sustainable way. Eversource has demonstrated its commitment to diversity and inclusion by making executive compensation contingent upon achieving the company goal of having women and people of color comprise 40% of total leadership promotions and new hires. Additionally, Eversource has executive-level oversight of its ESG initiatives, many of which are also linked to executive remuneration.
Composition
The Fortune 500 real estate investment trust (REIT) Healthpeak Properties (NYSE: PEAK) is an example of a company that has the right composition to be a sustainability leader. Healthpeak’s Sustainability Committee, led by the company’s executive vice president, chief operation officer, and chief development officer, is in part compensated for how well its sustainability initiatives are executed. Every member of Healthpeak’s board, except for the CEO, is independent, which mitigates conflicts of interest. REITs generally receive high marks for their ethics and compliance programs, and Healthpeak follows that trend. Sometimes the best testimony for a company’s strong governance policies is a lack of incidents, and Healthpeak has experienced no significant major controversies, has had zero fines and non-monetary sanctions, and zero incidents of non-compliance with its code of conduct.
Competency
For competency, we point to one of the largest U.S.-based insurers Prudential Financial (NYSE: PRU). Prudential’s corporate governance reflects the intention to enact a growing number of ESG policies globally. Areas of strength include several of its businesses’ commitment to the United Nations-supported Principles for Responsible Investment (PRI), protections for whistleblowers, and a strong anti-bribery and corruption policy. By keeping a steady hand on the amount of risk taken with the investments backing its obligations, Prudential prevents the kind of losses that endangered other insurers during the financial crisis. This is most reflected in its A-level ratings provided across ratings organizations. Management structure and disclosure is also a point of strength for Prudential. Average board director tenure is under seven years, reflecting the board’s above-average independence. The level of pay disclosures for the CEO and other executives has been lauded as above the industry average.
Clarity
The communications equipment company Cisco Systems (Nasdaq: CSCO) is a leader when it comes to providing clarity around its ESG policies that are financially material for the company. Cisco releases an annual Corporate Social Responsibility (CSR) report, which includes a biennial materiality assessment, with an internal material refresh on off years. Cisco’s report is guided by the Global Reporting Initiative (GRI) Standards and features a thorough assessment of corporate responsibility topics — the 2019 report is 230 pages — and its related United Nation-supported Sustainable Development Goals (SDGs). The company has a Corporate Affairs team designated to manage stakeholder engagement and corporate responsibility. To reinforce the importance of Cisco’s CSR policies, one hour of new employee orientation is dedicated to information about the CSR program.
Consistency
For consistency, a company that comes to mind is Delta Air Lines (NYSE: DAL). Creating and managing a strong culture of safety is critical to an airline, as one mistake could cost hundreds of lives. Delta was one of the first airlines to implement the Federal Aviation Administration (FAA)-required enterprise-wide Safety Management System, and it currently oversees one of the industry’s most robust plans. A key aspect of the system is the enhanced flight safety operations, which are intended to limit accidents. Notably, Delta has not had any aviation casualties since 1996.
Because the ‘G’ in ESG determines the strength and efficacy of a company’s social and environmental policies and practices, we often give it more weight in our ESG analysis. Th 5 C’s provide a framework for how we think about the most important and measurable components of corporate governance.
For a discussion with Sage President & CIO Bob Smith, listen to the podcast The 5 C’s of ‘G’ in ESG.
Originally published by Sage Advisory
Disclosures: This is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy or investment product. Although the statements of fact, information, charts, analysis and data in this report have been obtained from, and are based upon, sources Sage believes to be reliable, we do not guarantee their accuracy, and the underlying information, data, figures and publicly available information has not been verified or audited for accuracy or completeness by Sage. Additionally, we do not represent that the information, data, analysis and charts are accurate or complete, and as such should not be relied upon as such. All results included in this report constitute Sage’s opinions as of the date of this report and are subject to change without notice due to various factors, such as market conditions. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results.
Sage Advisory Services, Ltd. Co. is a registered investment adviser that provides investment management services for a variety of institutions and high net worth individuals. For additional information on Sage and its investment management services, please view our web site at www.sageadvisory.com, or refer to our Form ADV, which is available upon request by calling 512.327.5530.