Since the U.S Securities and Exchange Commission (SEC) proposed rules governing climate-related disclosures from all public companies on March 21, environmental, social, and governance (ESG) reporting has become a necessary part for technology company corporate boards to address, especially in today’s environmentally and socially conscious world.
Whether it’s understanding how the technology company is combatting climate change, how diverse the technology company’s leadership is, or what the technology company’s corporate policies are, investors, customers, and even their employees want transparency into the ESG impacts, both good and bad, of the technology company’s activities and their sustainability initiatives.
However, to fully understand the roles technology corporate boards need to play in navigating their ESG reporting, we first need to understand what’s wrong with the current system.
The State of ESG Reporting Today
When technology companies disclose ESG reporting in their annual reports, proxy advisory firms, such as Institutional Shareholder Services (ISS), take that information and put it on a rating system. The technology company’s ESG efforts are graded on an ABCD+- level. Some proxy advisors, including ISS, also assess companies for overall positive or negative social impact and assign them a score. For example, just by visiting ISS’s ESG Gateway, you can see that ISS assigns Apple a “B” ESG rating and was judged to have a +3.5 limited positive social impact. Amazon’s ESG Corporate Rating is a C- and is judged to have a –5.3 social impact. Unfortunately, proxy advisors rarely delve deep into the reasoning for companies’ ratings which poses a challenge for investors attempting to ascertain which companies are the most environmentally or socially conscious. For the boards of directors at technology companies, this challenge is even more significant. Because proxy advisors are opaque about their standards for obtaining high ESG marks, it is very difficult to know which factors are most critical. Case in point, Apple and Amazon have relatively similar corporate diversity, pay levels, and operations; however, they have significantly different ESG and social impact scores from ISS.
Because proxy advisors’ 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 taken issue with this business model because of potential conflicts of interest.
This 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, thus making them a subject of a federal investigation and sparking the conversation for a new set of standards to maintain financial integrity. Today’s ESG reporting mirrors this situation, as companies may try to do anything to earn a better grade and impress their investors. Of course, shareholders and stakeholders want to see credible environmental and social change through a new set of ESG standards, but issues with the current ESG system must first be resolved.
What Needs to Change?
With the current ESG evaluation system seemingly more focused on ratings than bringing about change, proxy advisors issuing these ratings need to consider reforming their organizations to focus on either ESG ratings or ESG consulting, as both operations create the challenges we are seeing with companies trying to leverage the system for their beneficial evaluations, instead of identifying true change throughout the technology industry. Just like the Enron story, consulting firms were helping the company boards prop themselves with false reporting, leaving shareholders to hold the bag of worthless stocks and company valuations at the end of the day.
Even though ISS is not the only proponent of ESG ratings, proxy advisors use their methodologies to rank and score technology companies. The reports produced are at times rife with inaccuracies and ultimately cause confusion in the markets. These inaccuracies then consume the bandwidth of technology companies as they scramble to address misstatements that surface in these reports – taking the valuable time that could be much better spent on improving ESG performance.
The people at the shareholder and stakeholder level, who do want to see technology companies adhere to a set of ESG standards, are the losers in the current system. Instead of having the transparency of technology companies responsible for ESG, investors are essentially in this conflict-of-interest system where ESG ratings mean nothing unless a change is taking place.
The New ESG Standards for Technology Companies
When thinking of the standards technology corporate boards need to focus on in their ESG reporting, there need to be checkbox standards across each environmental, social, and governance branch that the technology company reports, where any investor can publicly verify that reporting. Without transparency, the system will continue to hurt companies supporting ESG goals while benefiting those willing to “game” the system. Instead, a transparent system will give ESG-conscious investors a leg up in understanding their investments while benefiting companies truly committed to doing the right thing.