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The Governance Effect on Sustainable Investing

Roz Brewer, Starbucks chief operating officer and group president, speaks on stage during the Starbucks Annual Meeting of Shareholders on Wednesday March 20, 2019 at WaMu Theater in Seattle.

ESG is a three-letter acronym that stands for environmental, social, and governance. Incorporating these factors into how a company runs its business has become a must since 2020.  In 2021, the process is expected to further accelerate under a more favorable regulatory environment and investments into the space. 

We’ve covered the “E” and the “S” in prior stories. For now, let’s focus on what “G”, or governance, means to investors.

Governance is probably the oldest factor when it comes to investors assessing a company’s non-financial health. MSCI, a leading provider of ESG ratings, views governance as being made up of two aspects: corporate governance and corporate behavior.

Corporate governance includes everything from board diversity, executive pay, ownership, control of the company, and the quality of its accounting. Corporate behavior further extends the governance factor to business ethics, anti-competitive practices, tax transparency, corruption, and financial system instability.

There are companies doing this well. Starbucks has concentrated efforts on building a diverse board of directors – incorporating diversity across age, race, and gender. Five of the 13 directors are women with an overall board of directors age range of 39 – 74 years old. Many believe this diversity has helped the company maintain its global market share.

GM ranked 18th on the Fortune 500 and features a female-majority board with six of the 11 directors being female, including CEO and chairwoman Mary Barra. In fact, the company boasts a gender pay gap of less than three percent, making it a leader in workplace gender equality.

Another example is Trader Joe’s, the privately-owned grocery store chain that is beloved by customers for its friendly customer service practices and by its employees for its transparent pay practices. When surveyed, 69 percent of employees gave a high rating for the fairness and transparency of the company’s pay policies.

Companies are finally becoming more aware of how important it is to consider ESG factors in their operations and business dealings. Investors and other market players can turn to leading ESG rating firms, including MSCI, Sustainalytics, and S&P Global Ratings, to evaluate how a company or fund complies with various ESG factors.

At the same time, more and more positive governance initiatives are on the rise. Nasdaq’s recent announcement to require company boards to be more inclusive and diverse could pave the way for other exchanges to follow suit. 

Prudential Financial, one of the largest U.S. insurers, has committed to enacting various ESG policies globally, according to an ESG report by Sage Advisory Services. Its governance initiatives include protections for whistleblowers, substantial bribery and corruption policy, as well as executive pay disclosures. According to the report, it also strives to provide a diverse workforce and have up to 40 percent of leadership roles filled by women. 

Cisco Systems, mostly known for its networking and infrastructure tech, has chosen the path of transparency by releasing its Corporate Social Responsibility reports on an annual basis, and conducting a full materiality assessment every two years, noted the Sage ESG report as part of its governance assessment of the company. 

“Cisco’s code of conduct is considered best-in-class and covers topics such as antitrust, conflicts of interest, insider trading, and corruption in detail, and third-party due diligence has been implemented to ensure compliance with the code,” states the report.

The world’s largest investment firm, BlackRock, decided to pursue a firm-wide commitment to ESG. The New York-based asset manager plans to integrate ESG information into its investment processes across all its investment divisions and teams.

BlackRock’s chairman and CEO Larry Fink in 2020 sent a letter to company CEOs stressing the following: “We believe that when a company is not effectively addressing a material issue, its directors should be held accountable.” Fink pointed out that in 2019, the company had voted against or withheld votes from 4,800 directors at 2,700 different companies.  

Fink also stressed that “companies, investors, and governments must prepare for a significant reallocation of capital.” As a result, companies have a responsibility – and an economic imperative – to give shareholders a clear picture of their preparedness. And in the future, greater transparency on questions of sustainability will be a persistently important component of every company’s ability to attract capital.”

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