Preparing the Business Plan – Collecting Information

Business planning begins with information.  As noted above, one important part of the strategic value of the business planning process, and the formal written business plan that emerges from that process, is the knowledge that the founders and the other senior managers acquire while they are collecting the information needed to prepare the plan.  Moreover, timely and complete information on all relevant aspects of the company’s projected market and products and services is required in order to obtain the support of investors, banks and other prospective business partners.  If the business plan fails to convey an understanding of the data that is most relevant is assessing the viability of the business concept then it is likely that the venture will fail due to its inability to attract the necessary resources from its environment.  In addition, the steps taken to identify the best sources of information for the initial business plan should also serve as a foundation for creating a permanent system for collecting additional information in the future that can be used to measure the progress of the business and to make refinements to the strategic business plan as the company moves forward and environmental conditions change.

 

The outline of the contents of the business plan presented below should provide a guide as to the scope and amount of information that will be needed in order to prepare the plan.  In general, the process should begin with an examination of the industry sector(s) where the company hopes to compete with its products and services and, in particular, the specific markets within those industries that the company intends to target initially and in the future.  Sector analysis should include a review of the overall performance of the sector in relation to the general economy and the collection of current and reliable information on forecasts, growth trends, and environmental factors.  Market analysis focuses on the specific stakeholders that the company will need to include within organizational domain and should include customers, suppliers, distributors and competitors.  Customer information is obviously critical and the company must be able to collect the data necessary to answer several basic questions—who are the customers, where are they located, what are they currently doing to solve the problem addressed by the company’s products or services, and how might they use the company’s products and services as an alternative solution.  Information should also be collected on the current and projected spending habits of the customer base.  With regard to competitors the goal is to collect enough information to understand their strengths and weaknesses and how they operate within the target market.  In order to do this the company must gain access, legally, to information regarding competitors’ product lines, customer base, manufacturing and distribution strategies, and financial condition.

 

Presumably, the founders and senior managers will have sufficient experience in the industry to allow them to get a good reading on the initial risks and costs associated with the proposed venture.  However, there are a wide variety of other sources of planning information that might be useful in certain instances.  For example, national governmental agencies (e.g., U.S. Small Business Administration and the Department of Commerce) spend large sums of money on research and a number of government publications can provide statistics on the size of relevant markets and expenditures for research and development, manufacturing, marketing, and human resources.  Government publications can be particularly useful when the business is planning on a significant volume of foreign sales activity.  Local agencies, as well as nonprofit organizations, also provide assistance to persons interested in starting up a new business and can guide the founders and senior managers to information specific to the geographic area where the business will be organized.  Trade associations may be able to provide a substantial amount of current information on business resources that are very industry and niche specific and can also provide an overview of relevant laws, regulations and competitive conditions. Finally, financial information released by listed companies involved in the same line of business may also be useful in putting together long-term projections and analyzing the ratios between income and expense items that might be set as goals for the new business.  While information is abundant, there may be situations where the specific kind of information necessary for a particular part of the business plan is not available or is not sufficiently updated to provide readers with a current picture of all the relevant issues.  This does not, however, mean that an issue should be ignored; it simply means that the founders and senior managers should make note of the shortcomings in the information base and how they might impact the decisions that need to be made during the strategic planning process.

 

While collection and assessment of information for use in the business plan is often a heavily quantitative process that involves a substantial amount of sophisticated statistical analysis, the founders and senior managers should not ignore the value of “business intelligence” that can be obtained through old-fashioned personal surveys.  Before finalizing the business plan and circulating it to prospective business partners the founders should make direct contact with key parties within their developing organizational domain to gather further information and test some of the assumptions that may be guiding their thinking regarding the strategic planning process.  For example, the founders and senior managers should visit sales outlets operated by potential competitors and also talk informally with prospective customers to find out directly what there concerns and requirements might be with respect to the proposed products and services to be offered by the company.  Input from these personal survey techniques may be used as part of the formal business plan and, perhaps even more importantly, can be referred to as a sign of credibility in one-on-one meetings with potential investors and business partners who should appreciate the fact that the founders and senior managers are not relying solely on the library to define the vision for the company.

 

Audit Committees and Sustainability Oversight

The audit committee, working in collaboration with the board’s corporate social responsibility committee, should be expected to play an important role in overseeing the company’s sustainability policy, commitments, procedures and reporting.  Some of the specific duties and responsibilities of the committee in this area include:

  • Monitoring compliance with sustainability policy, commitments and regulations; ensure internal audit procedures are in place to assess cross-company compliance with sustainability commitments, policies and management systems; review results of internal audits of compliance with sustainability policies, commitments and regulations
  • Reviewing integrity of the organization’s sustainability information systems and reporting processes, both internal and external; ensure the company has implemented adequate systems, controls and processes to support the compilation of key sustainability performance metrics appropriate for reliably tracking performance, setting targets, benchmarking, compensating executives and external reporting
  • Ensuring sustainability information is consistent across corporate websites, social media and voluntary reports and that provided in government filings, financial statements, investor presentations and other corporate disclosures
  • Ensuring a process is in place for timely, accurate, consistent and complete external sustainability reporting
  • Monitoring developments, trends and best practices in sustainability accounting and reporting
  • Ensuring sustainability is sufficiently addressed in the annual budget and business plan
  • Ensuring tax policies and planning are fair and equitable and do not attract reputational risk
  • Ensuring public policy positions of the company and the trade associations of which it is a member are consistent with the company’s sustainability commitments

Commentators such as Castka et al. have argued that the audit committee is an important element of a company’s efforts to develop an effective corporate social responsibility and corporate governance (“CSR/CG”) management system.  A description of a CSR/CG management system suggested by Castka et al. that was intended to be compatible with other management system standards, particularly ISO 9001 and ISO 14001, called on organizations to establish an audit committee and determine arrangements and criteria for audit committee membership that were best suited for the relevant circumstances of the organization (taking into account size, sector, risk profile, etc.).  Members of such a committee should be independent non-executive directors, and the committee shall have adequate resources, authority and experience to monitor the performance of the CSR/CG management system and the integrity of the internal audit function. According to Castka et al., the role of the audit committee should be to act independently from executive directors to monitor the CSR/CG management system; monitor and review the effectiveness of the internal audit function and fulfilment of the audit plan and make recommendations to the board/management in order to improve its performance; and propose an external audit body/auditor and monitor and review the independence, objectivity and effectiveness of external audits.

Castka et al. recommended that organizations establish and maintain the audit plan, audit criteria and frequency, and methods of audit for the CSR/CG management system and that internal audits be conducted at planned intervals to determine whether the CSR/CG management system conforms to industry standards and that the requirements established for the system have been properly implemented and maintained.  The audit committee should lead the organization’s effort to continuously improve the credibility of the CSR/CG management system by third-party verification or external audit including verification of the organization’s annual reports. The extent to which independent audit is carried out should be determined by the board and monitored by the audit committee and should be based on the results of identification of stakeholder expectations, risk assessments and the monitoring of objectives, targets and indicators of CSR/CG performance.

Sources for this article included The Essential Role of the Corporate Secretary to Enhance Board Sustainability Oversight: A Best Practices Guide (United Nations Global Compact, September 2016); and P. Castka, C. Bamber and J. Sharp, Implementing Effective Corporate Social Responsibility and Corporate Governance: A Framework (British Standards Institution and the High Performance Organization Ltd., 2005), 18.  For fuller discussion of the management system proposed by Castka et al., see “Sustainability Governance and Management: A Guide for Sustainable Entrepreneurs” in “Corporate Social Responsibility: A Library of Resources for Sustainable Entrepreneurs” prepared and distributed by the Sustainable Entrepreneurship Project (www.seproject.org).

This article is adapted from material in Sustainability and Corporate Governance: A Handbook for Sustainable Entrepreneurs, which is prepared and distributed by the Sustainable Entrepreneurship Project and can be downloaded here.

Alan Gutterman is the Founding Director of the Sustainable Entrepreneurship Project, which engages in and promotes research, education and training activities relating to entrepreneurial ventures launched with the aspiration to create sustainable enterprises that achieve significant growth in scale and value creation through the development of innovative products or services which form the basis for a successful international business.  Visit the Project’s Library of Resources for Sustainable Entrepreneurs to download handbooks, guides, articles and other materials relating to sustainable entrepreneurship and keep up with the Project’s activities by following Alan on LinkedInTwitter and Facebook.

Sustainable Finance: A Primer for Sustainable Entrepreneurs

Sustainable finance has been described as the interrelationships that exist between environmental, social and governance (“ESG”) issues on the one hand, and financing, lending and investment decisions, on the other.  Sustainable finance has also been explained to be a long-term approach to finance and investing, emphasizing long-term thinking, long-term decision-making and long-term value creation.  Companies now operate in an environment in which more and more capital providers are taking sustainability issues into consideration when deciding whether to fund a particular company or project and this means that the finance committee, as well as the entire board of directors, need to understand how the company’s ESG-related strategies, principles and practices can impact its access to capital and the stability of its relationship with investors and bankers.  An additional consideration is measurement and reporting of ESG-related performance, a topic that the finance committee must consider in collaboration with other board-level committees such as the audit and corporate social responsibility committees.  Measurement and reporting techniques are evolving and differ across jurisdictions; however, there are emerging standards that need to be understood as more investors and lenders rely on sustainability reporting for collecting information necessary for them to make decisions about allocating their capital.

When reviewing and approving the company’s financial strategies and specific capital projects the finance committee needs to be mindful of the various factors that motivate investors and decision makers to incorporate sustainability aspects into their investment and lending decisions:

  • Many investors and lenders take sustainability issues into consideration in order to make better risk management decisions, avoid future financial issues and make better long-term investment and lending decisions. Investors and lenders are increasingly skittish about funding companies and projects that carry high legal and reputational risks due to concerns about compliance with applicable laws and regulations and ESG norms and standards.
  • A growing number of investors and lenders are focusing on sustainability as a means for uncovering promising new business opportunities and undervalued assets. Companies that can offer investors and lenders a path to participate in financing innovative solutions to environmental and/or social problems can tap into new pools of capital.
  • Investor are taking a more values-driven approach to funding decisions and avoiding investment in companies or projects considered to be “unethical” and/or which are likely to cause environmental or social harm. At that same time, these investors are proactively seeking out projects that have a demonstrable positive environmental or social impact.
  • Certain investors, as well as shareholder activists, are interested in applying pressure on companies to change their behavior with respect to operational activities that have adverse environmental and social impacts (e.g., threatening to withhold or withdraw capital unless companies cease to engage in activities considered to be unsustainable).
  • Some investors, like consumers, enjoy being associated with “good causes” and are therefore driven to invest in companies that have a good reputation with respect to ESG matters as a means for embellishing their own social identity.

Sustainable investment can be broken down into several categories, information that is helpful to companies when they attempt to identify the types of sustainable investors that might be interested in providing capital for their operations and new projects:

  • Negative/exclusionary screening: Negative or exclusionary screening consists of avoiding specific assets due to considerations of moral values (e.g., tobacco or gambling), standards and norms (e.g., human rights), ethical convictions (e.g., animal testing), or legal requirements (e.g., controversial armaments such as cluster bombs or land mines, excluded in order to comply with international conventions). Companies engaged in “negative” activities must be prepared to make significant modifications to their business models in order access capital from investors and lenders applying these types of screens.
  • Best-in-class/positive screening: “Best-in-class” (positive) screening contrasts significantly with negative screening and calls for investment and lending decisions to be made based on a company’s demonstrated high ESG performance. Investors can rely on a growing number of reference indexes to select projects that can improve both the risk and return aspects of their portfolio and companies need to be mindful of the criteria applied by the reference indexes and track their performance, although it should be understood that such indexes are not infallible and that it remains difficult to reliably measure ESG performance..
  • ESG integration: ESG integration involves new and emerging methodologies intended to systematically and explicitly include ESG risks and opportunities into traditional financial-based investment analysis. ESG integration differs from ESG indexing in that it does not rely on benchmarking ESG performance vis-à-vis peers.  As with ESG indexing, companies need to understand the how investment analysis taking ESG risks and opportunities into consideration is conducted, not only to gain a better understanding of the expectations of investors but also to potentially improve their own risk-adjusted rate of return on assets and mitigate sustainability-related risks.
  • Impact investing: Impact investing has been described as “investments made in com­panies, organizations, and funds with the intention of generating social and environmental impact (pursuit of positive externalities) alongside a financial return”. So far, impacting investing, which has often focused on microfinance and development investing, has been available mostly through private markets from funds managed by specialized asset managers.  Access to capital from impact investors may be limited for companies that lack scalable high-quality investment projects.
  • Thematic investments: Thematic investments include investment activities focused on specific high profile sustainability themes such as cleantech, infrastructure, energy-effi­cient real estate or sustainable forestry and thematic investments are projected to become increasing important for certain long-term oriented investors such as pension funds, insurance companies and sovereign wealth funds.
  • Active ownership: Active ownership takes a different approach to sustainable finance by focusing on engagement and dialogue with portfolio companies after an initial investment is made in order to influence ESG strategies and actions through exercise of ownership rights and being a visible activist for change.  The growing role of activism can be seen by charting the increasing numbers of proxy votes relating to ESG issues, a trend that has materially impacted how boards and senior executives manage investor relations.

For lenders, as opposed to investors seeking attractive risk-adjusted returns in addition to recovery of their original capital, ESG issues appear in their reluctance to enter into loan transactions that might ultimately involve them in financing controversial activities and/or projects that are overexposed to identifiable environmental or social risks and potential liabilities.  Lenders are not only concerns about the possibility that ESG issues for the parties to whom they lend may impact their ability to repay but also fear reputational damage from being associated with such borrowers and their environmentally harmful and/or unethical practices.  Many lenders follow an approach similar to the negative/exclusionary screening described above.  At the same time, however, lenders are themselves interested in enhancing their sustainability reputations and are adopting various types of positive screening and ESG integration methodologies into their loan analysis and proactively seeking qualified borrowers in the areas of interest to thematic sustainability investors.

The board of directors as a whole, as well as the members of the finance committee, need to understand the role that investors and lenders can play in impacting the future structure of the economy and, in turn, the influence that the priorities of investors and lenders can have on the business and financial strategies of their potential portfolio companies.  This means making various adjustments to the how the finance committee approaches some of its traditional duties and responsibilities.  For example, companies are being urged to move beyond conventional net present value analysis of projects to implement sustainable asset valuation and capital budgeting techniques such as analyzing projects based on “net present sustainable value”, which has been described as estimating “the net present value added across financial, environmental and social dimensions using a required rate of return that considers not only investors’ opportunity cost for their financial capital, but also the opportunity costs of the environmental and social capital inputs”.  With respect to capital budgeting, analysts are beginning to favor in incremental savings of water, energy and waste.  Another transition necessary for companies to take advantage of sustainable financing opportunities is shifting toward reporting and disclosure that includes environmental and social matters, particularly when companies are seeking targeted financing for projects based on renewable energy, climate change action, community and economic development and natural resource conservation and management.  Oversight of insurance matters by finance committees must take into consideration the evolving needs of insurance companies to mitigate their exposure to sustainability-related risks (e.g., natural disasters, ecosystem and community damage from operational activities and litigation costs associated with claims from employees based on hazardous work conditions and/or consumers based on issues with defective and/or hazardous products).

As mentioned above, finance committee strategies with respect to investor relations will need to take into account the surge of activity with respect to the incorporation of ESG issues into investment practice.  The world’s largest institutional investors have signed on global standards such as the United Nations Principles for Responsible Investment developed by an international group of institutional investors through a process convened by the UN Secretary General.  Finance committee members need to understand that investors that have signed on to the Principles for Responsible Investment are committed to incorporating ESG issues into investment analysis and decision-making processes and being activist owners through the exercise of their voting rights and engaging with portfolio companies on ESG matters.  One of the finance committee members, working with the CEO and CFO, should be responsible for engagement with the company’s largest investors to ensure that investor concerns regarding sustainability are addressed.

Sources for this article included A. Krauss, P. Kruger and J. Meyer, Sustainable Finance in Switzerland: Where Do We Stand? (Zurich: Sustainable Finance Institute, September 2016), 15-20 and Ignited: A Brief Overview of Sustainable Finance.

This article is adapted from material in Sustainability and Corporate Governance: A Handbook for Sustainable Entrepreneurs, which is prepared and distributed by the Sustainable Entrepreneurship Project and can be downloaded here.

Alan Gutterman is the Founding Director of the Sustainable Entrepreneurship Project, which engages in and promotes research, education and training activities relating to entrepreneurial ventures launched with the aspiration to create sustainable enterprises that achieve significant growth in scale and value creation through the development of innovative products or services which form the basis for a successful international business.  Visit the Project’s Library of Resources for Sustainable Entrepreneurs to download handbooks, guides, articles and other materials relating to sustainable entrepreneurship and keep up with the Project’s activities by following Alan on LinkedInTwitter and Facebook.

You Need a Chief Risk Officer for Your Organization

Lee and Shimpi noted that enterprise risk management (“ERM”) has emerged as an important and essential management practice and a recognized strategic discipline and that organizations have created ERM-specific roles, responsibilities and structures, notably the position of “chief risk officer” (“CRO”) that has taken its place along with other members of the C-suite.  Lee and Shimpi argued that the CRO has become instrumental in assuring that the organization has processes in place so that it complies with the very much heightened risk management expectations of shareholders, regulators, and even elected officials and attorneys general, and in developing and introducing an integrative risk management framework that helps the organization mitigate risks and allocate capital to build shareholder value with a full understanding of both the positive and negative potential of the risks involved.  Specific duties and responsibilities of the CRO generally include central oversight of the organization’s risk assessment and risk appetite; familiarizing the organization, its shareholders, regulators and rating agencies with the ERM program; implementing a consistent, integrated risk management framework throughout the company; managing that program with a particular emphasis on operational risks; and developing ways to mitigate and finance risk within the organization’s larger business strategies.

There are several different strategies that companies use with respect to the reporting obligations of the CRO position.  The most popular approach is for the CRO to report to the CEO, although many companies have the CRO report to the CFO due to the fact that many of the risk factors that a business must face and overcome are finance-related.  A smaller group of companies have opted to have the CRO report directly to the board of directors or the board-level committee responsible for risk management.  Even if the CRO’s first reporting obligation is to another member of the C-suite, the compliance and risk management committee should be vested with explicit authority to oversee the activities of the CRO and his or her support group and should carefully monitor the CRO’s relationship with other members of the senior management team, operating groups, finance, legal and human resources.  Lee and Shimpi commented that the most successful CROs forge close relationships with the internal audit function to gather information about the effectiveness of existing risk management programs and the planning function as a means for integrating risk assessment into the development of the company’s future business strategies.

Goldberg and McNamara advised that the CRO should work closely with the company’s general counsel and other members of the in-house legal team to ensure that potential legal risks and liabilities are integrated into the ERM program and that the program operates in a manner that mitigates liability and risk exposure.  The general counsel should be able to analyze best practices and provide advice to senior management and the members of the board-level compliance and risk management committee on how the ERM program should be structured.  In addition, the general counsel can be a valuable resource in identifying, assessing, prioritizing and managing legal risks and liabilities.  The general counsel is also responsible for advising the board of directors, and the board’s compliance and risk management committee, on their duties and responsibilities with respect to oversight of risk management.

This article is adapted from material in Sustainability and Corporate Governance: A Handbook for Sustainable Entrepreneurs, which is prepared and distributed by the Sustainable Entrepreneurship Project and can be downloaded here.

Alan Gutterman is the Founding Director of the Sustainable Entrepreneurship Project, which engages in and promotes research, education and training activities relating to entrepreneurial ventures launched with the aspiration to create sustainable enterprises that achieve significant growth in scale and value creation through the development of innovative products or services which form the basis for a successful international business.  Visit the Project’s Library of Resources for Sustainable Entrepreneurs to download handbooks, guides, articles and other materials relating to sustainable entrepreneurship and keep up with the Project’s activities by following Alan on LinkedInTwitter and Facebook.

Audit Committee Membership? Expect to be Busy

Members of the audit committee must be prepared to spend a substantial amount of time in discharging their duties and obligations in relation to the company.  For example, commentators are advising that audit committees should schedule full-day meetings on no less than a quarterly basis.  The schedule for the meetings should allow sufficient time to review earnings releases and proposed 10-Q filings.  The chairperson of the audit committee plays a key role in ensuring that the time of the committee members is invested wisely and efficiently and he or she needs to be prepared to work on the committee agenda to make sure that meetings run smoothly and coordinate with other committees, such as the compliance and risk management committee and the disclosure and reporting committee, to avoid unnecessary waste of effort through duplication.  The committee chairperson should also have a good understanding of the business, its risks, and controls; be professionally skeptical and possess integrity and confidence; have strong communication and interpersonal skills; and prepared and willing to set aside large amount of time to overseeing the committee’s agenda and projects and meeting with management, other board members, the independent auditors, members of the internal audit function and representatives of key stakeholders.

At each meeting, members should be prepared to engage in lengthy and detailed discussions with senior management, as well as the company’s internal and external auditors, to understand the financial reporting system of the company and the decisions that are to be made relating to the accounting treatment of various transactions.  Under no circumstances can any of the audit committee members fail to achieve a clear understanding of any transaction, the manner in which it is presented, and the economic effect it will have on the financial position of the company.  Audit committee members should be able to review and evaluate the results that would have been reached if alternative accounting methods had been elected.

In addition, the audit committee should schedule extra time to allow for discussion of all financial information and other disclosures that are to be made in response to regulatory requirements, including financial statements, press releases and earnings guidance and other financial information given to analysts and rating agencies.  Discussions with the company’s independent auditors are particularly important in this process, especially given the oversight responsibilities now vested in the members of the audit committee.  The auditors should be quizzed about the procedures and decisions that they themselves might have used or made had they been given complete authority over the preparation of the company’s financial statements.  This inquiry is designed to focus on differences from the approach taken by management toward the reporting process.  The auditor should also be asked to put itself in the shoes of senior management and opine as to whether or not the auditor believes the company’s internal controls are sufficient for the auditor to be comfortable in delivering the certifications required of senior managers.  Finally, the auditor should be asked whether it would be satisfied with the financial information provided by the company if it were an investor.

Given the time required by audit committee members to complete the necessary consultations, it is more important than ever that audit committee meetings and activities be carefully scheduled.  This requires proper advance planning for meetings, including timely dissemination of the materials to be discussed at the meeting, and sufficient time during the meetings to accomplish all the work that needs to be done.  In addition, audit committee members must anticipate the need to devote additional time for follow up on questions and issues that arise at the meetings.  All of this means that each prospective audit committee member should evaluate carefully the existing demands on his or her time before accepting this important assignment and the Commentary to the NYSE listing standards actually includes conditions that must be satisfied before an audit committee member will be allowed to simultaneously serve on the audit committees of more than three public companies.  Audit committee members should also expected to be tapped for assignment to other board-level committees that handle topics that overlap with the traditional responsibilities of the audit committee in order to ensure that there is effective coordination and collaboration between those committees.  For example, audit committee members are good candidates for service on the board’s compliance and risk management and disclosure and reporting committees.

Given the broad array of duties and responsibilities that have been vested with the audit committee, and the corresponding need for interpretation of applicable rules and regulations, it is not surprising to find that the audit committee will often require focused advice from independent counsel.  Recognizing this need, SEC rules now provide the audit committee with authority, as discussed above, to engage independent counsel and any other advisers the committee determines may be necessary in order for it to carry out its duties and obligations.  For example, it can be expected that counsel will be consulted for interpretation of basic issues, such as whether a nominee for the audit committee is “independent” or whether a particular service provided by an accounting firm falls within the scope of the audit committee’s approval requirements.  Counsel will also be required to assist the audit committee in the development of rules and procedures, including written charters that must be developed to define the scope of audit committee activities.  Finally, counsel will be required to assist the committee in overseeing and conducting internal investigations that may be brought to the attention of the committee through the professional standards requirements imposed on attorneys..

This article is adapted from material in Sustainability and Corporate Governance: A Handbook for Sustainable Entrepreneurs, which is prepared and distributed by the Sustainable Entrepreneurship Project and can be downloaded here.

Alan Gutterman is the Founding Director of the Sustainable Entrepreneurship Project, which engages in and promotes research, education and training activities relating to entrepreneurial ventures launched with the aspiration to create sustainable enterprises that achieve significant growth in scale and value creation through the development of innovative products or services which form the basis for a successful international business.  Visit the Project’s Library of Resources for Sustainable Entrepreneurs to download handbooks, guides, articles and other materials relating to sustainable entrepreneurship and keep up with the Project’s activities by following Alan on LinkedInTwitter and Facebook.

Compliance and Risk Management Committee for Your Board

Compliance with laws and regulations applicable to the company’s business activities and identifying and managing the risks associated with those activities are two of the fundamental duties and obligations of the board of directors.  The emergence of sustainability as a new factor for consideration in boardrooms has expanded the compliance duties to include adherence to voluntary standards that the board has committed to with respect to governance and environmental and social responsibility and broadened the definition of risks to include environmental and social issues and challenges.  While creating a separate board committee to focus on compliance and risk management is not a new phenomenon, such committees have grown in importance.  Some companies separate compliance and risk management into two different committees and companies may also place board-level groups assigned to compliance and/or risk management as subcommittees of another standing committee of the board, such as the audit committee.

In a December 2016 report on how board committees among S&P 500 companies had evolved to address new challenges, the EY Center for Board Matters reported that compliance committees among those companies were typically responsible for oversight of programs and performance relating to legal and regulatory risks and the implementation and maintenance of the company’s code of conduct and related matters.  Specific areas of focus for this committee included the environment, health and safety and technology.  The functions of a compliance committee might overlap with the risk, public policy and sustainability committees.  Sectors most likely to have a compliance committee included health care, energy and financial.

With respect to risk management committees, the preparers of the EY report found that these committees generally were responsible for making recommendations for the articulation and establishment of the company’s overall risk tolerance and risk appetite; overseeing enterprise-wide risk management to identify, assess and address major risks facing the company, which may include credit, operational, compliance/regulatory, interest, liquidity, investment, funding, market, strategic, reputational, emerging and other risks; and reviewing and discussing management’s assessment of the company’s enterprise-wide risk profile.  The functions of a risk management committee might overlap with the finance and compliance committees.  Sectors most likely to have a risk committee included financial services (almost 75% of the companies in that sector had a risk committee), industrials, utilities, consumer discretionary, information technology and consumer staples.

The charter for a board-level compliance and risk management committee should include a statement of purpose that addresses both compliance and risk management, recognizing that the two areas overlap substantially.  From a compliance perspective, the purpose of the committee can be stated to include oversight of the company’s implementation of compliance programs, policies and procedures, including the company’s code of conduct, that are designed to respond to the various compliance and regulatory risks facing the company; and assisting the board of directors and the other committees of the board, notably the audit and governance committees, in fulfilling their oversight responsibilities for the company’s compliance and ethics programs, policies and procedures.  When defining compliance, the focus should not only be on relevant laws and regulations but also any voluntary standards that the board has agreed should be adhered to with respect to the day-to-day conduct of the company’s operations and other activities.  A Global Compact publication recommended that the purpose statement of a risk management committee should include ensuring that the risks and opportunities arising from current and emerging corporate sustainability trends are included and addressed in the company’s Enterprise Risk Management program and that the board is informed of material issues relating to current and emerging economic, social and environmental trends.

 While the name of the committee may imply that compliance and risk management should be considered side-by-side, many companies view the primary focus of the committee to be risk management and that compliance risks are just one of many risks that identified and evaluated along with other operational and business risks.  Given the potential scope of any company’s operational, business and compliance risks, it is important for the board to thoughtfully allocate primary responsibilities for certain types of risks among the board’s various committees to ensure that the appropriate focus and expertise is applied to those risks.  For example, in the charter of its risk and compliance committee the board of directors of Target made it clear that the entire board would retain oversight responsibility over the company’s key strategic risks, as well as the company’s reputation and corporate social responsibility (“CSR”) efforts (which could also have been assigned to a separate board-level committee formed to oversee CSR), and oversight responsibility for certain other risk areas were assigned to other committees of the board (i.e., the audit and finance committee would handle financial reporting, internal controls and financial risks; the infrastructure and investment committee would handle risks related to the company’s capital expenditures, major expense commitments and infrastructure needs; the human resources and compensation committee would handle compensation incentive-related risks, organizational talent and culture, and management succession risks; and the nominating and governance committee would handle governance structuring, board succession and public policy engagement risks).

It is common practice to break out the description of the scope of duties and responsibilities in the committee charter into compliance and risk management.  With respect to compliance matters, the compliance and risk management committee should be charged with overseeing the company’s activities in the area of compliance that may impact the company’s business operations or public image, in light of applicable government and industry standards, as well as legal and business trends and public policy issues.  The mandate of the committee can be quite extensive, especially for companies operating in highly regulated industries and markets, and generally includes establishing, in conjunction with the senior management of the company, programs regarding operational and legal compliance and sound business ethics for the company; overseeing the company’s relationships with its principal regulatory authorities; reviewing matters relating to the education, training and communications to ensure the company’s compliance and ethics policies and procedures are properly disseminated, understood and followed; and monitoring and reviewing the company’s activities to ensure that legal requirements and high standards of business and personal ethics are communicated within the company and are being met by the company, its officers and employees and the company’s business partners.

As for risk management, Deloitte suggested that the committee should be concerned with overseeing the company’s risk exposures and risk management infrastructure; addressing risk and strategy simultaneously, including consideration of risk appetite, and advising the entire board on risk management strategy; monitoring risks; and overseeing and supporting the efforts of the CRO, the company’s management risk committee and other groups within the organization formed to monitor risks and implement risk programs.  Deloitte noted that it was important to determine how the risk committee will stay informed on developments in risks so it can evolve in its response to them and suggested that such committees develop procedures to ensure that members stay abreast of leading practices as risks evolve and understand the new risks associated with new businesses and locations and how changes in regulations increase or decrease risk.  The committee should also benchmark risk governance practices of peers, remain current on risk-related disclosure requirements and conduct annual evaluations of committee performance.

Among the items in a comprehensive list of duties and responsibilities with respect to risk management included in the committee charter of Brierty were the following:

  • Maintaining an up-to-date understanding of areas where the company is, or may be, exposed to risk and compliance issues and seek to ensure that management are effectively managing those issues;
  • Providing input to the board and senior management regarding the company’s risk profile and tolerance,
  • Assessing and monitoring appropriate risk management and internal control systems to ensure that risk is managed at levels determined to be acceptable by the board;
  • Reviewing the adequacy and effectiveness of the company’s policies and procedures which relate to governance, risk management and compliance and updating these policies and procedures where required;
  • Making recommendations to the board on the appropriate risk and risk management reporting requirements to the board and the committee;
  • Providing advice to the board and the CEO on relevant corporate level performance indicators and targets for risk management and compliance activities;
  • Undertaking an annual review of risk management policy and underlying strategies and procedures to ensure its continued application and relevance;
  • If considered necessary by the committee, establishing a periodic and independent review of the implementation and effectiveness of the risk management policy to provide objective feedback to the board as to its effectiveness;
  • Receiving and considering reports on risk management and compliance programs and performance against policy and strategic targets;
  • Providing the board with advice and recommendations regarding the appropriate material and disclosures to be included in the section of the company’s annual report which relates to the company’s risk management and compliance policies;
  • Ensuring that the board, before it approves the company’s financial statements for any financial period, is provided with declarations from the CEO and the CFO that in their opinion, the financial records of the company have been properly maintained and that the financial statements comply with the appropriate accounting standards and give a true and fair view of the financial position and performance of the company and that this opinion has been formed on the basis of a sound system of risk management and internal control which is operating effectively;
  • Reviewing the adequacy of the company’s insurance coverage; and
  • Ensuring that management has embedded an appropriate risk management culture in the organization and that risk management is an integral part of the company’s decision-making process.

Sources for this article included The Essential Role of the Corporate Secretary to Enhance Board Sustainability Oversight: A Best Practices Guide (United Nations Global Compact, September 2016).

This article is adapted from material in Sustainability and Corporate Governance: A Handbook for Sustainable Entrepreneurs, which is prepared and distributed by the Sustainable Entrepreneurship Project and can be downloaded here.

Alan Gutterman is the Founding Director of the Sustainable Entrepreneurship Project, which engages in and promotes research, education and training activities relating to entrepreneurial ventures launched with the aspiration to create sustainable enterprises that achieve significant growth in scale and value creation through the development of innovative products or services which form the basis for a successful international business.  Visit the Project’s Library of Resources for Sustainable Entrepreneurs to download handbooks, guides, articles and other materials relating to sustainable entrepreneurship and keep up with the Project’s activities by following Alan on LinkedInTwitter and Facebook.

Linking Sustainability Performance and Executive Compensation

It is no secret that incentive elements of executive compensation arrangements have long been tied to financial performance and increasing shareholder value as demonstrated by improvements in share prices.  Certainly financial success is important to the long-term viability of the business and provides the CEO and other senior executives with access to the capital necessary to remain competitive and pursue and commercialize innovative products, services and technologies; however, there is growing interest among stakeholders, including many institutional investors still very interested in financial returns, to create links between executive compensation and sustainability measures (i.e., metrics based on environmental, social and governance targets).  A Global Compact publication recommended that the duties and responsibilities of the compensation committee include:

  • Ensuring that sustainability issues are included in the compensation philosophy (e.g., the intent to reward sustainability performance and innovation, pay a living wage, ensure equitable pay, ensure appropriate CEO to worker pay ratios and limit excessive compensation, etc.)
  • Drafting a CEO position profile/description that includes reference to sustainability experience, values and leadership, fostering a sustainability culture, incorporating sustainability into corporate strategies and enterprise risk management, ensuring effective internal controls and management systems for sustainability and maintaining quality stakeholder relationships
  • Mandating that the CEO’s annual performance plan and evaluation/review include sustainability objectives, leadership and competencies
  • Implementing succession planning and management/leadership development programs that include sustainability competencies, leadership and values alignment; incorporate sustainability as a factor in position profiles, development plans and career planning for executive leadership and potential successors; and integrate sustainability into talent management strategies and discussions

While a strong business case can be made for including sustainability in the overall strategic goals and objectives for a company and, in turn, integrating sustainability into the elements of executive compensation, it is still far from settled practice.  In fact, surveys conducted by executive compensation consultants among S&P 500 companies have found that only 2% of the companies tied voluntary environmental targets (e.g., reduction of greenhouse gas (“GHG”) emissions) to executive compensation and that just 2.6% of the companies had a performance metric tied to diversity. Several practical issues need to be overcome in order for sustainability performance to take a more central role in executive compensation. For example, compensation arrangements become unworkable if they attempt to address too many metrics. According to Burchman and Sullivan, compensation consultants have traditionally recommended that compensation plans focus on no more than five metrics—one or two financial metrics, such as sales growth or earnings per share, and two or three nonfinancial metrics, in areas such as quality or innovation—and cautioned that including additional metrics, such as sustainability, will likely dilute executive focus.  Another problem, at least in the US, is that regulators have been slow to prioritize sustainability and environmental risks in their pronouncements regarding reporting; however, regulators outside the US, notably in Europe, have moved aggressively to formerly include sustainability into corporate governance frameworks,  voluntary reporting on sustainability has become increasingly prevalent and companies are becoming more sophisticated with respect to integrating sustainability and financial performance in the disclosures they make to their stakeholders.  Advances in sustainability reporting provide a foundation for constructing sustainability metrics that can be added to the financial results and measures of quality and innovation.

While the compensation and organizational development committee is the body of the entire board of directors that focuses its efforts on executive compensation, significant actions in that area must still be reviewed and endorsed by all of the directors.  Directors have long considered financial performance and long-term shareholder value to be the bedrock of their fiduciary responsibilities; however, in recent years boards have shown a willingness to “explicitly embrace the proposition that sustainability is a core indicator of the CEO’s and internal company’s responsibilities and performance”.  The key, according to Burchman and Sullivan, is to focus on those environmental, social and governance (“ES&G”) factors that are “relevant to a company’s business” rather than attempting to address all 17 of the sustainable development goals identified by the United Nations.  Any ES&G factor recommended for inclusion in executive compensation performance metrics must be grounded in a solid business case and accompanied by a clear plan of action with milestones that are reasonably within the scope of the CEO’s direct authority—in other words, as explained by Burchman and Sullivan, “well-defined metrics tied to concrete plans”.  Burchman and Sullivan noted that if companies are not yet able to define a specific sustainability metric, the board can still reasonably incentive the CEO and other executive to “do no harm” by retaining the right, which should be laid out specifically in the executive compensation policy, to reduce incentive awards in case of substantial damage to the company’s business or reputation due to a failure to take adequate precautions (e.g., an oil spill or harm to workers in the supply chain due to malfeasance by the company’s supply chain partners that should have been discovered).

The future of linking sustainability performance to executive compensation may be anticipated by observing the steps that have already been taken by a handful of high profile companies around the world, especially firms operating in industries where it is clear that operational activities can and do have significant and visible environmental and social impacts.  For these companies it is already fairly straightforward to make the business case for targeted, and relatively easy to track, sustainability initiatives such as managing and reducing GHG emissions and energy or water use, improving workplace diversity and enhancing employee safety.  What is needed is for companies to make the pitch to investors that pursuit and achievement of these goals is not only the “right thing to do” from an environmental and/or social perspective but also will reap financial benefits in the form of cost savings, better risk management and a stronger brand that will attract new customers and talented workers.  Metrics must be creatively designed given the end results of most sustainability initiatives cannot be learned for many years, often decades after they are first launched.  In these situations, executives must be incentivized by rewards that are based on achieving clearly defined interim milestones.

Sources for this article included The Essential Role of the Corporate Secretary to Enhance Board Sustainability Oversight: A Best Practices Guide (United Nations Global Compact, September 2016); S. Burchman and B. Sullivan “It’s Time to Tie Executive Compensation to Sustainability”, Harvard Business Review (August 17, 2017),; K. Larsen, “Why tying CEO pay to sustainability still isn’t a slam dunk”, GreenBiz (May 26, 2015); and In-Depth: Linking Compensation to Sustainability (San Francisco: Glass Lewis, March 2016).

This article is adapted from material in Sustainability and Corporate Governance: A Handbook for Sustainable Entrepreneurs, which is prepared and distributed by the Sustainable Entrepreneurship Project and can be downloaded here.

Alan Gutterman is the Founding Director of the Sustainable Entrepreneurship Project, which engages in and promotes research, education and training activities relating to entrepreneurial ventures launched with the aspiration to create sustainable enterprises that achieve significant growth in scale and value creation through the development of innovative products or services which form the basis for a successful international business.  Visit the Project’s Library of Resources for Sustainable Entrepreneurs to download handbooks, guides, articles and other materials relating to sustainable entrepreneurship and keep up with the Project’s activities by following Alan on LinkedInTwitter and Facebook.