Trends in Corporate Sustainability

In recent years, corporations have begun to voluntarily adopt sustainability measures to better manage risk and respond to more-educated investors in an increasingly transparent, more-connected world.

This article provides an overview of why companies are adopting these voluntary programs, the risks companies are balancing, and what to expect with the new U.S. administration.

Managing risk

To understand why a company would voluntarily adopt sustainability practices, it is helpful to examine the concept of risk. Risks include the rather obvious risk of a catastrophic event, such as a plant explosion; more-remote, but recently better defined, risks, such as supply chain disruptions due to rising sea levels; and the more ambiguous risks related to "doing the right thing."

Because of technological advancements, previously undefined and seemingly remote risks can now be observed and quantified. As risk sharpens into focus, investors are becoming more aware of risks and have started to support more targeted investor activism. In turn, companies are reevaluating their approaches to risk management and investing more aggressively in managing a wider range of risks.

Corporate risk management: The basics

Risk to corporations in the U.S. arises from the demands of complying with the law of corporations itself, as well as a corporation's duty to comply with other laws, including environmental laws. Corporations must also consider general business risks such as market trends, competition, general economic conditions, conflicts (e.g., war), acts of God, and any other threat to the business of the corporation (e.g., climate change). In addition, the existence of material business risk can trigger additional legal duties and thus liabilities.

How are corporations subject to risk and what duties are triggered in response to risk?

Generally speaking, corporations are legal persons, formed pursuant to a state's law of corporations. In conducting their activities, corporations are subject to legal enforcement and liability similar to natural persons. However, the benefit of doing business in the corporate form is that it generally allows natural persons who may choose to invest in a corporation to limit their personal liability for that corporation's financial and other liabilities, unless, of course, that person's individual actions trigger personal liability. For example, if a corporation's air or water discharge exceeds its discharge permit limits, the corporation is liable, but there would be no personal liability for individual investors, although the investor could lose value in the shares of its stock as a result of environmental enforcement against the corporation.

General corporate risk-management principles focus on protecting the corporation and its investors by protecting the business of the corporation [i.e., its performance and assets) and ensuring compliance with the law of corporations and compliance generally, including the disclosure of all material information to investors so that investors can make informed decisions about their investment. Within this subset of laws, corporations are first subject to the law of incorporation - the laws specifically governing their formation and operation that address the powers of the corporation, elections of directors, duties of the directors and officers, provisions regarding the sale of stock and stockholder protections, meetings, insolvency and dissolution, and more.

An important facet of corporate law is a corporate director's fiduciary duty to the corporation and stockholders, which includes duty of care and duty of loyalty. In general terms, this means that a director acts in the best interest of the corporation and stockholders rather than serving their own interests. The duty of care requires a director to make informed business decisions, generally considering all material information reasonably available to them. The duty of loyalty requires the director to act in good faith to advance the best interests of the corporation and refrain from conduct that injures the corporation.

Beyond the applicable state law of incorporation, additional disclosure rules apply to publicly traded corporations (and certain privately held as well). Investors in publicly traded (and some privately held) companies are protected by requirements imposed by the U.S. Securities and Exchange Commission (SEC), which implements statutes adopted to ensure the public trust in publicly traded corporations, such as the Securities Act of 1933 (1), the Securities Exchange Act of 1934 (2), and the Sarbanes-Oxley Act of 2002 (3). Corporations must comply with applicable disclosure requirements to ensure that investors are armed with sufficient information to understand material risks to the corporation, including its viability and performance.

Thus, to survive, a corporation, whether private or publicly traded, must manage the risk of noncompliance with the law of corporations, including fiduciary duty and disclosure requirements, in addition to the laws triggered by corporate activities, such as health, safety, and environmental laws.

The landscape for managing environmental risk

Corporations are subject to legal liability for breaking environmental laws, including strict liability (that is, regardless of the presence or absence of fault) for civil penalties assessed by federal or state government for noncompliance. Strict liability imposes responsibility even in the absence of proof of negligence or intent.

Corporations are also liable under state common law to individual persons, including other corporations, for any damages they inflict to persons or property. Courts award damages for such liabilities through litigation. Damages awarded by courts are not predictable. Thus, a general principle of corporate risk management is that corporations can avoid prospective harm - and its associated relatively predictable range of potential governmental assessed penalties and less predictable litigation risk - through compliance with statutes and regulations designed to prevent harm to human health and the environment from corporate activities (e.g., manufacturing).

In theory, the more potential future harm a company can avoid by complying with statutes and regulations, the less harm is likely to occur from unregulated scenarios, which would need to be addressed after the harm has occurred, solely through the courts. In the absence of laws and regulations aimed at limiting future risk, corporations are more likely to face allegations that they have caused harm after the fact, in court and before a jury, and more often face court-ordered damage awards. After such an experience, a corporation may adopt internal procedures designed to avoid such catastrophic liability.

This dynamic can be observed in cases that involve dangerous products. Consider, for example, asbestos. After significant litigation, Owens Coming was faced with overwhelming liability from past human exposure to asbestos products that occurred prior to asbestos product regulation and before asbestos products were prohibited. After it emerged from bankruptcy, Owens Coming adopted internal corporate procedures - product stewardship - to prevent any such future product from exposing the company to similar liability.

Another example of responsive corporate risk management is action intended to avoid liability for past releases of hazardous substances pursuant to the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), also referred to as Superfund (4). Superfund imposes retroactive, joint-and-several, strict liability on generators, facility owners and operators, and transporters involved in waste transport or disposal that are responsible, in whole or in part, for releases of hazardous substances. Corporations have adopted many methods for avoiding Superfund liability. For instance, corporations follow procedures available through the 2002 CERCLA Brownfield Amendments to ensure they do not acquire property that could bring with it Superfund liability.

These examples illustrate corporate willingness to adopt sound risk-management procedures to avoid material liability that could negatively impact the financial well-being of the corporation. Such risk management also helps corporations withstand the risk of doing business in the face of legal authority, whether imposed prospectively through statute or adopted pursuant to contracts, or threatened retroactively through litigation.

From explosions, to climate change and sustainability

Risk management decisions can be quite clear, in the case of environmental and other regulatory compliance, where failure to comply can subject corporations to significant financial and other liability. Corporations may have more difficulty, and less clarity, in determining how to implement more-proactive measures that are intended to avoid incidents such as plant explosions, which may go beyond process safety management and environmental regulatory requirements. And, as scenarios progress to the more remote, indirect, or poorly defined risk, such as those related to climate change, a corporation's risk-management approaches broaden and must address concerns from informed shareholders, greater public awareness that could affect branding, and more comprehensive cost-benefit analysis.

Risk management: Climate change

Setting aside for purposes of this article risk arising from failure to comply with U.S. greenhouse gas (GHG) emission regulations, other regulatory compliance risks related to climate change need to be considered. In 2010, the SEC issued its Interpretive Guidance on Disclosure Related to Business of Legal Developments Regarding Climate Change (5). While it does not impose new disclosure requirements on publicly traded companies, that guidance does interpret existing SEC disclosure requirements with respect to the types of risks that could constitute material risks to the corporation arising from climate change.

After reviewing the impact of legislation and regulation on corporate decision-making, which in turn could have business and market impacts, the SEC guidance separately reviews the physical effects of climate change that could give rise to material risks. These effects can impact a corporation's personnel, physical assets, supply chain, and distribution chain. They can include changes in weather patterns, such as increases in storm intensity, sea-level rise, melting of permafrost, and temperature extremes. Changes in the availability or quality of water or other natural resources on which the corporation's business depends, or damage to facilities or reduced efficiency of equipment, can have material effects on companies. Physical changes associated with climate change can reduce consumer demand for products or services; for example, warmer temperatures could reduce demand for residential and commercial heating fuels, service, and equipment.

For some corporations, financial risks associated with climate change may arise from physical risks to other entities. For example, climate-change-related physical changes and hazards to coastal property can pose credit risks for banks whose borrowers are located in at-risk areas. Companies also may depend on suppliers that are impacted by climate change, such as companies that purchase agricultural products from farms adversely affected by droughts or floods.

Thus, the SEC's 2010 guidance put publicly traded corporations on notice to include climate-change-related risks when filing their SEC disclosures. For publicly traded and private corporations, the guidance provided a better understanding of what is considered a material risk arising from climate change.

The more-obscure risks associated with climate change create broad issues that impact a corporation's future growth and viability, as well as support industries, such as the insurance industry. This is especially the case where standard riskmanagement tools are impacted, such as the flood mapping by the Federal Emergency Management Agency, which may be updated to account for changing rainfall data, hurricane patterns, and storm intensities. And while the SEC may not enforce its 2010 guidance, the disclosure of climate-changerelated risks is standard practice internationally because it is considered healthy for the financial markets. Such disclosures are so important that the international Financial Stability Board (FSB) Task Force on Climate-Related Financial Disclosures (TCFD), chaired by Michael Bloomberg, was created to develop voluntary, consistent climate-related risk disclosures to assist investors, lenders, and insurers in understanding physical, liability, and transition risks associated with climate change and effective financial disclosure of those risks.

Risk management: Sustainable development

Compliance with sustainable development concepts, unlike compliance with environmental law, is not mandated by U.S. environmental statutes. However, sustainable development practices are related to corporate risk management in much the same way that physical effects of climate change are considered in evaluating material risks to corporations. Sustainable development refers to development that meets the needs of the present without compromising the ability of future generations to meet their needs.

Recognizing that sustainability principles enlarge the universe of direct risk to include mitigation of indirect risk to supporting populations and societies, resources, and resource-supporting ecosystems, clearly, sustainable practices may support and thereby protect long-term business viability. Thus, sustainable development can protect corporations from risk, regardless of the precise reason for adopting these principles. For example, a corporation may adopt more-sustainable source reduction and waste minimization practices for several reasons, such as to avoid: unnecessary regulation that could create risk of noncompliance; the disposal of hazardous substances, which could create Superfund liability or cause personal injury or property damage subject to litigation; the risk of damage to ecosystems from environmental pollution; and unnecessary costs from the generation of waste. A company might also adopt such practices to satisfy shareholder petitions.

Corporations are also recognizing sustainability as an overlapping, complementary, supporting, and enabling, and potentially even synonymous, goal with climate change mitigation. The 2015 Sixth Annual Sustainable Innovation Forum, scheduled as a side event to the COP21, which hosted the signing of the Paris Agreement, was held to catalyze partnerships needed to accelerate low-carbon development solutions. The 2016 Seventh Annual Sustainable Innovation Forum focused on the implementation of the Paris Agreement, including panel sessions on decarbonizing the energy supply, climate change adaptation, financing climate action, sustainable urban development and mobility, water management and resilient agriculture, low-carbon innovation in emerging regions, sustainable business as a driver of change, accelerating green economic growth, and women and climate change.

With sustainable development's clear benefits to corporate viability and its relationship to climate change, corporate shareholders have become more active in demanding greater transparency in reporting of both climate change and sustainability. Last year was a record year for SECapproved shareholder initiatives emphasizing sustainability and the disinvestment of carbon assets.

Additionally, the Global Reporting Initiative (GRI) recently released new guidelines for corporate sustainability reporting. The new guidelines provide the global best practice for reporting on a range of economic, environmental, and social impacts. GRI also released guidelines linked to the Carbon Disclosure Project (CDP) to assist companies in reporting on climate-related activities and impacts. In addition, the International Organization for Standardization's (ISO) completed second draft of ISO 20400, Sustainable Procurement - Guidance, provides assistance for corporations in purchasing more-sustainable materials.

Shareholders can more reliably choose to invest in companies that have disclosed climate-change risks and adopted sustainable development practices, including GHG emission reductions.

Power Forward 3.0, a collaborative project by the World Wildlife Fund, Ceres, CDP, and Calvert Research and Management, reported (6) that Fortune 500 companies are increasing their adoption of GHG emission reduction targets, improving energy efficiency, and increasing their sourcing of renewable energy. Since 2014, the number of Fortune 100 companies adopting or retaining such goals has risen five percentage points to 63%. Power Forward 3.0 reported that currently almost two dozen Fortune 500 companies are committed to 100% renewable energy, including Apple, Hewlett Packard, Microsoft, Procter and Gamble, Google, Johnson and Johnson, Facebook, and more (Figure 1). Praxair, Microsoft, and IBM, reportedly save tens of millions of dollars every year through energy efficiency projects.

PepsiCo's CEO, Indra Nooyi, said in a company press release (7): "Combating climate change is absolutely critical to the future of our company, customers, consumers - and our world. I believe all of us need to take action now. PepsiCo has already taken actions in our operations and throughout our supply chain to 'future-proof our company - all of which deliver real cost savings, mitigate risk, protect our license to operate, and create resilience in our supply chain."

A particularly interesting development is the emergence of science-based target-setting, whereby a company uses the best available climate science to define its appropriate share of the emission reductions required to limit global temperature increases to below 2°C compared to preindustrial temperatures. Companies including Hewlett Packard, Procter and Gamble, Johnson and Johnson, PepsiCo, Pfizer, and Xerox are using this target-setting approach.

The Power Forward 3.0 report recommends that investors continue to pursue GHG emission reductions in their investments through several channels. It recommends that investors consider implications of climate change, the transformation of the energy sector, and how companies are positioned for a global low-carbon future. It also recommends that investors disclose their investment portfolio exposure, engage in the Investor Platform for Climate Actions, file shareholder resolutions, consider investor strategies based on 100% renewable energy and sciencebased GHG targets, and engage in investor networks to address climate change and other key sustainability risks, such as the Investor Network on Climate Risk.

Companies continue to make progress, despite current events indicating conflict in the public arena. For example, on March 16,2017, President Trump issued a budget blueprint that eliminated programs related to renewable energy and sustainable development; Congress answered on May 1,2017, with a draft Congressional appropriations package that largely rejected that budget blueprint. And, on April 28, Trump removed information on climate change from the EPA's website; the next day, thousands marched on Washington, DC, to draw attention to climate change (Figure 2).

Final thoughts

Sustainability and reducing the corporate GHG footprint have long been recognized as good business practices. However, without government mandate, many corporations, with short time horizons geared toward discrete returns for specific investments, may not be persuaded to voluntarily adopt these practices simply because they might be good business. Yet, as tools continue to become available that allow us to better evaluate risk arising from unsustainable practices and unnecessarily large corporate GHG footprints, and such evaluation compels the disclosure of this risk, corporations may find themselves bound by duty and law to better manage this risk.

Many companies already recognize the value of better managing multiple discrete risks by generally adopting more-sustainable practices, including lowering GHG emissions. Clearly, broader implementation of conservative risk-management principles has compelled many companies to adopt a longer view - one that recognizes that sustainable development, beyond merely a method of managing risk and reducing costs, is a tool for achieving climate change mitigation. And, a growing number of companies see merit and value in utilizing science-based target-setting to quantify and mitigate their contributions to climate change, much like companies calculate and mitigate their contribution to other environmental pollution. ^^3