By Max Cohen-Casado, Senior Associate, Forward Risk and Intelligence
Over the past few months, I’ve read a lot of articles from my contemporaries within the investigations industry about ESG. I read about the difficulty in measuring ESG amid a lack of standardized metrics, the increased awareness of investors and boards concerning ESG issues, the heightened ESG oversight from financial regulators, and an analysis of the merits of qualitative versus quantitative ESG measurements, among other topics.
I noticed that many of these articles were high-level, theoretical discussions filled with jargon that make them difficult for the average reader to parse. These authors often highlighted their own firms’ abilities to provide a “360 degree view” of a target company’s ESG standing, but seldom did I read an explanation of how exactly they would actually go about providing that comprehensive analysis. Here, I hope to fill that gap.
I like to start my investigations first by analyzing a company’s environmental track record. There is certainly more to the “E” part of ESG than just environmental violations. Issues such as supply chain oversight, use of renewable energy sources, and waste minimization are important, but searching for a company through relevant environmental regulatory databases can still provide valuable insight.
Normally I start by looking for media references to a company’s environmental track record. To find these I’ll search the company’s name alongside a curated string of words that are frequently used as markers of an adverse finding. The specific words that are included in this search string vary depending on the type of industry. I’ll also search the company’s various affiliates; oftentimes construction companies or energy companies will create separate entities for each development or project.
Next I’ll conduct a search of the EPA’s Enforcement and Compliance History Online database, followed by searches of state and local environmental databases, depending on the company’s jurisdictions of operations. Executing these types of searches provides a decent baseline and is an easy way to identify any glaring environmental red flags. However, they do not provide the full picture.
Often, the best way to get a more comprehensive understanding of a company’s environmental standing is through human intelligence or source inquiries. In previous cases we have conducted, interviews with a company’s former employees have uncovered lackluster adherence to environmental standards and blatant safety violations, among other environmental red flags.
The “S” component of ESG has become increasingly important as consumers feel the need to purchase from corporations that share their values. Recognizing this need, corporations often go to great lengths to make themselves appear to be responsible, inclusive, and fair employers.
As before, I usually start off in a search engine to catch any glaring labor or discrimination abuses that may have been picked up by mainstream media. I’ll once again use a search string that includes words commonly found in media reports about wage theft, union issues, or workplace harassment, or other typical “social” violations.
Next I’ll search PACER, the federal litigation database, for lawsuits pertaining to workplace discrimination or other labor-related matters. To find these relevant lawsuits, I’ll use the database’s filters to only search for specific “nature of suit” codes; these are usually Civil Rights 442: Employment and Labor 710 to 791, which include Fair Labor Standards Act, Family and Medical Leave Act, and Employee Retirement Income Securities Act cases.
After searching for litigation, I’ll delve into several regulatory databases. Both the National Labor Relations Board and the Occupational Safety and Health Administration have great internal databases of complaints and investigations into employers about pay violations, union disputes, unsafe working conditions, and other potential issues.
Another important source to search is employee review websites such as Glassdoor. Although some of the reviews may come from former and likely disgruntled employees, I try to look for patterns in the review. Sure, one complaint about sexist leadership may not be indicative of much, but four or five comments about a “male-dominated leadership” or a “good-ole-boys club” starts to paint a more compelling picture.
Finally, I’ve found that a great way to understand a company’s intentions is by looking at their political contributions. Occasionally, media sources will highlight examples of corporations donating to candidates and political groups that contradict their stated values. If these donations are not covered in the media, I’ll then look through the FEC’s database of contributions, then move on to state-level databases. Searching donations from the company’s top executives as well as the company’s affiliated PAC often reveal a stark contrast. All too many times I’ve seen companies that tweet about how inclusive they are, and how much they value their employees, then donate thousands and thousands of dollars to politicians that vote in favor of restricting LGBTQ rights, unionization rights, and other worker rights.
Corporate governance can seem challenging to measure, largely because of the high volume of components needed to evaluate, many of which are subjective and open to interpretation.
Fortunately for us, proxy advisors, the most well-known of which are Glass Lewis and Institutional Shareholder Services, have complex models on what good governance looks like. Every year, they publish annual reports with explanations of their recommended best practices; these exhaustively detailed reports explain their criteria for inclusion on a board’s committees, recommendations for executive compensation structures, guidelines for board diversity, and suggestions for shareholder voting protocols, among other information. Other institutional investors often publish reports in which they indicate how they intend to vote on governance: I also look to these sources for guidance.
One component that particularly interests me is board independence: are “independent” directors actually independent from the company’s executives? For each member of the board, I’ll create a list of their affiliations. While some of these affiliations are pretty easy to find, more thorough research is often required to find more elusive connections.
Once this extensive list is created for each board member, I can cross-reference and look for connections that may not have previously been disclosed in SEC filings. In previous cases, my colleagues and I have found a CEO and a supposedly independent director that were actually longtime golfing buddies at the same country club; an “independent” director who was the principal of the CEO’s children’s school; and a “independent” director who was the nephew of the chairman’s longtime professional mentor.
Another aspect of governance to watch out for is executive compensation structure: how much of it is tied to company performance, and how much is tied to ESG metrics? These sorts of compensation structures are increasingly common, and companies who employ them are typically not shy about it.
I like to look for not just if compensation is tied to ESG, but how much of it? A company’s proxy filings will usually delineate how executive pay is calculated. In addition to the percentage of pay tied to ESG, these filings will also reveal which ESG metrics the company actually uses. As noted previously, there is a lot of disagreement about which ESG metrics are best, so each company measures its ESG performance in a different way. Despite this ambiguity, I find that seeing an explanation of both how much pay is tied to ESG, and which criteria are actually used, I can better understand if a company is actually interested in pursuing ESG goals or if it’s simply paying lip service to a trendy concept.
By focusing on what an ESG-focused investigation actually looks like in practice, I hope that I was able to cut through the fog to make the process more tangible. Now that the concept of ESG-minded investing is so widespread, I believe that discussions moving forward can be focused more on the implementation of the investigative process and less on highly abstract and conceptual discussions.