The recent
news that California utility PG&E Corp. filed bankruptcy should cause pause
in every corporate boardroom. On Monday January 14,2019, The Wall Street Journal (WSJ) reported
that analysts had pegged PG&E’s wildfire liability exposure to be as high
as $30 billion—roughly triple the company’s market value of $9.12 billion. By
Friday that week, WSJ called this “the first major corporate casualty of
climate change.” One week later, California investigators said
PG&E did not cause the major 2017 fire (Tubbs Fire), but although that
announcement caused a bump in stock price, it did not change the $30 billion
tab, which the company itself has estimated. The company filed for bankruptcy
on January 29, 2019.

But
judging its external environmental, social, and governance (ESG) ratings,
PG&E was doing fine. Clearly, this situation shines a spotlight on the
serious limitations of external ESG ratings. It also highlights the need for
companies across virtually all industry sectors to build robust ESG governance
systems.

Judging
by the praise voiced by external ESG ratings organizations, PG&E seemingly had
its ESG house in order. Sustainalytics, a leading provider of ESG and corporate governance research, ratings,
and analysis, named PG&E an “outperformer” (in 88th
percentile on environment and 82nd percentile on governance).
PG&E rated number one among utilities and twenty-second overall in Corporate Responsibility Magazine’s 100
Best Corporate Citizens. Newsweek
Green Rankings listed the company the best among electric and gas utilities and
fourth overall. And, PG&E was named to the Dow Jones Sustainability North
America Index for the eighth time. Certainly there were apparently good reasons
for high ratings.

  • The company’s recently-published 187-page 2018 Corporate Responsibility and Sustainability Report seems to “check all the boxes.” Sustainability is explicitly called out in the company’s mission, vision, and values. Board committees are in place, ESG materiality assessment has been done, ESG is incorporated in the company’s financial incentive plan, and the organization has a dedicated chief sustainability officer, along with an outside advisory group. PG&E has a long history of ESG disclosure, bold goals to cut greenhouse gas emissions, and a record of early delivery on rigid California compliance standards (three years ahead of schedule). The list goes on.
  • PG&E has $34.5 billion worth of renewable energy contracts.
  • The company has discussed the California wildfires, noting actions PG&E is taking to address the “new normal.”

So we have a situation of high external ratings and a company apparently in compliance. Yet a $30 billion environmental liability exposure happened anyway. Clearly, there is a disconnect somewhere. I noted in my earlier NACD blog “Scorecard Data Suggests Many Companies Are Not Future-Ready that “without getting governance right, it’s hard to get anything else right.” That is precisely the lesson companies can learn from the PG&E situation.

Were the ESG raters wrong?

Clearly,
PG&E has a long track record of important accomplishments in the areas of
environmental stewardship and social responsibility. But what can outsiders
know about the company’s internal governance processes? Did something go amiss
here?

How can
other companies learn from this situation? It starts by avoiding two fatal
flaws:

  • It’s often not about compliance. U.S. companies have a 50-year history of looking at environmental, safety, and societal issues as compliance. They often view ESG oversight and management through a compliance lens. That’s yesterday’s view. Managing the mega risks today (climate change, water shortages, etc.) is often not about compliance. You might comply with your water intake permit requirements, but what happens when the well runs dry, or when, like in Flint, Michigan, the water is contaminated?
  • Beware the 80/20 governance trap. Only a very small
    portion (let’s call it 20 percent) of what constitutes robust management and
    oversight of environmental and social risks can be measured from outside the
    company. The other 80 percent—what I call “the soft stuff” —is comprised of the internal company practices and business
    processes to manage risk. That 80 percent does not easily lend itself to
    being measured.

External ESG raters
look at “the hard stuff”—aspects of corporate governance and strategy that can
be measured. Examples include gender diversity of the board or executive ranks,
CEO compensation as a multiple of average worker pay, or the mere existence of
a board committee with ESG oversight. But while external ESG raters may measure
the existence of a board committee, it is almost impossible for them to measure
the effectiveness of C-suite and board deliberations about ESG risk.

Bottom
line: a company may be in compliance today and may receive high marks from
external ESG raters; but directors should take all of that with a grain of
salt.They should insist on
measuring the other 80 percent of what constitutes robust governance.

The “soft stuff” actually can be measured

Companies
can measure the soft components of sustainability
governance. They can measure the effectiveness of C-suite and board
deliberations about ESG risk. More than 60 major U.S. corporations have used
the Corporate Sustainability Scorecard, a management tool for companies, built
over 20 years based on industry best practices. The Scorecard is
available to companies requesting access. And, the rating criteria are now
public, published by De|G PRESS (November
2018)in “Sustainability:
What It Is and How to Measure It
.”

I do
not know what went amiss at PG&E. But we do know that, using the Scorecard,
eight peer utilities rated themselves fairly low on over a dozen key
sustainability indicators (KSIs) that aim squarely at the ESG risk oversight
issues highlighted in the PG&E situation. On those dozen KSIs, the peer
utilities rated themselves on average at about Stage 1.7 on a stage 1–4
maturity scale. In other words, they acknowledged they have a long way to go if
they deem those items material to their business.

I
challenge directors to check it out.

Gib
Hedstrom is a member of the NACD faculty, specializing in ESG. He runs his own
advisory firm, working with mostly large companies on oversight of ESG issues.
His earlier book
,
Sustainability–A Guide for Boards and C-Suites, is available on Amazon or from him at www.hedstromassociates.com.