Engagement at the Top

EHS governance takes on new dimensions when business executives and the board of directors seek a second opinion

• By Richard MacLean
• Oct 01, 2005

The accounting scandals, perp walks to prison, and Sarbanes-Oxley (SOX) have sent shock waves throughout the ranks of boards and executives. Has this significantly improved environmental, health, and safety (EHS) and social responsibility governance at the top? Unlikely. What will it take to get executives and the board fully engaged?

Alex Pollock, at the American Enterprise Institute, recently argued that financial accounting in America is shifting from a profession where skilled judgment is critical to one where technocrats follow prescriptive rules.¹ Rules are needed, of course, but he argues that no amount of rulemaking will cover all the possible contingencies, not to mention keep one abreast of emerging business dynamics. It does, however, make more work for lawyers who second guess accounting decisions; see the follow-up editorial in the Wall Street Journal to Mr. Pollock's paper headlined, "As Lawyers Invade Accounting, Clarity Flees."²

Sarbanes-Oxley is 66 pages and does not mention -- even once -- the words environment, health, safety, or social responsibility (SR). Nonetheless, Section 404 requires that possible material issues (and by implication EHS and SR concerns) must be subject to internal controls and reporting. Pre-SOX, Securities and Exchange Commission regulations required essentially the same thing. One might say that, this time, the government really means it. Companies are responding with armies of lawyers and accountants following the rules (and the billable hours).

The danger in all of this is that executive management and the board of directors may be lulled into the belief that the company is responsibly carrying out its obligations, including EHS- and SR-related concerns, by going through the SOX motions. They certainly may be keeping themselves out of an all-expenses-paid vacation in a federal hotel, but how does this cost-effectively protect shareholder assets? Therein lies the basis of the many recent complaints about SOX in business literature.³

How can SOX possibly promote a better understanding of the emerging EHS and SR issues if the accountants and lawyers involved in these audits have little understanding of their subtleties and dynamics? This is not a negative statement on the competency of these individuals; it is just recognition that EHS and SR are niche areas that are rolled into all the other issues covered. Again, an audit by checking off boxes on a list may be effective for regulations, but it is not necessarily revealing.

More Than Just Regulations
If counting corporate beans, as Alex Pollock implies, cannot be reduced to detailed, prescriptive rules, just imagine how difficult it would be to codify every aspect of EHS -- especially an issue as fluid and fuzzy as social responsibility. Virtually all of the senior managers I know at large corporations spend the bulk of their time on emerging issues in these areas; the routine compliance stuff is handled by staff. Getting the complexities of EHS and SR dynamics across to top business executives and boards of directors is a major challenge. Summarized here, in order of effectiveness, are five different "formal approaches" that are currently in use in industry (not listed here are effective, "informal," one-on-one or small group discussions).

The most basic approach is periodic written summary reports or scorecards circulated up through the organization. This may promote a general understanding of where the company is versus established goals, but it promotes little in-depth understanding of emerging issues. These reports are usually dominated by lagging indicators of "results," and the performance metrics may not even track what is truly important to the company's long-term success.

The next level is direct, in-person updates to business executives and the board. This approach can be effective if: 1) it is done by the actual EHS and SR functional experts (as opposed to intermediate layers of business management applying their best spin); 2) sufficient time is spent in open dialogue, not just carefully scripted presentations; 3) some time is spent in education management on emerging dynamics; and finally, 4) the sessions occur, at a minimum, biannually and up to one hour each.

The third approach is the use of an executive business committee consisting of the CEO, COO, CFO, chief counsel, and/or other members of the business executive team that meets periodically for an in-depth review of EHS and SR progress. The challenge with these committees is to keep them interesting and not offer just a series of boring "talking heads" presenting results and current performance issues. Executive committees are still relatively rare in corporate circles, but they are gaining in popularity.

The fourth level is a committee similar to the preceding, but with the addition of external advisors. They may sit on the committee for some finite term or be brought in on an "as-needed" basis due to the subject matter covered. These advisors may offer their opinions, provide suggestions, or deliver formal presentations on their areas of expertise. They may be valuable in encouraging two-way dialogue and in raising issues that may be awkward for internal staff to introduce.

These committees are rare. Dow, Bristol-Myers Squibb, Duke Energy, Coca-Cola, Johnson & Johnson, Rohm and Haas, Schering-Plough, and possibly a handful of other U.S.-based companies, now or in the past, have opened their doors to outside intervention (and possibly criticism) concerning their planning and management processes.⁴ Mixing independent outsiders with business management is something that only the most self-confident and competent EHS and SR managers appear willing to do.

"Stakeholder engagement" is growing in popularity, but this is not the same as the preceding business committee function (although the dividing line can be a bit blurry.) The essential differentiating elements relate to the roles and levels of involvement of these individuals outside the company. Stakeholder engagement can be quite specific to individual projects and programs; generally, it does not involve top business executives. Business management may hear about the input, but might not participate in the process, which could, for example, involve the use of focus groups. External stakeholders have a vested interest in the outcomes and, thus, may or may not give objective advice. Advisors are usually called in to provide a broad assessment of a company's EHS and SR plans based on independent, impartial expertise.

The fifth level represents the penultimate degree of board engagement and governance: intervention by independent, specialized expertise interfacing directly with the board of directors. For other business issues, boards have long sought the advice of external advisors. Not so with EHS and SR, although a number of boards have had members with EHS and SR credentials (Ashland, Southern Cal Edison, DuPont, Freeport-McMoRan, and Pacific Gas and Electric come to mind). But independent intervention for EHS and SR is so rare that I was not even aware that companies have considered this option until a recent trip outside the United States.

Level Five Companies
BHP Billiton is the world's largest mining company and is based in Melbourne, Australia. The company's board of directors has a health, safety, and environmental subcommittee. This subcommittee structure is not unusual; board subcommittees that attend to EHS and SR matters are quite common in the United States and abroad. Sometime these responsibilities may fall under some other committee (e.g., audit, governance, or some other group), but the functional and fiduciary responsibilities are similar. What makes the BHP Billiton subcommittee special is that it is composed of four board members, including the CEO, plus four external, independent advisors with a global perspective (they hail from the UK, the United States, and Australia).

The subcommittee meets four times per year. What gives these meetings particular power and relevance is the degree of advance preparation provided: a half-day session is spent with the EHS staff in an update meeting with the four external advisors. These exchanges are sometimes supplemented with site visits. The first day session is followed the next day by another half-day briefing with the EHS functional heads. Finally, on the afternoon of the second day, the entire subcommittee meets formally.

Intrigued by BHP Billiton's approach to governance at the top, I started searching for other companies using a similar model. To date, I have found only one other company: Con Edison, the New York City-based utility.

First, some background. In 1989, the aftermath of a steam-pipe explosion in Manhattan led to the indictment of two of Con Edison's officers on various charges, including conspiracy to conceal the fact that asbestos was released. In 1994, the company pleaded guilty and was fined $2 million. A federal judge placed the company on probation and appointed a staff attorney with the Natural Resources Defense Council to monitor all company environmental operations. The company had been released from probation only a few months when, in 1998, a fire in a transformer released polychlorinated biphenyls (PCBs) containing oil into the environment. Con Edison was late reporting the presence of PCBs and was forced to pay penalties and fines. These problems resulted in a number of unique regulatory constraints, consent orders, and the return of the court-appointed monitor for two more years.

Con Edison has long since been released from any mandatory oversight, but the experience taught executives that independent oversight provides an insight to operations that would be difficult to otherwise achieve. Business management formed an Environmental Quality Review Board (EQRB) consisting of three outside advisors who provide input to the Environmental, Health, and Safety Committee of the Board of Trustees. The EQRB also serves on the Environmental and Safety Committee made up of senior company officers (i.e., a level-4 committee). In an arrangement similar to BHP Billiton's, the EQRB has extensive access to information and direct contact with ongoing operations.

Resources, Egos, Opinions, and Needs
The feedback received from all of the companies that I have interviewed using level 4 or 5 techniques (i.e., outside advisors interfacing with business management) is that it has been extremely useful. So why does this governance method remain so rare today?

I have received a vast array of responses to this question. One of the most frequently voiced is, "We cannot afford it -- no time and no resources." But that is bogus. For example, local university professors or retired individuals may be willing to help with little or no cost to the company. And how can you possibly break out of the regulatory rat race unless management better understands the emerging issues that seem to be consuming so much of our time today? I suspect it is not a lack of resources, but a lack of imagination and creativity that stand in the way.

Another response is, in essence, "We know what we are doing; we already get plenty of input through benchmarking and we do not need any more input." Oh really? The real issue may be the risk of damaged egos should something of significance be uncovered through deep probing by external advisors. Loss of control and a lack of self-confidence may be the real concern. For example, a number of the top EHS and SR slots are being filled by business managers who are rotated, for career development, through these positions. They may not want to rock any boats and surface any issues during their brief tenure. Again, this is a weak argument, since they can demonstrate good business judgment by getting on top of issues before they erupt. A surprise eruption on their watch can be career damaging. One way to get over this concern is to conduct a pre-audit or other baseline evaluation before an external committee is set up.

Recently, an EHS management individual from a major corporation told me that he was reluctant to bring in external reviewers because they "would just be offering their opinion of how things should be done." This is a valid point and raises the issue of the type of personality you should avoid. "Know-it-all" advisors with massive egos who pontificate their supposedly superior way of accomplishing EHS and SR objectives can be very dangerous, especially if placed in front of business managers who may have limited understanding of the options on the table.

You need to select people who are rooted in reality and who understand these sensitivities. Theory is fine, but people who have "been there/done that" are much more familiar with how difficult it can be to take a great theory from development to implementation (See sidebar, "Board Advisory Best Practices" for guidelines).

Finally, some say they just do not need these advisors because their business sector is at low risk and their company does not have any significant problems. Indeed, they can point out that the companies that have level 5, 4, or even level 3 committees have had significant issues in the past or are in high-risk sectors. True, but issues can arise and shift suddenly. Coca-Cola found this out recently when they were forced to close a plant in India over an issue related to water use and alleged contamination. These committees are less about informing business management of past issues and slowly developing regulatory issues, and more about rapidly emerging business dynamics and long-term company positioning.

And besides, do you know of a better way to get the board and top executives engaged? If you do, I'd like to hear about it.

Board Advisory Best Practices

• Rotate advisors -- Advisors should not be permanent members of the committee or they become, over time and in essence, company employees. They are less willing to critique current practices or raise issues since they have become part of the system.
• Pay appropriately -- Advisors should be compensated appropriately for their time, but not so much that they are in it for the money. They should be willing to leave at any time and be willing to raise sensitive issues without concern for the loss in income.
• Pick competent individuals, not trophies -- Having the Nobel Prize winner for physics for his/her work on air dispersion analysis may sound impressive, but what will this expertise bring to the table? Pick people that have current relevant expertise, not just prestigious titles or affiliations. Choose not just theorists, but individuals who have actually had to accomplish difficult objectives.
• Avoid conflicts of interest -- Be ready to pass the straight-face/front-page test on any advisor. If they are your brother-in-law, golf partner, roommate from college, and/or business partner in some other venture, their relationship and objectivity may be suspect. And if they are your advisor, they cannot also do consulting on the side for your company.
• Balance the expertise -- The collective group of advisors should not focus on one specific area, such as law, the environment, or safety. Each should be a generalist covering a broad array of issues so that, in total, the group represents a comprehensive spectrum of oversight and assistance.
• Set the rules of engagement -- Prepare a formal, written agreement on the scope of duties, responsibilities, expectations, confidentiality, and so on. For example, it should be clearly spelled out that this person is acting solely in an advisory capacity and is not the final decision maker, which is the function of the board and business executives. Misunderstandings and bruised egos must be avoided.
• Include external board members -- If the board of director subcommittee is composed solely of internal board members (e.g., company officers), the committee loses some of its objectivity. It is more akin to an internal management committee (i.e., level 4).
• Carefully structure the meetings -- The worst-case scenario is that the committee becomes passive, receiving only a series of management reviews related to ongoing performance. Advisors should be allowed time for background prep, including site visits and informal face-to-face exchanges with company employees. At the formal meetings, there should be sufficient time allocated to discuss emerging issues, strategy development, and so on.

References

1. Alex Pollock, From Making Judgments to Following Rules -- The Evolution of U.S. Accounting, American Enterprise Institute for Public Policy Research, July 19, 2005.
2. George Melloan, "As Lawyers Invade Accounting, Clarity Flees," Wall Street Journal, August 9, 2005, Page A11.
3. See, for example, Steve Forbes, "Dump the Destructive Deadweight," Forbes, September 5, 2005, Pages 31-2.
4. R. MacLean and J. Musser, "The Best Advice May Come with Attitude," EM Magazine, October 1999, Pages 8-11.

This article originally appeared in the 10/01/2005 issue of Environmental Protection.