The rise of company-specific materiality assessments will require companies to undertake substantial organizational and behavioral adjustments, reduce their reliance on standardized metrics, and incent investors to dig more deeply into the inner workings of individual portfolio companies.

The emergence of ESG issues has generated a wholesale reevaluation of
corporations’ so-called social compact. It has upended the concept of
and raised questions about traditional methods of auditing and evaluating
companies. Corporate externalities, intangibles, purpose, culture, values and
other qualitative factors — formerly characterized as non-financial — are now
recognized as integral to a company’s risk profile, financial health and
long-term value. Accordingly, corporate executives and boards of directors are
expected to attend to an expanding list of ESG topics including climate change,
human capital management, pay equity, gender and ethnic diversity and justice,
the wealth gap, human rights, immigration, gun control, domestic terrorism,
voting rights, political contributions and more.

Simultaneously with their impact on corporations, ESG issues are having a
transformative effect on institutional investors and shareholders. Giant
financial institutions such as
State Street,
Fidelity and many other asset owners and managers around the globe, are
waking up to the need to include ESG factors in their investment decision-making
and stewardship of portfolio companies — and millennial and Gen Z investors are
bringing their personal concerns about the environment, society and politics
into their selection of asset managers, their choice of asset classes and
directly into their engagement with the companies they own. ESG issues have
become a dominant focus for shareholder
and have contributed to their growing record of success. Social media is further
accelerating the process by which corporations are linked to ESG issues in the

E and S versus G

The transition to ESG engagement presents company managers with substantial new
challenges. In particular, the monitoring of environmental and social policies
cannot rely on the compliance methodology used for corporate governance. While
governance can be evaluated across different companies using a standardized
checklist of best practices (albeit often with a comply-or-explain option), a
prescriptive, one-size-fits-all approach does not work for environmental and
social issues. E and S factors vary widely at individual companies — depending
on their industry, size, location, competitive standing and a variety of other
considerations. This problem of variability is apparent in the proliferation of
competing global standards that have been developed to measure climate risk and
assess responses to climate change across different industries and in different
markets. The Sustainability Accounting Standards Board (SASB)’s 77
industry standards are a case in

However, global E and S standardization remains an important goal. Companies,
investors, NGOs and regulators deem standardization essential to achieve
comparability and ensure fair valuation of both listed and private companies. An
important move toward standardization is the recent creation of the
International Sustainability Standards

(ISSB) — a consolidation of the International Financial Reporting
Standards Foundation
, the Climate Disclosure Standards Board and the
Value Reporting Foundation (which in turn combines SASB and the
International Integrated Reporting Council).

Despite the push for standardization — and even if ISSB does achieve its
objective of providing “a comprehensive global baseline of sustainability
disclosures” — bespoke analysis of individual companies on E and S issues will
continue to be necessary.

Thinking differently about materiality

Experts and regulators pondering the growing need for customized treatment of E
and S factors have suggested that the traditional concept of “financial
materiality” should be supplemented with alternative definitions — such as
“double materiality,” “dynamic
and “pre-financial materiality.” It is important to carefully consider whether
the financial materiality standard is sufficiently comprehensive to embrace ESG
issues. If so, alternative definitions may confuse materiality analysis rather
than clarifying it.

In an April 27, 2021, comment letter to the Securities and Exchange
on the subject of “Climate Change Disclosures,” Uber
Technologies, Inc.
recommended an expanded approach to materiality that would
not require a redefinition. While endorsing an ISSB-type “harmonized climate
change disclosure framework” that “… would not only provide the
standardization, comparability and reliability sought by investors and other
stakeholders, but would allow … companies to streamline reporting and
communications on climate change,” Uber encouraged the Commission to consider
requiring that companies perform a company-specific materiality assessment to
identify the ESG issues most relevant to their businesses.

Uber’s “company-specific materiality assessment” contemplates a two-step
analytical process that, in addition to determining what an average investor
would want to know, asks additional questions:

  • What issues do we, the people running the business, think are strategically important
  • What do our stakeholders want?
  • To what degree are third-party standards applicable to our business?
  • What are peer companies doing?
  • What do our statement of corporate purpose, our company values, our culture, our reputation, our branding and our public image require?

These are important business questions whose answers are contextual and specific
to individual companies. They in no way depart from the traditional standard of
financial materiality. In fact, they rely on it. A company’s determination as to
whether an ESG issue is
ultimately turns on whether the issue has an actual or potential financial
impact on the business. Once the financial materiality determination has been
made, the ESG issue is no longer theoretical; it is redefined as a business
issue grounded in the company’s specific activities and circumstances.

While Uber’s company-specific materiality assessment rests on traditional
financial criteria, the approach will over the long term require companies to
undertake substantial organizational and behavioral adjustments. ISSB standards
will provide helpful guidance for companies willing to adopt reforms such as
holistic management, stakeholder engagement and greater Board transparency as a
means to achieve ESG integration.

The concept of company-specific materiality assessments also impacts
institutional investors. It will require them to dig more deeply into the inner
workings of individual portfolio companies and to engage with their managements
systematically — and will further reduce their reliance on standardized metrics,
regulatory guidelines and wholesale recommendations from outside advisors and
service providers.

Published Feb 18, 2022 7am EST / 4am PST / 12pm GMT / 1pm CET

John C. Wilcox

John Wilcox is founding chairman of Morrow Sodali, an international consultancy providing strategic advice and shareholder services to corporate clients around the world. During a career spanning more than four decades, John has specialized in corporate governance, capital markets, securities regulation, board accountability, shareholder activism, corporate control transactions and investor communication. He brings knowledge of both business and investor perspectives to help issuers deal with the challenges they face because they are answerable to shareholders. He has degrees from Harvard College, Harvard Law School, UC Berkeley, and New York University Graduate School of Law.