Why Private Companies Should See ESG as an Opportunity

Private companies, long at the forefront of innovation and capital formation, have many qualities and advantages that allow them a unique opportunity to lead in the development of environmental, social, and governance (ESG) protocols and frameworks. Within the constraints that well-established public companies must operate in lies a potential opportunity for the private company. Private companies tend to be versatile and focused on creative solutions to difficult problems. And often they have financial capital, time, and intellectual capital that afford them the opportunity to think outside the box. Private companies engage in the process of creative destruction in a way that public companies may not be able to and are uniquely positioned to explore avenues to innovation. Finally, they operate outside of the regulatory framework imposed on public companies.

However, like public companies, private companies still must meet the needs of their many and varied stakeholders to create long-term value for their investors, their employees, and their customers to remain sustainable organizations. ESG issues apply equally to private firms, too. Regardless of where on the ESG spectrum an organization falls, private companies have a lot at stake when it comes to addressing these issues. For this reason, it is surprising that some indicators seem to point to private company ESG practices maturing more slowly in comparison to those of public company peers. Consider the following insights from the 2022 NACD Private Company Board Practices and Oversight Survey:

• Less than half (39 percent) of private company respondents to the survey indicated that their boards have reviewed ESG-related risks and opportunities for their companies, a prerequisite for more advanced practices. As an example of the gulf between current practices at private versus public companies, 18 percent of private company respondents indicated that their boards have assigned clear ESG oversight responsibilities to specific committees, compared to 64 percent of public company respondents.

• Less than a third (30 percent) of private company respondents indicated that the frequency of climate-related discussions has increased on their boards, compared to 54 percent of public company respondents. A quarter (25 percent) of respondents indicated that climate change is not a concern for their companies.

Since private companies have operating environments that allow for more discretion to find solutions and deal with the issues at hand, there is an opportunity for these firms to lead the ESG innovation curve.

One consequence of stakeholders trying to effect change is that they are causing companies to rethink the assets they hold that have negative ESG implications. The shifting investment landscape is causing some companies to look at divesting assets rather than rehabilitating them. Many of these assets are in demand by consumers and in some cases many economies may depend on them. There could likely be a growing alignment of interests between public and private companies to shift high-risk ESG assets from public corporations to private organizations. If this comes to fruition, this trend could result in the following:

• more private companies working (perhaps with regulators) to solve pressing ESG issues, including those related to climate change;

• greater regulation for private companies;

• increased regulatory scrutiny for private companies around climate disclosure and other ESG-related disclosures; and

• increased litigation and director and officer (D&O) exposures, depending on how well the ESG risks are managed.

As the ESG landscape develops there is potential for private companies to lead ESG innovation and positive outcomes could impact how insurance underwriters assess D&O risk. Insurers could begin to underwrite private companies in much the same way that they underwrite public companies, including with more focus on corporate governance and board engagement on ESG issues.

Whether a company is private or public, a board must understand and take an active role in making sure that they can recognize ESG risks and work to mitigate them. It is essential for private companies to ensure that they secure the broadest D&O insurance coverage available in the market. D&O litigation can emanate from many sources including employees, regulators, customers, and nongovernmental organizations, as well as from shareholders. And D&O insurance protects a company balance sheet from exposures as well as potential liabilities to the personal assets of directors and officers of privately held companies. A comprehensive D&O insurance plan can be an essential element in attracting and retaining a strong board while managing risk, including risk related to ESG oversight.