In the final entry of this series, we explore the governance component of environmental, social and governance (ESG) reporting. By examining a company’s internal procedures, leadership structure and potential conflicts of interest, good governance policies can help keep you out in front of potential violations or sanctions.
In prior installments, we discussed the importance of self-reporting on both environmental and social impacts. Now, we’ll dive into how governance ties both of these together to help identify your company’s risks while also presenting opportunities.
Corporate governance: a brief history
Corporate governance covers the structure, principles, processes and other mechanisms used by the Board of Directors to manage and oversee a corporation. While the practice of corporate governance can be traced to the 17th century Dutch Republic (ExchangeHistoryNL), its more modern incarnation grew out of the Wall Street Crash of 1929 and evolution of management theory after WWII. Despite that long history, the term “corporate governance” first appeared in the Federal Register in the U.S. in 1976, according to the European Corporate Governance Institute ECGI. Since then, the field of corporate governance has evolved considerably around the world.
"The financial crisis can, to an important extent, be attributed to failures and weakness in corporate governance arrangements."
The financial crisis that struck world markets in 2008 was the most devastating economic disaster since the Great Depression, according to many economists. It triggered the downfall of investment banks across the globe, and many countries have experienced the long-lasting effects of the crisis since.
While numerous factors contributed to the recession, it could be argued that poor corporate governance and oversight played a major role, citing an overemphasis on short-term profits, excessive pay and greed at the expense of long-term sustainable growth. Poor corporate governance practices have oftentimes been the foundation of some of the biggest corporate scandals and controversies.
The “G” of ESG
It is fundamental to understand the importance of corporate governance as the driving force behind the other two elements of ESG. Yet, when discussing ESG reporting, the governance element often receives little attention compared to climate risk and social responsibility. This is, in part, due to the fact that until recently ESG was viewed as more of a specialty of boutique investment firms. Today, ESG imperatives are fast becoming corporate priorities in the context of new institutional investor understanding that sustainability and climate issues are material to financial risk analysis. As a result, the long-held belief that maximizing financial returns for shareholders is the priority of corporate decisions — and therefore corporate governance concerns —is being replaced with a mindset that emphasizes long-term stakeholder outcomes.
For example, in August 2019, sustainability-focused groups called upon CEOs of major U.S. enterprises who make up the Business Roundtable to “concentrate on providing benefits to all stakeholders rather than primarily on deriving profits for shareholders.” This resulted in 180 of the roundtable CEOs signing a pledge expressing the view that their focus should be “on overall benefits to customers, employees, suppliers and communities along with shareholders,” of tackling issues such as climate change, water quality and deforestation.
“Mounting evidence shows that sustainable companies deliver significant positive financial performance, and investors are beginning to value them more highly.”
Many investors have long tracked and championed good corporate governance practices, so it’s fair to ask what we mean by governance when we talk about ESGs.
The Global Reporting Initiative – a global standard setter for impact reporting – provides helpful guidance to consider. GRI requires disclosure of reporters’ governance structure and composition, the role of the “highest governance body” (often the Board) in setting purpose, values and strategy, in risk management, in sustainability reporting, in evaluating performance, member competencies and performance, remuneration and incentives (GRI).
Composition factors include membership in underrepresented groups, gender and other factors that have new prominence today. For example, S&P Global Market Intelligence research revealed that companies with better female representation within corporate boards and C-Suite positions experience greater financial performance and profitability than companies with lower gender diversity.
The study found that, “in the 24 months post-appointment, female CEOs saw a 20% increase in stock price momentum, and female CFOs saw a 6% increase in profitability and 8% larger stock returns.” The analysis found that the driving force for the superior results was due to female executives being held to a higher standard.
Other “governance” issues in the ESG domain that have gained traction in recent years include attention to excessive executive compensation, corporate ethics and more.
Investors are increasingly identifying links between ESG performance, value creation and risk reduction. With Blackrock and others seeing “board quality and effectiveness” as a top engagement priority for the companies in which they hold interest and their commitment to take action against directors they feel are not taking sufficient action to address long-term risks, business leaders are wise to take stock of their governance infrastructure and policies (Blackrock).
The future of corporate governance
Understanding the "G" in ESG reporting is paramount, as evolving social, political and cultural attitudes about environmental and sustainability issues will drive both more governance risk and opportunity. The three components of ESG are profoundly interrelated and demand a cohesive methodology to amplify overall benefits and synergies. Environmental and social concerns are ultimately interconnected, and good corporate governance is the structure that links them together.
Despite a dramatic increase in interest in ESG reporting in recent years, many business leaders are unclear about how to take action.
UL can help you develop objectives and strategies to help your organisation improve their governance reporting and accountability.UL’s 360 Sustainability Essentials software will help you develop frameworks and gain insights into your business operations, improve partnerships and increase engagement from your stakeholders.
Environmental in ESG
In this first article of a three-part series, UL’s 360 ESG and sustainability team will analyze and break down the foundations of Environmental, Social and Governance (ESG) reporting.
360 Sustainability Essentials software
Rated #1 by Verdantix, our award-winning investment-grade sustainability data management system is available as an out-of-the-box solution. 360 Sustainability Essentials includes everything you need to report to leading frameworks while allowing you to focus on performance improvements.