CSG in the Board Room

Sustainability in the Boardroom

 “In its broadest sense, corporate governance is concerned with holding the balance between economic and social goals and between individual and communal goals. The governance framework is there to encourage the efficient use of resources and equally to require accountability for the stewardship of those resources. The aim is to align as nearly as possible the interests of individuals, of corporations, and of society.” 

Sir Adrian Cadbury

 Good governance is essentially about effective leadership. Leaders have to rise to the challenges of modern governance. Such leadership is characterized by the ethical values of responsibility, accountability, fairness and transparency and based on both legal and moral duties. Responsible leaders direct company strategies and operations with a view to achieving sustainable economic, social and environmental benefits for all.

 Sustainability is the primary moral and economic imperative of the 21st century. It is one of the most important sources of both opportunities and risks for businesses. Nature, society, and business are interconnected in complex ways that should be understood by decision-makers. Most importantly, current incremental changes towards sustainability are not sufficient – we need a fundamental shift in the way companies and directors act and organise themselves. We need to move from trying to do ‘less bad’ to doing ‘good’.

In the United Kingdom, the Corporate Social Responsibility relevant part of the Companies Act came into operation in October 2007. It requires that directors consider in their decision-making, the impacts of the company’s operations on the community and the natural environment. As has been pointed out in ‘The Reform of United Kingdom Company Law’, the intention of corporate law reform in this area was to:

The success of companies in the 21st century is linked to three interconnected systems – the global economy, the social system and the natural environment on which they both depend. Companies interact with and depend on all three so they need all three to flourish. A key challenge for leadership is to make sustainability issues mainstream: Strategy, risk, performance and sustainability have become inseparable.

The achievement of best practice in sustainability is only possible if the leadership of a company embraces the notion of integrated sustainability strategy, performance and reporting. Companies should expand their view of success and redefine it in terms of lasting positive impacts for all.

 Sustainability is, however, about more than just reporting on sustainability. It is vital that companies focus on integrated strategy and performance. The board’s role is to set the tone at the top, design strategies so that the company can achieve this integrated performance. Sustainability therefore also means that management pay schemes must not create incentives to maximise relatively short-term results at the expense of longer-term performance and viability of the business and the social and natural systems on which it depends.

 ESG Policies in the Board Room

 The Board needs to define its policies on ESG / CSR matters clearly to ensure that they are understood and abided by throughout the organisation, its operations and its supply chain.  This will also provide the understanding to stakeholders of the organisation’s position on CSR matters which removes misalignment of expectations.

The next stage is to implement a monitoring, performance measurement and assurance system that allows for full disclosure and reporting at all levels within the organisation.  Staff and stakeholder require accountability to ensure that these matters are taken seriously by all parties to ensure that change makes a difference.

 CSG – Stakeholders in the Board Room

 It is recognised that in what is referred to as the ‘enlightened shareholder’ model as well as the ‘stakeholder inclusive’ model of corporate governance, the board of directors should also consider the legitimate interests and expectations of stakeholders other than shareholders. The way in which the legitimate interests and expectations of stakeholders are being treated in the two approaches is, however, very different. In the ‘enlightened shareholder’ approach the legitimate interests and expectations of stakeholders only have an instrumental value. Stakeholders are only considered in as far as it would be in the interests of shareholders to do so. In the case of the ‘stakeholder inclusive’ approach, the board of directors considers the legitimate interests and expectations of stakeholders on the basis that this is in the best interests of the company, and not merely as an instrument to serve the interests of the shareholder.

What this means in practice is that in the ‘stakeholder inclusive’ model, the legitimate interests and expectations of stakeholders are considered when deciding in the best interests of the company. The integration and trade-offs between various stakeholders are then made on a case-by-case basis, to serve the best interests of the company. The shareholder, on the premise of this approach, does not have a predetermined place of precedence over other stakeholders. However, the interests of the shareholder or any other stakeholder may be afforded precedence based on what is believed to serve the best interests of the company at that point. The best interests of the company should be interpreted within the parameters of the company as a sustainable enterprise and the company as a responsible corporate citizen. This approach gives effect to the notion of redefining success in terms of lasting positive effects for all stakeholders.

Is the company’s reputation and its linkage with stakeholder relationships a regular board agenda item?

Has the board identified important stakeholder groupings, as well as their legitimate interests and expectations, relevant to the company’s strategic objectives and long-term sustainability?

Does the risk management process deal with the identification, assessment and associated actions of stakeholders that could materially affect the operations of the company?

 Remuneration 

Sustainability also means that management pay schemes must not create incentives to maximise relatively short-term results at the expense of longer-term performance and that it must encompass more than just financial performance indicators.

An important task of governance is setting executive compensation. Although a majority of board directors say that pay should be tied more closely to performance, CEO pay is too often structured to reward a leader simply for having made it to the top, not for what he or she does once there. Meanwhile, polls show that the disconnect between pay and performance is contributing to the decline in public esteem for business.

CEOs and other executives should be paid to act like owners. Once upon a time we thought that stock options would achieve this result, but stock-option-based compensation schemes have largely incentivized the wrong behavior. When short-dated, options lead to a focus on meeting quarterly earnings estimates; even when long-dated (those that vest after three years or more), they can reward managers for simply surfing industry- or economy-wide trends (although reviewing performance against an appropriate peer index can help minimize free rides).

Finally, it has to be said that few compensation schemes carry consequences for failure—something that became clear during the financial crisis, when many of the leaders of failed institutions retired as wealthy people whilst thousands lost their employment, homes and retirement plans.

Board Member Effectiveness

 This is about understanding –

-          the key environmental trends (External) and how they are likely to affect the business (e.g. mineral resources scarcity, water scarcity, climate change, biodiversity loss, de-forestation, eco-system degradation, desertification, etc…)

-          the key social and societal trends (External) and how they are likely to affect the business  (e.g. local and worldwide demographic trends, increase demand for transparency, responsibility and accountability, etc…)

-          the need as a Board Member to be able to make the link between External trends and the organisation’s Internal capability – this is required to ensure the organisation is able to anticipate, mitigate and / or adapt the survive, prosper and support a sustainable company and environment.