Blurb: Often left out of mainstream media in favour of its ‘E’ and ‘S’ counterparts, governance is increasingly important in ESG strategies, and as this article will highlight, is not as mundane a topic as some may think.
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What is governance?
Amidst a heightened focus on not only a company’s ability to satisfy shareholders in monetary terms, but additionally their ability to create long-term benefits for all stakeholders, ESG has become an increasingly popular way of ranking and rating companies based on their environmental, social and governance practices. In mainstream media, often environmental and social issues are brought to the forefront, like the poor treatment of employees, or high emissions statistics. However, whilst matters such as climate and social risk are hugely important, not only to the continuance of a firm’s operations, but equally in considering how the said firm impacts the world around it, governance is equally as critical to include in the spotlight.
So, what exactly is it? The ‘G’ of ESG refers to the governance factors of decision-making, whether this be defining the purpose of a corporation, distributing responsibilities among different members of corporations, or determining the compensation of top executives. All of these, and more, are key topics in the governance of a business.
Why is governance important?
Corporate governance is often deemed important by investors as it can concern shareholder rights, and is often deemed necessary in generating higher shareholder returns. However, in present times with the rise of ESG, governance is not just assessed through the lens of shareholder returns, but equally as a key driver in helping companies meet their targets and commitments on environmental and social issues. Governance is therefore foundational to a company’s realisation of both ‘E’ and ‘S’, as well as being a component of ESG itself.
The importance of governance is rarely stated when it is done well, but more often when it is poorly enacted. A few examples include the Lehman Brothers, which faced difficulties after using repurchase agreements to disguise the fact that its outstanding loans significantly exceeded its available capital, eventually leading to its filing for bankruptcy in 2008. Another is Facebook, which harvested and sold data from 87 million users to Cambridge Analytica in 2013, leading to Mark Zuckerberg being questioned by the US Congress, and Volkswagen (VW), where poor whistleblowing protocols and an opaque, top-down company culture ended up costing the company over $30 billion in fines and damages over its emissions scandal in 2015. The extent to which companies have rebounded and changed their governance practices after such scandals has differed, yet they have all faced significant, if not fatal, financial repercussions because of such errors.
What does good governance look like?
In its 2022 report, the World Economic Forum (WEF) Global Future Council on Transparency and Anti-Corruption has developed a number of indicators which should be considered when assessing a company’s governance. The list is said to have been built off the rise of the ‘Chief Integrity Officer’, a higher impetus on anti-corruption in ESG investing, and a broader recommendation to standardise reporting and metrics on sustainable value creation, all topics covered by the WEF. The list includes matters such as transparency, tax strategy, political responsibility, fair competitive practices, stakeholder engagement, and many more.
In practice, governance is not a one-size fits all approach, and different companies are at different stages in ensuring their governance strategy enables responsible business practice. Good corporate governance has often been showcased in the aftermath of scandals, whereby an overhaul in leadership has resulted in new and refreshed company priorities. The aforementioned VW scandal left the company with two options: to eventually succumb to the fines and reputational damage through business as usual, or to restore its brand. Choosing the latter, the company brought in a diversity council to help lead VW into becoming a world-leader in sustainability. In simple terms, the strategy included a cultural, policy and technology shift, and resulted in multiple positive outcomes for the company, one being its modern-day focus on the electric vehicle market.
The case going forward
Whilst corporate governance scandals are far from being a thing of the past, with a heightened focus on ESG, responsible governance is crucial in achieving both social and environmental issues. If investors and the public are rightly keen to scrutinise these company wrongdoings, the impetus and focus must initially be with the corporate governance practices at the root of the cause.
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