After the financial crisis, we’ve seen considerable debate about the role of corporations in society. It has become broadly accepted that corporations — particularly the world’s largest publicly-traded corporations – need to be governed with respect for society and the environment. What is the role of companies in addressing the challenges of the 21st century? And how can their governance contribute to the greater good?
Listed below are a few key principles for creating long-term sustainable value and building resilience in big, publicly-traded companies, as well as some actions that businesses can take to move in the right direction.
1. Define the purpose of the corporation
A company’s purpose determines its ability to recognize, respect and balance stakeholder needs, which are key to its long-term success.
The purpose of the publicly-traded company should be to create sustainable long-term value while contributing to societal well-being and environmental sustainability — not just short-term shareholder value.
Corporations should create real value for customers and wealth for shareholders as joint and mutually-reinforcing objectives, while taking account of environmental sustainability and societal well-being.
What next? Companies can embed a clear statement of purpose and corresponding rights and responsibilities of directors, shareholders, and other stakeholders in governance documents and articles of incorporation.
2. Improve executive pay and employee incentives
Incentives effectively determine the goals of corporate directors and managers. A significant part of top executive pay consists of bonuses, which tend to be set based on short-term performance. This can perversely reward executives who divert corporate resources from investment in innovation or employee well-being to strategies aiming to increase short-term share price.
What next? Ensure that incentive structures and metrics are aligned with a company-specific, long-term value creation strategy that integrates financial and non-financial objectives.
3. Integrate stakeholder voice into decision-making
Businesses ignore the interests of stakeholders other than shareholders at their peril. Stakeholders are crucial to the company’s long-term success; these include employees, creditors, suppliers, customers, local communities and the environment.
A business strategy that profits at their expense can quickly undercut a corporation’s social license. Moreover, the scale and complexity of social, environmental and economic challenges facing our societies require that businesses actively contribute to solving rather than causing them.
What next? Use a corporate form or governance arrangement that provides control or monitoring rights to stakeholders.
4. Clarify the obligations of company directors
Two distinct forms of obligations, called fiduciary duties, are relevant to improving corporate governance:
- Those of corporate directors to promote the success of the corporation, which are owed to the corporation itself.
- Those of institutional investors (such as pension fund trustees) to act in the interest of their beneficiaries.
There is a lot of confusion about the content of these obligations. Company directors and pensions are legally permitted, and in some cases required, to take the environment and human rights into account. Also, there is an obligation to proactively and critically evaluate material financial risks and opportunities — which is increasingly being understood to include climate change, for example.
What next? This one is mostly for regulators. There is a need to clarify the content of fiduciary duties with respect to specific environmental and social issues, e.g. systemic financial stability in the case of banks, the mitigation of environmental impacts for mining companies, and the development of fair and sustainable supply chain models for the garment industry.
5. Improve corporate reporting
The way that businesses report on their activities to investors and other stakeholders can have a huge impact on how observers perceive the corporation. The form of reporting used creates powerful incentives for boards to set targets and the strategies use to hit those targets. Current accounting models focus mainly on short-term financial information and do not address many issues that are essential for businesses’ ability to create sustainable value.
At the same time, investors are increasingly interested in the value creation process and there is a clear trend among successful corporations towards reporting on long-term value creation. This is supported by research that shows that corporations with good ESG performance and reporting outperform their peers on the stock market in the long-term and benefit from lower cost of capital.
What next? Companies can adopt the International Integrated Reporting (IR) Framework to meaningfully report on their value creation strategy, taking into account intangible assets and non-financial capitals.
These recommendations have been taken the ‘Corporate Governance for a Changing World: Report from a Global Roundtable Series,’ which contains further thoughts about next steps for creating inclusive, sustainable and purposeful companies. The report presents an emerging comprehensive approach to corporate governance that can assist corporations to focus on a broad understanding of their purpose, long-term sustainable value, building resilience, and sustaining a strong social license.
This article was originally published in TriplePundit: http://www.triplepundit.com/2016/10/5-steps-stronger-companies/
