What is Governance in ESG?
Governance describes how a company is controlled and directed. It includes all the rules, policies, and systems the organization has in place to dictate corporate behaviour. Risk management, ethics, compliance, and board management practices are all part of corporate governance.
Why is Corporate Governance important in ESG?
When governance is effective, your organization should be able to see to it that everyone follows ethical and transparent decision-making processes. Strong governance not only prevents fraud and abuse but also ensures that corporate leaders act in the best interest of customers, employees, and shareholders — which brings us back to ESG.
Why do investors care about governance?
Investors care about the ‘G’ in ESG because it protects their interests. Strong governance practices have a direct impact on shareholder returns. Research published in The Journal of Finance showed that adopting just one governance proposal increases shareholder value by 2.8%.
Transparent management has also been linked to increased employee engagement — meaning that if employees trust their leaders, they will work harder for them. This is key to achieving the company’s mission, vision, and values.
What are some examples of governance issues?
Governance is a sweeping term that touches on all aspects of an organization’s operations. Some of the most common examples of governance issues shareholders are interested in include:
Executive compensation
Executive compensation deals with how (and how much) executives are paid. This includes benefits like salaries, bonuses, benefits, equity, and so on. Executive compensation is an important ESG issue for investors and shareholders because high pay can help attract and retain the best leadership.
What’s more, the way this pay is structured can incentivize executives to make decisions that benefit shareholders — for example, by making executive pay dependent on the company’s performance.
Investors are also interested in a firm’s CEO-to-employee pay ratio. If the gap in compensation between executives and their employees is too big, this can be an indicator of inequality.
The Institute of Policy Studies found that the wage gap between CEOs and workers is widening, with the average executive making 670 times as much as their employees. Meanwhile, inflation is growing and employee pay is down. Investors, however, are pushing back on this trend.
Board diversity, equity, and inclusion (DE&I)
Shareholders also want to see that the board reflects the diversity of the organization’s customer base and that boards incorporate equity and inclusion into the way they govern.
Are women, people of colour, individuals with disabilities, and other minority groups represented on the board? Are their opinions welcomed and respected? Are efforts made to challenge discrimination? These are all important issues for ESG investors.
Despite efforts to increase diversity, corporate boards are still overwhelmingly white and male. According to Deloitte’s Board Diversity Census, more than 8 in 10 Fortune 500 board seats are held by white individuals, even though they represent only 60% of the population. Meanwhile, just 26.5% of seats on Fortune 500 boards are held by women.
Perhaps ironically, the same research also found that “women and minority board members currently are more likely than white men to bring experience with corporate sustainability and socially responsible investing.”
But companies are facing a reckoning. In 2021, Citigroup, Johnson & Johnson, JPMorgan, and Nike all faced (and fought) shareholder proposals concerning diversity, equity, and inclusion. The SEC sided with investors in all cases, empowering shareholders to drive ESG issues forward.
Compliance
Compliance also falls under the governance umbrella. It refers to how your organization ensures that it meets all applicable laws and regulations, as well as its company policies.
Compliance extends to many areas including environmental regulations, labour laws, OSHA, the SEC, financial regulations, customer data privacy, and more. Risk management, internal controls, audits and inspections, and corrective actions are all part of compliance.
Compliance is a key issue for investors because running afoul of laws can result in fines, penalties, and loss of reputation which can ultimately hurt stock performance.
Deloitte Centre for Financial Services found that companies that maintain a best-in-class compliance program financially outperform those that do not. And, as Former Deloitte LLP Board Chair Sharon Allen put it, “Once a reputation is lost, no amount of money can buy it back.”
For proof, look no further than Facebook, which was fined $5 billion by the FTC for deceiving billions of users about their ability to control how their personal information is shared. Facebook’s reputation suffered tremendous damage, with users calling for a boycott of the platform.
EHS governance responsibilities
As an EHS professional, not all these issues will fall under your purview. EHS professionals do not have much say in how their company’s executives are paid, or who is appointed to their boards. However, some governance issues are the direct responsibility of or are supported by, the EHS function. These include:
- Ensuring compliance with workplace safety and environmental regulations
- Developing and enforcing internal EHS policies
- Managing EHS risk and implementing appropriate risk controls
- Performing or overseeing audits and inspections
- Setting EHS performance expectations and communicating progress to executives and board members, customers, and shareholders
Final thoughts
Along with social and environmental issues, governance has become a critical issue for investors and, in turn, for companies. Today, governance is a key element of non-financial reporting. Companies are expected to disclose information on issues like their executives’ compensation, the makeup of their boards, and their compliance efforts — among other things.
Understanding why these issues matter to investors and what information they are looking for is key to developing better, more relevant ESG data collection and reporting practices.
