When it comes to environmental, social, and governance (ESG) issues, it is easy to conclude that the “E” and “S” receive the lion’s share of attention. A Morningstar Sustainalytics survey of more than 500 CSR and sustainability professionals found that 46% of respondents rated corporate governance as the least important aspect of their ESG efforts. But while environmental and social issues may grab media attention, it is good governance that serves as the solid foundation necessary for companies to build an effective ESG strategy.
The connection between good governance practices and strong performance has been well documented. Researchers have been compiling data on governance practices and their impact on corporate performance for a long time. As a result, there is an abundance of data demonstrating that good corporate governance is linked to a firm’s value.1 In this blog, we take a deeper look at corporate governance, its role in developing strong ESG programs, metrics companies can use to measure their governance performance, and approaches to governance management from three industries.
The Role of Good Governance in ESG
In simple terms, corporate governance is the set of rules, practices, and processes that determine how a company is operated and controlled. Its main aim is to ensure that the company acts in an open and accountable manner, and that its leadership acts in the best interests of stakeholders. Corporate governance encompasses virtually every aspect of management, making its risks material to all companies, regardless of the industry.
With recognition that a company’s board of directors, shareholders, management, and employees have certain rights, good corporate governance policies incorporate measures to ensure those rights are protected. These measures may include processes for selecting and evaluating board members, establishing committees for auditing, and implementing codes of conduct and ethics. If implemented correctly, corporate governance aligns the interests of directors, shareholders, management, and employees and builds trust with investors, the community, and public officials.
Additionally, a company’s governance structures form the foundation of its ESG programs and the scaffolding on which policies addressing environmental and social issues are built. Numerous studies have shown that organizations that prioritize and implement best governance practices tend to perform better financially and attract more investors. For example, firms with better corporate governance processes and procedures tend to achieve organizational objectives and goals more consistently than those without.2 Conversely, poor corporate governance can undermine a company’s integrity, reliability, ability to raise capital, and hinder its ESG ambitions.
More generally, corporate governance is considered by analysts to be a significant variable influencing the growth prospects of an economy because best governance practices can reduce risk for investors and improve financial performance.
Measuring What Matters: Metrics for Corporate Governance
The complexity and variability of metrics can make it difficult for companies to understand their governance performance. Corporate governance metrics can include both qualitative and quantitative data. Before you can measure any aspect of your company’s governance performance, you must first adopt a methodology to define what aspects you will measure. Sustainalytics’ methodology for analyzing corporate governance performance is divided into six pillars, summarized in Table 1 below.
Table 1. Metrics for Corporate Governance: Six Key Pillars
Board and Management Quality and Integrity
The experience, track record and actions of a company’s board should reflect its ability to provide strategic leadership and oversight.
The board’s structure should allow for sufficient oversight, representation, and accountability to its shareholders.
Ownership and Shareholder Rights
A company’s constitution and ownership structure should respect outside shareholders’ rights as they would for the board, management, and major holders.
A company’s remuneration policies and practices should incentivize management to build value.
Auditing and Financial Reporting
A company’s financial reports should be reliable and subject to necessary oversight.
A company’s decision-making should reflect the needs and expectations of all stakeholders, including customers, workers, suppliers, communities, and investors.
While the specific quantitative and qualitative data and key performance indicators each company uses will be tailored to its business context, they will broadly fall into these categories.
Corporate Governance in Practice: Taking a Bird’s Eye View of Banks, Airlines and Mining
Although corporate governance is material to every public company, each industry (and their respective subindustries) faces unique demands and challenges across the six pillars outlined above. Each company will have to analyze the demands of its subindustry to determine which metrics it should prioritize. Diversified banks, airlines, and mining companies, for example, all face a different set of corporate governance challenges.
Diversified Banks: The Importance of Good Governance for the Financial System
Proper corporate governance of diversified banks, for example, is especially important given their essential role in our financial systems. Diversified banks are the most significant providers of credit, making their sound operations imperative to maintain financial stability. Poor oversight of banks’ corporate governance practices can create a snowball effect with the potential to disrupt the entire economy. Maintaining board integrity and being transparent with auditing and financial reporting is imperative for banks to build trust. Airlines, on the other hand, face a different set of challenges.
Airlines: A High Stakes Subindustry Demands Strong Leadership
Due to the significant carbon footprint of the airline industry, companies need to have a strong environmental policy with oversight from senior management. Additionally, the airline industry is known for its volatility, making sound leadership even more important. Due to the wide range of stakeholders airlines engage with – including governments, investors, and travellers – strong stakeholder governance is of particular concern for the industry. The diversified metals mining subindustry faces yet a different set of corporate governance priorities.
Diversified Metals Mining: Corporate Governance in a Complex Environment
Given the complexity of the environment in which mining companies operate, difficult decisions are a part of the job. This makes it imperative that a mining company’s board act in a responsible manner when weighing those decisions against strategic objectives. In an industry with a reputation for corruption, transparency is especially important. Furthermore, proper corporate governance at mining companies is vital as they play an essential role in supporting the global energy transition.
As demonstrated in these examples, effective corporate governance is crucial for the success of any public company, but it must be tailored to the unique demands of each subindustry. By recognizing and prioritizing the six pillars of corporate governance for their subindustry, companies can steer their course towards sustained success and responsible growth.
Interested in learning more about managing ESG performance and metrics? Read our guide, Managing ESG Performance: A Practical Guide for Corporate Governance, Business Ethics and Human Capital or get in touch with our team to learn more about Sustainalytics’ Corporate Solutions.
1 Giorgion, M., Monda, B. 2023. “Corporate Governance and Shareholder Value in Listed Firms: An Empirical Analysis of Five Countries (France, Italy, Japan, UK, USA). SSRN. March 3, 2023. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=22271842 Abebe, A.A, Bezabih, S.W., Zelalem, B.A. 2022. “Corporate governance and financial performance in the emerging economy: The case of Ethiopian insurance companies.” Cogent Economics & Finance. September 4th, 2022. https://www.tandfonline.com/doi/full/10.1080/23322039.2022.2117117
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