As a consequence, corporate governance practices and the roleof boards of directors are becoming critically important considerations with social, economic, environmental and political implications. As the body with ultimate responsibility for the governance of the corporation, the board of directors must navigate an increasingly complex and interconnected environment, whether through direct operations or globally connected supply chains. Yet remarkably little attention has been focused on the role of corporate boards in this area. As noted by Professor Robert Eccles (Harvard Business School 2014):
"Until recently there have been two separate worlds. There are experts in the fields of corporate governance, those who focus on compensation and other boardroom issues — and there has been the sustainability universe, which includes investors. Now we are beginning to see a convergence."
by Prof. Rober G. Eccles
What is the biggest barrier to sustainable development? There are many, but I’d like to flag one that I think hasn’t received enough attention so far: boards of directors of companies and asset managers. Too many are only focused on short-term financial performance at the expense of both the organization they represent and our global society and planet. It is a result of a fundamental misperception about what is their “fiduciary duty.” A simple step, however, can be taken to dramatically improve this problem. And it is a simple one-page “Statement of Significant Audiences and Materiality” published every year by a company’s board of directors.
Executives at the world’s biggest companies, as well as those at the largest international asset owners and managers, are recognizing that “sustainability” is something that can no longer be compartmentalized in a specialist department that often has “second-class” citizenship status in the organization. Instead, material environmental, social, and governance (ESG) sustainability issues are increasingly being factored into corporate and investment strategies at the highest level. It is resulting in genuine sustainable strategies, instead of mere sustainability programs that are viewed as side shows to the company’s business. And evidence is mounting that sustainable strategies generate long-term financial returns. These strategies executed at scale by the world’s largest companies and investors will also contribute to planetary benefits, as laid out in the Sustainable Development Goals ratified by the Untied Nations in September 2015, and as committed to in the Paris COP21 climate change accords.
What big companies and big investors do is as important as what most countries can do in creating a more sustainable world. Consider the fact that last year the revenue of Wal-Mart, the world’s largest company, was at $486 billion — greater than the GDP of 86% of the countries in the world. And while there are thousands of asset managers, the top five control 20% of all the world’s assets under management and the top 50 control 60%. Clearly the world’s largest companies and investors can be a tremendous force for good. But are they showing leadership in this regard? Too often, on both the company and investor side, they are not.
A sustainable strategy for a corporation requires long-term focus and rigorous analysis in order to determine the limited number of ESG issues that are material for that company. And “Materiality” is a fundamental but elusive in corporate reporting. In the end, it is entity-specific and based on judgment. It is the responsibility of the company to determine what is material and, I would argue, ultimately it is the responsibility of the company’s board of directors.
Picture: French Foreign Minister and president of the COP21 Laurent Fabius uses a hammer to mark the adoption of the agreement during the final conference at the COP21. (AP Photo/Francois Mori).
Original published on Forbes.com
The basis for this post is a new Harvard Business School Working Paper that expands on the idea of the climate custodians within the unique governance context of the Statement of Significant Audiences and Materiality for subsidiaries of large bank holding companies. Focusing on the Big Three global custody banks — State Street, BNY Mellon, and JPMorgan Chase — we make the case for large custody banks assuming the role of climate custodians for corporations and institutions.
Custody banks provide settlement, safekeeping, and reporting of customers’ marketable securities and cash, enabling liquid securities markets. These banks have no trading decision rights over their customers’ assets, and take direction from clients, regulators, and other claimants. In Q3 2015, three banks — State Street, BNY Mellon, and JPMorgan Chase — held $75.5 trillion in custody assets, which represent nearly two-thirds of tradeable global assets. These Big Three global custody banks are systemically important to the liquidity and safekeeping of the global economy. Both the banks and their largest clients and counterparties (asset managers, pension funds, other non-custody banks, securities trading entities, and large asset owners) are highly regulated.
There is growing recognition by major players in the global political and financial systems — such as The Financial Stability Board’s industry-led disclosure task force on climate-related financial risks, the two big U.S. pension funds of CalPERS and CALSTRS, the “Portfolio Decarbonization Coalition” assembled by the Swedish pension fund AP4 and French asset manager Amundi with committed assets of $600 billion, and the Ceres’ Investor Network on Climate Risk with $13 trillion in assets — that reversing the trend in climate change is key to the long-term survival of mankind. There is also a growing conversation about the role large corporations can play in addressing the perils of climate change and how institutional investors and regulators can support these efforts. We believe that global custody banks are key players that have been missing from the conversation.
by Ann Gregg Skeet
Instead, it’s an unlikely group of people who might agree on how Exxon finds itself at the center of this century’s industry meltdown over research reminiscent of the tobacco industry.
The New York attorney general is investigating two issues regarding Exxon Mobil’s honesty: that the company lied to the public about the risks of climate change or to investors about how those risks would impact future earnings. With both reputational and financial risk exposure, this is big news for the company and also has implications for corporate America.
This story breaks on the heels of public musings by influential leaders, statements that could ultimately encourage corporations to be specific and transparent about which stakeholders are being considered important as executives manage performance and board members govern. This should lead to meaningful changes in corporate reporting and board directors’ job descriptions.
In April, BlackRock CEO and Chairman, Larry Fink wrote a letter to 500 S&P CEOs and leaders of other large companies his firm invests in, and in it he cites a range of trends from activist shareholders to public policy failures as contributors to the short-term, purely financial corporate view of value creation. He writes that corporate leaders should be loyal first not to every investor or trader who owns shares at any moment in time but to the company and its long-term owners. He promises that corporate leaders who pursue strategies for sustainable, long-term growth will receive BlackRock’s support.
In June, Pope Francis’ encyclical on the environment invited readers to open a dialogue, and it was a successful strategy, as people and political parties now debate the full meaning of his message. Is capitalism evil and should technology be set aside in the name of embracing the science of climate change?
No, the Pope instead offers new language to shift us from extreme perspectives and give us something to care about in common-- our home, Earth. In Laudato Si, Pope Francis is reminding us, as St. Ignatius, the founder of his Jesuit order, did before him, that we are all leaders and leadership is not a job but a way of living. We each have not only a stake in the outcome but a responsibility to it.
In September, Robert Eccles and Tim Youmans of Harvard Business School released a working paper on research about “shareholder primacy,” the notion that corporate boards must hold shareholder return as the sole interest they protect. They contend that their global research finds this to be ideology only, not law. They state that a corporation’s objective is to exist and thrive; that shareholders have tradable rights but boards shoulder the burden of ownership; and say “the board must simply decide which audiences are the most significant for the ability of the corporation to create value over the short-, medium- and long-term.”
The paper ends with a call to add a new report to required corporate disclosures, one that identifies the stakeholders the company is holding itself responsible to in pursuing its goals. They would require companies to clearly state if they are managing only for short-term, shareholder return or identify all major stakeholders they consider. A “Statement of Significant Audiences and Materiality” such as the one Eccles and Youmans propose has not appeared on board agendas yet. But I predict it soon will, as well it should.
In his encyclical, Pope Francis reminds us that “caring for eco-systems demands far-sightedness, since no one looking for quick and easy profit is truly interested in their preservation.”
On the need for corporate leaders to embrace such farsightedness to protect the interests of important stakeholders in addition to shareholders, Larry Fink, Pope Francis, HBS scholars, and Exxon Mobil investors can agree. I can too.
Homeowners, after all, usually make better home improvements than renters. As citizens of the earth accept responsibility for our home, so CEOs and boards should act like the owners of the companies they lead.
The theme of this year’s Sustainable Investing Seminar is “Moving into the Mainstream.” What does that mean to you?
Using material environmental, social, and governance (ESG) issues as a potential outperformance driver is becoming more common across asset managers, asset owners and asset classes, although those doing so are still in the distinct minority. Investors are beginning to closely examine “what is sustainable investing” and moving beyond Socially Responsible Investing which is effectively negative screening. As Sustainable Investing, defined as generating consistent returns on a long-term basis, increasingly moves into the mainstream, it will continue to expand globally. I’d even venture to say that within six months, nearly every asset owner and asset manager will claim to have one or more ESG products.
by John C. Wilcox, Chairman, Sodali
For a growing number of listed companies around the world the annual shareholder meeting has come to resemble a trial by ordeal. Instead of the traditional town-meeting business forum, the AGM has morphed into a jousting field where activists, proxy advisors and various special interest groups play a dominant role. This state of affairs has evolved because for the past three decades companies have been resistant to change and defensive about governance reform, while shareholders and activists have taken the lead in successfully promoting greater board accountability and stronger governance rules. Corporate scandals, the financial crisis, escalating CEO pay, declining public trust in business leaders together with enhanced shareholder rights have transformed the annual meeting into an event where companies often focus on damage control rather than showcasing their business.
The challenge for companies is to restore balance to the AGM so that it can fulfill its many important governance, accountability and business functions. To do so, we believe that the focus of the AGM should be shifted away from shareholders and back to the board of directors. The AGM should be a board-centric event that brings control back into the company where it belongs, while giving shareholders what they have always wanted – greater boardroom transparency and director accountability.
The first step toward a board-centric meeting is for companies to acknowledge that the AGM (by which we meanthe entire process of disclosure, communication, proxy solicitation and engagement, as well as the meeting itself) should be treated as a governance event. It should be an occasion for directors to answer the question “How are we doing?” with respect to their long list of duties and responsibilities relating to corporate governance, sustainability and strategic oversight of the business.
The second step is for companies to recognize that as the list of directors’ duties and responsibilities has grown, the list of stakeholders and other audiences whose interests the board must represent has also expanded. The board’s question “How are we doing?” needs to be responsive not only to the electorate of shareholders and investors, but also to the management, employees, suppliers, customers, communities in which the business operates and to future generations affected by the company’s activities over the long term. Renewed attention to the idea of the corporate social compact means that boards should also consider the macro-economic impact and political implications of their decisions.
At the same time that the board’s governance responsibilities and audiences are expanding, a parallel set of related rules and best practice guidelines are raising the bar for institutional investors at the AGM. Legislation and stewardship codes now require asset managers to increase their oversight and engagement with portfolio companies, monitor and evaluate directors diligently and exercise voting rights with the same fiduciary care that governs their investment decisions.
The AGM is the point of convergence for all of these trends.
By Kevin LaCroix
When the U.S. Department of Justice recently announced a renewed emphasis on the prosecution of individual directors and officers in instances of corporate misconduct, it raised the possibility that in the future we could see increased numbers of corporate officials prosecuted and convicted for actions they took as representatives of their company.
There are times when popular sentiment rallies in favor of the prosecution of corporate officials – as, for example, was the case during and after the recent global financial crisis. And while there have been instances in the U.S. where corporate officials have in fact been convicted for criminal misconduct, it has been rare. I suspect that even under the new guidelines it will be only the unusual or egregious cases that will involve criminal prosecutions of individuals.
By Robert G. Eccles and Tim Youmans
We routinely hear board directors, CEOs, and CFOs of publicly-listed corporations refer to shareholders as owners of the corporation. Under this thinking, it is natural to conclude that the board’s duty is to its shareholders. Contrary to this popular belief, however, a board’s real duty is to the interests of the corporation itself.
As one of us responded in a recent interview with John Authers of the Financial Times, “The shareholders don’t actually own the corporation. They own shares in the corporation. The corporation owns itself.”
Clarifying this common misunderstanding about the ownership of modern corporations is a central point of our new paper, Materiality in Corporate Governance: The Statement of Significant Audiences and Materiality. Aiming to improve corporations’ public disclosures, we argue that the board should publish an annual statement in which it identifies the significant audiences for the corporation’s vitality and long-term success. This clearly includes shareholders, but it could include other stakeholders, such as employees. This is simply about transparency in the purpose the board sees for the corporation.
by Robert G. Eccles and Tim Youmans
Many executives across the globe believe that a company’s board of directors has a fiduciary duty to place shareholders’ interests above all others. However, this view of shareholder primacy is an ideology, not the law.
Our research on the board’s fiduciary duty to shareholders clearly demonstrates that the law in many countries rejects the primacy of shareholder interests.
As a separate legal person, a corporation has two basic objectives: To survive and to thrive. Shareholder value is not the objective of the corporation; it is an outcome of the corporation’s activities. While shareholders entrust their stakes in a corporation to the board of directors, shareholders are just one audience among others that the board may consider when making decisions on behalf of the corporation.
These audiences, typically called stakeholders, may also include other financial stakeholders, such as bondholders, and nonfinancial stakeholders, such as employees, customers, suppliers, and NGOs representing various concerns of civil society. In the face of limited resources, no matter how large the corporation, directors must make choices regarding the significance of the corporation’s many audiences.
by Robert G. Eccles, Professor and Tim Youmans
THOSE were the final two sentences in Ann Klee’s article “Ratings Good for the Environment?” published in the May/June issue of The Environmental Forum. Ann is General Electric’s (GE) Vice President, Global Operations – Environment, Health and Safety. She is echoing a theme we hear in our research across many industries, namely that the current state of sustainability reporting is in some ways, “contra-materiality” when the proper meaning of the term “materiality” is understood. In this post we will illustrate this point using the examples of GE and of the Dow Jones Sustainability Index (DJSI).
Various stakeholder groups who wish to encourage sustainability are mounting calls for corporations to take into account sustainable development while still adhering to their legal duties to shareholders. This is putting front and center the question of fiduciary duty: what is it and to whom is it owed. In the United States, for directors and the lawyers who advise them, fiduciary duty means putting the interests of shareholders and the corporation first. How a board defines and balances the often-competing interests among various shareholders and the corporation itself is a core part of the fiduciary duty discussion.
It is clear that US directors must address matters that impact the long-term value of a company. In an increasingly connected and globalized economy, companies are vulnerable to and threatened by diminution of value based on both an increasingly resource-constrained world and a company’s impacts on stakeholders. Indeed, the extent to which directors must take action to understand and address these vulnerabilities is central to the discussion on how directors fulfill their fiduciary duty to protect shareholder and corporate value. The September 2015 adoption of the United Nations’ Sustainable Development Goals in the document “Transforming our world: the 2030 Agenda for Sustainable Development” further heightens the importance of attention on this key issue.
Careful legal analyses of fiduciary duty and to whom that duty is owed have been prepared by law firms all over the world and are posted on this website. We hope that these memoranda below will inform and enrich discussion among directors, and the lawyers who counsel them, about how changing circumstances near and far affect their ability to meet fiduciary duty requirements. Prof. Robert G. Eccles and Tim Youmans of Harvard Business School led a collaboration of The UN Global Compact and the American Bar Association’s Task Force on Sustainable Development to gather these legal perspectives from law firms in a wide range of countries, posted here. Our goal is to have these perspectives from all G20 countries and significant others. We also welcome offers from law firms in countries for which we do not have this document to participate in this in process.
In addition to the leadership shown by the ABA Task Force and the UN Global Compact, we are grateful to Linklaters in the United Kingdom for working with us to develop the research questionnaire template, and to Matthos Filho in Brazil, the first firm to produce a legal memos based on the Linklaters’ template. These legal memos are posted below with the permission of these firms. We thank all of them for their excellent pro bono support. Without them, this database would not exist. We believe this collection of memoranda on the legal and regulatory framework underpinning corporate directors’ fiduciary duty will be valuable to practitioners ranging from boards to law firms to management teams to investors, as well as to academics who want to study patterns in fiduciary duty and corporate reporting all over the world.