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How Corporate Governance Affects Corporate Sustainability and Why It Matters

The Huffington Post The Huffington Post 7/10/2015 Alliance for Research on Corporate Sustainability

By Judith Walls and Pascual Berrone
Most often, corporate governance is thought of as a mechanism put in place to protect shareholder wealth from the claws of opportunistic managers. In this sense, the term corporate governance typically arises alongside phrases such as investor myopia, short-term goals, incentive alignment, financial crisis, and even corporate misconduct and accounting fraud.
Nevertheless, corporate governance is increasingly applied to an extended form of monitoring corporate activities that include the impact on society and the natural environment. This additional agenda that companies take on--often in response to demands from stakeholders--can create tension and conflicting priorities among the traditional roles of shareholders, boards of directors, and chief executives as it asks them to shoulder corporate responsibilities in new ways.
For example, over the last decade, shareholders have actively taken a stance on corporate issues such as labor rights, destruction of rainforests and other habitat, sustainable supply chain management, and reporting on social and environmental measures. In response, companies have designed environmental and social policies, implemented sustainability management systems, and put structures in place to monitor these issues up to the level of the board. Corporate leaders, too, have begun to shape visions that integrate sustainability into the strategic directions of companies.
The shift in priorities at shareholder, board, and managerial levels arises as a result of the differences in time horizon and expectations of relatively short-term tenures of CEOs against the long-term consequences of their decisions. While stakeholders such as the general public and the natural environment may seek to hold companies accountable for outcomes that may happen at some point in the distant future, companies and their leaders are regularly judged at a quarterly or annual basis. This divergence in temporal perspective has important implications for the role of corporate governance in monitoring a company's triple bottom line (economic, environmental, and social outcomes). These differences in how shareholders, boards, and executives behave when it comes to the triple bottom line, compared to their classic roles defined according to agency theory with a focus on financial outcomes, are evident from recent research.
Shareholder activism benefits corporate sustainability, but blockholders constrain firms' efforts
Companies are more likely to face activism from shareholders when their environmental record is poor. This can threaten firms' legitimacy because shareholders are the most salient stakeholder a company has, and the issues they raise are therefore urgent. New research suggests that companies can, however, resolve such issues behind closed doors rather than in the public eye by engaging these stakeholders in dialogue, which results in proxy proposals being dropped from annual general meeting agendas.
A confounding effect of shareholders is in the form of shareholder concentration. Typically, concentrated share ownership is thought to be more effective at disciplining companies, because such blockholders have substantial influence over the company's strategic direction. In the case of environmental sustainability, however, shareholder concentration appears to have a negative effect on companies' proactiveness in sustainability. It may be that blockholders constrain a firm's strategic flexibility to pursue longer term goals in favor of financial ones.

Independent and experienced boards are valuable
At the level of the board, similar conflicting effects exist. In Anglo-Saxon models of corporate governance, board independence is believed to be beneficial for financial performance. However, in our research, board independence was negatively associated with environmental performance. Perhaps companies that perform better environmentally benefit from having insider board members, whose knowledge of the company's operations and competencies is better suited to driving environmental sustainability. Similarly, a diverse board seems to alleviate the number of environmental concerns companies have.

Also important are board members who have relevant experience in dealing with sustainability issues. This expertise can be based on past job roles, past membership on dedicated corporate CSR board committees, or exposure to sustainability through participation in non-profit and other community organizations. Companies with more environmentally experienced boards are able to engage in sustainability well above-and-beyond that of their peers, particularly if their companies are less centrally located in the network of corporations generally.
Dedicated board CSR committees signal both 'good' and 'bad' environmental performance
Some boards have dedicated sub-committees to deal with social and environmental issues. The presence of these committees, however, does not guarantee that companies have 'good' environmental performance. Our research suggests, instead, that such committees may be set up by 'bad' environmental performers as a response to pressure companies face from stakeholders to do more about their environmental sustainability. On the flip side, companies with strong environmental performance are similarly more likely to have dedicated CSR committees which suggest that proactive companies dedicate expert resources to the issue of sustainability. What remains unknown is whether setting up a CSR committee at poorly performing companies has a snowballing effect. It may be that once a dedicated board committee is set up, attention is brought to the issue of sustainability and agendas are developed, allowing companies to begin a process of improvement.

Companies reward CEOs for environmental performance

Incentive alignments for chief executives are critical in managing the agency gap between owners and managers of the firm. But, for sustainability outcomes, their role has different effects. For instance, CEOs with higher salaries are associated with companies that display more environmental concerns. However, companies with better environmental performance actually pay their CEOs more. By contrast, companies with explicitly designed environmental pay policies do not reward their CEOs more than others, suggesting that such policies play a symbolic role.
CEOs with MBAs and more personal power are able to do more
Interestingly, when CEOs have a strong educational foundation in spotting business opportunities, in the form of an MBA, they are more likely to be open about environmental disclosure than CEOs with other educational backgrounds such as law degrees. Our latest research also shows that CEOs with more power actually do better in driving their companies towards sustainable outcomes, particularly if the source of that power is rooted in expertise on sustainability issues, or when companies face strong pressure from activist shareholders.
Family-owned firms are more proactive
Finally, firms that have less of an agency gap, as a result of being managed and owned by families, perform better environmentally than their counterparts. This is true even when the CEO is not a family member, or when the CEO holds a dual position as board chair. Our research shows that family owners' ultimate goals may go beyond that of optimizing financial wealth. Instead family owners seem to care about a broader set of goals which the top manager closely identifies with, such as maintaining family bonds to the firm through dynastic succession. This, in turn, make family firms more likely to adopt strategies that pose short-term risks and require significant upfront costs but have the potential for long-term benefits, such as sustainability.
Amidst this growing body of academic research, it has been suggested that we need to look more closely at how these different mechanisms--shareholders, boards, and managers--work together to affect sustainability outcomes. As these corporate sustainability initiatives become more embedded, we may have to rethink the role of corporate governance mechanisms to monitor all aspects of firm behavior that affect society at large.

Judith Walls is Assistant Professor of Strategy Management and Organization; Nanyang Business School, NTU Singapore
Pascual Berrone is Associate Professor of Strategic Management at IESE Business School, Barcelona, Spain and Holder of the Schneider-Electric Chair of Sustainability and Business Strategy

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