How to measure & improve your governance performance for ESG
How to measure & improve your governance performance for ESG
Corporate governance frequently enters the public eye only after a scandal, mismanagement, or a toxic work environment. We have witnessed many recent governance problems ranging from the individual company to the national economy. The FTC fined Facebook $5 billion for their mishandling of data in the Cambridge Analytica scandal. At a systemic scale, the Black Lives Matter movement has shown the large disparity in corporate leadership, where only four CEOs of Fortune 500 companies are black.
Governance, however, entails more than crisis management. Investors and corporations more widely accept governance data as an indicator of financial performance compared to environmental or social data because of its extent and quality. Researchers have tracked and compiled corporate governance data for a long time. This research helps develop standards and metrics that identify good or poor governance. The investment specialist RobecoSAM created one such governance metric called the economic dimension score (EDS) that many investors use when tracking ESG.
The EDS evaluates eight specific criteria that influence a corporation’s governance and management performance. Good governance entails implementing the following practices for each of the eight criteria:
1. Corporate governance
The EDS corporate governance criteria measure how well a company addresses the interests of its shareholders. The structure, effectiveness, and diversity of a company’s board largely factors into this criteria score.
Achieving a well-functioning board requires a search and nominating process that eliminates bias. Bentley University found that most Fortune 500 companies select directors from an imbalanced diversity pool. In the study, sitting or retired CEOs or CFOs made up 73% of new director selections. Only 5% of Fortune 500 CEOs are women and four CEOs are black. Your company should develop a formal board search and nominating committee to avoid further perpetuating this disparity in board membership. This committee can cast a wider candidate pool that includes leaders in both your sector and related sectors such as law, academia, and philanthropy.
You should also look to give your shareholders more authority in key decisions such as executive compensation. Companies have historically increased value and profits by disclosing more information to shareholders and stakeholders and increasing the rights and ownership of these groups. Examples of these actions include disclosing CEO-to-median employee pay and scheduling more proxy votes. Companies that lack this board oversight of CEOs and other senior executives risk significant business disruptions. WeWork, for example, put its initial public offering on hold due to flaws in the company’s corporate governance structure.
2. Codes of business conduct
Good governance develops publicly accessible, easy to read, and comprehensive codes of business conduct. Codes of business conduct elaborate on a company’s ethics and how leadership and staff should act on a day-to-day basis. Typically these codes discuss corporate policies for anti-bribery and corruption, human resources, and intellectual property. I-Sight compiled a list of 18 best code of conducts that may help with developing your code of business conduct.
3. Risk & management crisis
The EDS considers more metrics to evaluate corporate governance performance compared to traditional governance scores. Most traditional governance scores, for example, would leave out risk and crisis management. The EDS includes risk management because it provides investors with powerful data regarding your company’s short- and long-term performance.
The ESG data firm MSCI compiled one such powerful data set by studying how its ESG Rating scores linked to company profitability and risk. MSCI tracked two types of risks in this study. First, idiosyncratic risk, which measures the internal factors that can lead to unanticipated costs such as staff accidents and injuries. Second, systematic risk, which tracks how activity of the overall financial system or market impacts a company’s future performance.
The MSCI study found that companies with an aggregate ESG score in the highest-rated quintile exhibited higher profitability, lower idiosyncratic risk, and lower systematic risk in the span of a year. Good governance significantly contributed to these positive results according to MSCI. The MSCI aggregate ESG score encompasses pillar scores for E, S and G. Of the three, MSCI found that the G score most impacted the results for the three financial factors in the short-term. The E and S scores become more relevant for measuring long term profitability and risk. Meanwhile, the G score maintains its relevancy in these long-term financial measurements.
4. Supply chain management
The actions of your company’s suppliers reflect and shape your reputation with investors, employees, and customers. Good governance ensures suppliers adhere to your codes of business conduct, share your values, and avoid human rights, environmental, and corruption violations. ESG transparency throughout your supply chain or assets will improve your governance performance. The apparel company Patagonia, for example, employs its Footprint Chronicles to share with stakeholders the vendor operations, raw materials, and workers used to make Patagonia products. Patagonia can track these metrics by setting key performance indicators (KPIs) and goals that best align with their values.
5. Tax strategy
Very related to risk and crisis management, the EDS tax strategy category follows the ability of companies to avoid tax issues and extra-financial risks associated with its tax practices. Components of a strong corporate tax strategy include:
- A tax risk statement
- Board oversight of tax risk
- Adequate staffing of tax operations and risk management
- Disclosure of tax risks
Governance best creates long-term value from ESG by linking these practices to the bottom line. Engaging stakeholders in materiality assessments identifies the ESG practices most material to your business and performance. To develop your own materiality assessment, download GRI’s Defining What Matters guide.
7. Policy influence
2020 has seen many boycotts and protests of companies that lobby for policies or support advocacy organizations with stances that contradict the Black Lives Matter movement. The public will likely continue demanding improved social and environmental action from Wall Street and businesses. To meet or exceed the RobecoSAM policy influence criteria, avoid contributions to causes that contradict ESG and sustainable action.
8. Impact measurement & valuation
Businesses can’t work on items that they don’t measure. ESG has developed many metrics to track social and environmental progress and link that progress to long-term valuation. Standards such as GRESB and SASB make it easy to incorporate these metrics into your KPIs and other governance valuations.
Start improving your governance practices now
The eight criteria in the RobecoSAM EDS score reflect the far-reaching impacts of governance better than many traditional governance scores. Please note the EDS score isn’t the only option to improve and track your company’s governance data. ESG reporting standards of GRESB, SASB, and GRI sufficiently incorporate the eight EDS criteria into their ratings and reports. Goby’s team of experienced ESG specialists can help extract the most important governance data for these standards and identify best opportunities to improve your company’s governance.