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Governance

Governance assesses how a company uses policies and controls to inform business decisions, comply with the law, and meet obligations to stakeholders. Governance failures (for example, aggressive tax avoidance, corruption, excessive executive pay, or relentless lobbying) cause reputational harm and loss of trust.

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Governance
Corporate structure
Lack of board oversight
Empower independent directors
Unjustified remuneration
Introduce executive pay caps or pay ratios
Avoidance of regulatory scrutiny
Ensure proper segregation of duties, especially in compliance departments
Lack of adequate pension provision
Enhance powers for pension trustees
Lack of diversity at board level
Ensure broader representation at board level
Lack of shareholder representation
Introduce transparent share structure with equal voting rights
Share-based incentives
Set remuneration policies based on ESG targets
Risk management
Lack of ESG disclosure
Develop a quantifiable and timebound ESG plan and provide updates on progress
Cybersecurity breaches
Hire a Chief Information Security Officer to implement an effective cybersecurity strategy
Lack of stakeholder engagement
Involve stakeholders in strategic decision making
Lack of employee engagement
Implement employee development programs and hold employee feedback sessions
Corruption and bribery
Political contributions
Introduce a company-wide ban on political contributions
Related party transactions
Conduct an external audit of all related party transactions
Lobbying for unsustainable causes
Introduce a company-wide ban on lobbying for unsustainable causes
Money laundering
Implement employee-friendly whistle-blowing policies
Tax evasion
Introduce clear policies to punish tax evasion
Ethics
Auditor conflicts of interest
Rotate auditors regularly and introduce a ban on hiring auditor for consulting or M&A advice
Anti-competitive behavior
Introduce a ban on unethical competitive practices
Lack of complaint handling system
Implement policies to ensure effective response to complaints
Aggressive tax avoidance
Set up an independent ethics committee to review tax policies
Regulatory non-compliance
Empower the compliance team
Personal data sharing
Introduce robust data privacy policies
Union blocking
Engage with unions

Corporate structure

A corporate structure is typically defined by the company’s founders. This structure is unlikely to change much until a major event, such as a listing or a new tax structure, necessitates change.

Poorly designed corporate structures can cause many problems. Executives can be paid too much and workers too little. The company’s strategy can result in conflict with shareholders or other stakeholders. Regulators may be deceived or obstructed when investigating crimes. Employees may not be able to access the pensions that they have been promised. Minority shareholders may be mistreated and executives may be encouraged to value short-term profits above sustainable, long-term growth—to the detriment of other stakeholders and society as a whole.

Contributing factor Description Impact on the environment Mitigating actions
Lack of board oversight The failure of non-executive directors to adequately challenge the executive decisions made by the board on behalf of the company’s shareholders. Unchallenged CEOs increase the risk of mismanagement. For example, in 2018 and 2019, Boeing’s 737 Max airplane was involved in crashes, killing 346 people. The accidents are now known to have been caused by a software fault. However, further investigations indicated that the board was aware of the software issues for some time. Their failure to act stemmed from the leadership of the former CEO. One way to mitigate this risk is to split the role of chairman and CEO. Another is to empower non-executive directors, giving them the tools to restrain or restructure a poorly performing board.
Unjustified remuneration The practice of paying company executives unreasonably high salaries and bonuses relative to the median worker. In 2020, CEOs were paid 351 times as much as a typical worker. On average, a CEO at one of the top 350 firms in the US was paid $24.2 million on average. If left unchecked, excessive pay differentials between business leaders and ordinary people may contribute to social unrest. Since executive pay is commonly tied to short-term profits—which can be manipulated—one way to make CEO pay ratios fairer is to link compensation to ESG goals. Adopting executive pay ratios is another method.
Avoidance of regulatory security The creation of a corporate structure or corporate culture that makes it difficult for the authorities to properly investigate a company’s activities. Opaque corporate structures can obstruct regulatory scrutiny. For instance, Alibaba’s holding company is registered in the Cayman Islands, listed in the US and Hong Kong, and has over 90% of its operations in China. This allows management to play regulatory arbitrage. Their assets and operations are in legal jurisdictions where the Securities and Exchange Commission (SEC) has no authority to conduct investigations. Implement simple and more transparent corporate structures with full segregation of duties to ensure that all areas of the business can be scrutinized both internally and externally.
Lack of adequate pension provision The failure to ensure that pension commitments to employees are properly funded. Many organizations do not adequately fund their pension schemes. The risk is that if a company fails, its employees may not only lose their jobs but also their pensions. Implement a policy of fully funding employee pension schemes. Giving greater enforcement powers to pension trustees would also help.
Lack of diversity at board level The failure of a board to ensure it receives regular input from people with diverse backgrounds, whether by income, job function, gender, race, age, sexuality, or religion. According to the 2021 Missing Pieces Report, of those holding board seats in the top Fortune 500 companies, 74% were men, of which 62% were white. There is a risk that a lack of diversity at the board level can promote groupthink. Ensure a broader representation of diversity at the board level. Companies that do this are more likely to be in tune with their employee base, a broad range of stakeholders, and society.
Lack of shareholder representation The failure to take account of the views of the majority of shareholders in the running of a company. The shareholder structure of some companies can give too much power to certain groups of shareholders.Dual-class share structures, for example, give one class of shares greater voting rights than others. Meta (previously Facebook) and Alphabet have such structures, which means that the shares held by the founders carry higher voting rights than other shares. This makes the founders less accountable to the owners of the business.Some corporate structures are biased toward foreign investors. For example, Chinese companies listed in the US have a variable interest entity (VIE) structure, whereby foreign investors do not own the underlying operating assets of the Chinese company they are investing in. Instead, those operating assets are owned by Chinese nationals who have no legal obligation to recognize these foreign shareholders as rightful owners. Alibaba and Baidu are two Chinese companies with a VIE structure. The risk is that VIE structures could be ruled illegal, making the shares held by foreign investors worthless. Best practice governance requires clear and transparent shareholder structures where each equity share carries equal voting rights under the law.
Share-based incentives A way of paying the employees, executives, and directors of a company with ownership shares in the business. Share-based incentives typically reward short-term profit-maximizing performance. Over the last three decades, share-based incentives have been on the rise, but poorly set up schemes can cause significant societal damage. One of the causes of the 2007 banking crisis was the short-term profit targets of investment bankers. Many executives were encouraged to take ever-greater risks to generate ever-higher profits. They were awarded share-based incentives based on the profits they generated, while the risks they took were ignored. The result was the biggest financial crisis since the 1930s. Rewrite share incentive plans to align employee actions to ESG targets.

Risk management

Companies that manage risks and mitigate their impact are more likely to remain profitable long into the future. By contrast, poor risk management can expose a business to numerous threats, from natural disasters to financial uncertainties and legal liabilities, which could significantly jeopardize an organization’s future viability.

There are myriad risks that could be included in this governance section. However, we will focus on four risks to the long-term sustainability of a company: the lack of ESG disclosure, cybersecurity breaches, the lack of stakeholder engagement, and the lack of employee engagement. We may add more risks at a later stage.

The table below summarizes how poor risk management processes in these four areas could impact corporate governance and the mitigating actions companies can take.

Contributing factor Description Impact on the environment Mitigating actions
Lack of ESG disclosure This refers to the disclosure of an organization's environmental, social, and governance data to indicate its ESG performance. ESG disclosures indicate ESG performance to employees, stakeholders, andwider society. Disclosing ESG performance helps promote transparency, ensures that companies are held accountable, and enables progress toward ESG goals to be benchmarked. It can also assist investors in their investment decision-making. Develop a quantifiable and timebound ESG plan and provide updates on its progress.
Cybersecurity breaches A security incident resulting in unauthorized access to confidential company data. Cybersecurity breaches pose a threat to the profitability of companies and the safety of their employees and customers, especially if personal data is targeted. Cyberattacks can be driven by a range of motives, including financial gain, extortion, industrial espionage, malice, or activism.The average cost of a cybersecurity breach globally between 2020 and 2021 was estimated to be up to $4.2 million, increasing by 10% from the previous year, according to IBM and the Ponemon Institute’sCost of a Data Breach 2021 report. Many corporate directors lack adequate expertise in cybersecurity. Putting a chief information security officer (CISO) on a company's board ensures greater oversight of information and data security. A CISO would be responsible for implementing an effective cybersecurity strategy.Companies should also invest in security orchestration, automation, and response (SOAR) software that usesartificial intelligence (AI) and automation. This will significantly reduce response times to data breaches and lower average costs.
Lack of stakeholder engagement The inability of an organization to engage stakeholders in its business processes. Stakeholders can include employees and customers, as well as a range of other parties such as non-governmental organizations (NGOs), suppliers, governments, and competitor companies. Sometimes stakeholder interests can conflict with those of a company. Involve stakeholders in strategic decision-making. By engaging all stakeholders early, business leaders can pre-empt conflicts and better manage risk. A good dialogue with stakeholders is key to risk management as it ensures that any conflict between internal and external stakeholders with opposing interests can be reduced.
Lack of employee engagement The failure to involve company employees in decision-making processes and respond to their concerns. Employees are a key factor in the success of a company. Engaging with employees and ensuring their personal and professional development needs are met can help recruit and retain the best talent. Global employee engagement remains low at 20% and is estimated to cost the global economy $8.1 trillion, according to the 2021 Gallup report State of the Workplace. Companies can address their employees’ personal and professional development by creating long-term career development plans and holding consistent employee feedback sessions. Companies are devising novel techniques to increase engagement, from allowing senior leaders to work within the teams they oversee to paying employees to participate in philanthropic activities. According to a 2018 PwC report, Workforce for the Future, 74% of employees are ready to learn new skills or re-train to remain employable in the future.

Corruption and bribery

Corruption can take the form of extortion, fraud, deception, collusion, and money laundering. Bribery is also a form of corruption. The most common form of bribery is kickbacks, which involve payment of a commission in exchange for services. Another widespread form of bribery is facilitation payments, where money is paid to speed up or facilitate routine actions.

Widespread corruption and bribery can hinder social and economic development by diverting scarce resources away from the most economically productive activity.

The table below summarizes how corruption and bribery can impact corporate governance and the mitigating actions that companies can take.

Contributing factor Description Impact on the environment Mitigating actions
Political contributions Monetary contributions made in favor of a political party, directly or indirectly, in a bid to influence policy development. Political contributions that seek to influence policymaking in favor of a small set of vested interests do not serve the interests of society as a whole. Our framework recommends a companywide ban on political contributions.
Related party transactions Transactions between two parties that held a pre-existing connection before the transaction. Though not always illegal, related party transactions are unethical. They can create a perceived conflict of interest that disadvantages stakeholders if they are not conducted at arm’s length terms. For example, an officer of one company may overpay for services supplied by another company which they, or their immediate family, own. One of the ways in which companies can be transparent about related party transactions is through an external audit of all related party transactions.
Lobbying for unsustainable causes Any attempt made by companies to influence a government’s decision-making related to sustainability issues. For example, to relax or even block environmental laws. Businesses lobbying for unsustainable causes can act against the interests of society. For example, according to a 2019 report by InfluenceMap, the five largest oil and gas majors reportedly spend a combined $200 million a year lobbying to delay, control, or block policies to tackle climate change. Although lobbying of this nature is legal, it can seriously hinder sustainable development. Implement a company-wide ban on lobbying for unsustainable causes.
Money laundering The process of retaining, disguising, and concealing the proceeds of crime. Incidents of money laundering undermine the integrity of the banking system and strengthen the hand of criminals. According to the International Monetary Fund (IMF), the amount of money laundered globally in one year is between $800 billion and $2 trillion. Implement employee-friendly whistleblowing policies and anti-money laundering policies throughout the company.
Tax evasion A willful attempt to avoid tax liabilities by under-reporting income, misrepresenting financial records, or not paying the legal amount of tax due. Tax evasion leads to a tax gap, limiting the capacity of governments to fund their socio-economic policies. The tax gap totals around $600 billion annually, which equates to approximately $7 trillion of lost tax revenue over the coming decade. HM Revenue and Customs said that the tax gap was GBP35 billion ($47.6 billion) in the 2019–20 financial year, money that could otherwise have been spent improving public services. Unlike tax avoidance, tax evasion is illegal, so companies caught participating may see individual board directors facing criminal proceedings and possible prison time. Companies who wish to minimize the risk of tax evasion can ensure the proper segregation of duties and introduce clear policies to punish tax evasion. They can also implement employee-friendly whistleblowing policies.

Ethics

In today’s social media-dominated world, companies with unethical practices can fast become the target of consumer and shareholder ire. This can lead to a failure to attract top talent and the loss of business.

The table below summarizes how ethical violations can impact corporate governance and the mitigating actions companies can take.

Contributing factor Description Impact on the environment Mitigating actions
Auditor conflicts of interest The conflict of interest arising when a company’s auditor provides other, often more lucrative, services such as consulting or M&A advisory services. Conflicts of interest could encourage auditors to overlook suspicious accounting, faulty accounting, illegal activity, or unethical practices uncovered during an audit to protect its non-audit revenues. To mitigate the actual risk of auditor conflicts, businesses should rotate auditors every few years. To remove the perception of any conflicts of interest, businesses can ensure that they do not purchase non-audit services—such as management consulting services or M&A advisory services—from their auditor.
Anti-competitive behavior Business practices that restrict competition to boost profits without necessarily offering goods and services at a lower cost or higher quality. Anti-competitive behavior raises customer prices without any corresponding increase in quality, while limiting customer choice. Innovation can be stunted in the process. Supernormal profits are a prima facie indicator of anti-competitive behavior. In 2020 the US Department of Justice filed a lawsuit against Google for violating competition law to preserve its monopoly over internet searches. The claim is that the search giant is illegally protecting its dominant position in search and search advertising through deals with companies like Apple. Fines and prison terms are a deterrent for anti-competitive behavior in many countries. In the UK, a company engaging in anticompetitive practices can be fined up to 10% of its global turnover and sued for damages. Officers of a company involved in cartel activity can be sent to prison for up to five years. Segregation of duties and employee-friendly whistle blowing policies can further mitigate this risk
Lack of complaint handling system The absence of any processes for customers and employees to voice concerns about the company and its products. The lack of adequate complaint handling systems restricts constructive feedback, reducing a company’s ability to respond to its stakeholders’ needs. Generally, companies that deal effectively with complaints perform better than those that do not. Research by the Nottingham School of Economics found that 45% of customers withdrew a negative evaluation of a company after receiving an apology. Implement an effective and independent complaints policy to ensure complaints are handled satisfactorily.
Aggressive tax avoidance The use of legal loopholes to reduce a corporation’s tax bill. Aggressive tax avoidance allows some corporations to legally escape their obligation to pay their fair share of taxes, reducing the government’s ability to fund public services. Set up an independent ethics committee to review tax policies.
Regulatory non-compliance Failure to comply with laws and regulations. Regulatory non-compliance can give a company an unfair competitive advantage and may impose a health and safety risk to employees and customers. Compliance teams must be empowered to ensure regulatory compliance.
Personal data sharing The inappropriate sharing of customer, supplier, and employee data with third-party groups, sometimes in exchange for money. Personal data sharing violates an individual’s right to privacy. If this data falls into the wrong hands, it may also expose those individuals to the risk of theft or physical harm. Companies must ensure they have robust data privacy policies in place.In many countries, data privacy is protected by law, but enforcement by authorities can be weak.
Union blocking Limitations imposed on employees by the employer, banning them from joining or organizing labor unions. Labor unions have played an important role in securing improvements in working conditions and pay. Union blocking denies employees the right to collective bargaining. While union membership is in decline, it remains a fundamental legal right. Therefore, companies must be willing to engage with unions.

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