iQ 360’s Interview Series asks leaders in our network to share their experiences, expertise and insights on the future of their industry.
Environmental, Social, and Governance (ESG) standards are increasingly applied in corporate settings to evaluate entities and identify liabilities. As a result, these non-financial factors are becoming a standard part of material risk and growth opportunity analysis. Corporate Governance also provides the ethical structure for setting objectives and evaluating progress.
Dr. Demir Yener is a senior lecturer at Johns Hopkins University’s Carey School of Business. Having previously worked for the World Bank, he is a financial economist who draws on a broad base of global expertise as an academic and practitioner. His motto is, “What gets measured gets done.” He shared his insights on Corporate Governance and ESG with iQ 360.
Is Governance as important as the S and E factors in ESG?
Without effective Corporate Governance, the E and S factors in ESG cannot be implemented, nor can they be measured. We must have well-established Corporate Governance standards and procedures and clearly defined responsibilities and accountabilities used by stakeholders to overcome the conflicts of interest inherent to the corporate form. In other words, precautions and measures that make the environment inhospitable to corruption. And these standards must be adopted and implemented broadly, with leadership publicly buying in 100%.
Why is good corporate governance important to investors and other stakeholders?
Poor corporate governance practices resulted in several high-profile accounting scandals and corporate bankruptcies over the past several decades and are cited as a significant contributor to the 2008–2009 global financial crisis.
Problems that cause corporate failures include a lack of proper oversight by the board of directors, inadequate protection for minority shareholders, and negative incentives at companies that promote excessive risk-taking. So, it’s only natural that investors care about Governance when making investments.
McKinsey surveyed the largest global investors in 2001 and found that the ‘governance’ premium, the additional value derived from a company that embraces an ethical framework, varied from 17% to 27% on top of return on equity (ROE) depending on the country. The extent to which a company can draw upon these benefits will depend on how corporate governance is implemented. For example, little benefit can be expected if corporate governance is viewed as a minimum legal requirement, particularly in an emerging country. Only those companies that truly and holistically implement corporate governance, and are publicly recognized as such, can expect to reap the potential benefits of corporate governance.
There are four primary advantages that good corporate governance can bring to the company.
- Better access to outside capital
- A lower cost of capital (because transparency reduces firm-related risks for the investors)
- Improved operational efficiency and performance
- Better company reputation
Studies also show that good corporate governance significantly enhances the firm’s market value.
Good corporate governance also provides more immediate benefits such as:
- Effective management
- Improved technical and operational performance
- Increased production
- Growth in the financial viability of companies
All these benefits result in better access to finance and greater employee retention rates.
What do you say about the ESG backlash being voiced by certain groups? Does ESG have staying power?
Logically this backlash makes no sense to me. ESG is essentially taking corporate social responsibility (CSR) and turning it into something very practical and measurable. ESG isn’t socialist. Instead, it’s very much a capitalistic concept. It reduces the research burden on investors, and it reduces investment risk. I am confident that the investment world, by and large, will continue to better understand the role of Corporate Governance within the ESG context. As a result, there will be a greater commitment to developing corporate governance initiatives, which will help sidestep risk, preserve value, and maximize investor wealth.
“Fed rate hikes have driven up the cost of borrowing, making ESG compliance imperative for businesses needing favorable investments.”
What are the most important measures of good governance?
There are four essential measures of corporate governance:
- TRANSPARENCY. Ensuring timely and accurate information is available.
- ACCOUNTABILITY. Ensuring the CEO is accountable to the board of directors and the board is accountable to the shareholders.
- RESPONSIBILITY. Encouraging cooperation between the company and stakeholders.
- FAIR TREATMENT. Protecting shareholder rights and treating all shareholders equitably.
Can you discuss the interplay between Corporate Governance and the financial system?
In response to company failures, especially during the financial crises, regulations have been introduced to promote more robust governance practices and protect financial markets and investors.
Academics, policymakers, and other groups have published numerous studies discussing the benefits of good Corporate Governance and identifying core corporate governance principles that are believed to be essential to ensuring sound capital markets and the stability of the financial system.
Can you share your thoughts on corporate governance standards and adherence?
ESG metrics have their roots in investment screening strategies such as Socially Responsible Investing (SRI). However, the evolution has steered away from somewhat arbitrary criteria to a more substantive and thoughtful approach that considers the inherent value in companies.
Currently, ESG metrics are not commonly part of mandatory financial reporting, though companies increasingly make disclosures in their annual report or as standalone sustainability reports. Sustainable Accounting Standards Board (SASB), the Global Reporting Initiative (GRI), and The Global Disclosure System (CDP) are working to form standards and define materiality to facilitate the incorporation of these factors into the governance process.
The OECD Corporate Governance Standards of 2015 are increasingly being adopted by various jurisdictions in the world and include:
- The Basis for Effective CG Framework
- The Rights and Equitable Treatment of All Shareholders
- Institutional investors, Markets and Intermediaries
- The role of stakeholders
- Disclosure and transparency
- The responsibilities of the board
Should we think of corporate governance as a global structure? Or is it more realistic to approach it on a regional basis?
There is an increasing tendency in the investments field to work towards a global set of norms on Corporate Governance. These norms will serve as a universal structure that guides all jurisdictions. Global integration for corporate governance is critical because it ensures standard measurements across countries, creating a level playing field in international trade and a way to discipline the excesses of partially privatized state enterprises.
Corporate reform programs will pressure the managers of all firms to maximize shareholder value, which in turn discourages so-called profitless growth and other distortions that fuel many trade disputes. Moreover, governance convergence eliminates these trade disputes more or less automatically through market discipline rather than politically motivated bureaucratic intervention or international negotiations.
The fight against corruption starts at the top with a clear commitment from leadership to the culture of integrity and the fundamentals of good corporate governance: fairness, accountability, transparency, and responsibility. Boards of directors must set the course accordingly. The principles of corporate governance and business ethics can only be effective if they are translated into daily operations and internalized by employees at all levels.
Businesses, civil society, and governments must work together to devise and implement solutions that benefit all significantly. So long as strong corporate governance structures are in place and effective in companies, agency conflicts among other stakeholders are mitigated as well.