The trickle-down effect of good governance as part of ESG

By Cuma Dube, Senior Consultant, Mazars – Mazars Advisory (Pty) Ltd.

Currently, there’s no global mandated framework for how companies report ESG (Environmental, Social and Governance) progress, so it’s an optimal time to assess ESG progress and potential. Companies that move on ESG efforts now can start to tell their story to investors, employees and communities, engendering goodwill and paving the way for future opportunities.

A global trickle-down impact is imminent. By the end of 2021, the U.S. Securities and Exchange Commission is expected to introduce mandatory ESG reporting requirements for public companies. These requirements will inevitably influence stakeholder expectations for private companies. The EU is already implementing mandatory regulatory reporting requirements. Businesses will be required to report their carbon footprint, diversity numbers and verify progress by third-party assurance.

Consequently, early adopters in ESG can gain a competitive advantage to win contracts. They could also attract new investors who see the potential of a company that is rooted in balancing people, purpose and profit and meets accepted standards for doing so.

Additionally, as a record number of younger people change jobs and seek purpose-driven careers, companies without a plan to respond to stakeholder concerns could find themselves facing serious labour shortages and business disruptions.

Younger generations in the workforce truly care about ESG issues and want to work for companies taking meaningful social and environmental action. Strengthening a commitment to ESG can solidify a company’s culture and improve recruitment and retention, as ESG goals pivot around a shared purpose of greater good. 

Companies will face challenges finding and retaining innovative managers who can help improve processes and efficiencies and who care deeply about making progress on ESG initiatives. Making a decision to address diversity, equality and inclusion issues within an organisation now will bring new perspectives into a business and will set it up for success by fostering a more equitable workplace.

The King Codes of which The King IV Report on Corporate Governance for South Africa, 2016 (King IV™) is the latest iteration, sets out ‘voluntary principles and leading/recommended practices’ as guidelines to promote good corporate governance across all kinds of organisations in South Africa.

Good governance in respect of ESG necessitates that governance teams consider any factor that may materially affect the sustainable long-term performance of the business. The King IV principles promote the notion of the responsible corporate citizen. The integration of ESG into corporate decision-making provides a structured approach to good governance.

Corporate governance—the ‘G’ in ESG—often gets the least attention, but it’s difficult to achieve the ‘E’ and the ‘S’ without the ‘G’ which effectively provides a base for the other two.

What’s good about governance?

Without Governance it is difficult to measure performance against Environmental and Social issues or establish accountability regarding them. Good governance creates an enabling environment for employees to play their roles more effectively. Companies with good governance practices aim to operate in a fair and ethical way, addressing issues around pay, including executive compensation, minimum wage and pay equality.

Especially in South Africa, there is a common misperception that the King Codes solve everything relating to governance, and management consequently about issue categories (like some of the above). A good governance structure has to take into account every issue that affects the long-term sustainability of the business and is material to the business. At the issue level it has to address whether a company has clear policies in place, and whether it has the necessary skills at board and management levels.

Well governed companies have a clear balance of power. They are overseen by independent and diverse boards of directors. These boards work to uphold the rights of the company’s shareholders, and they seek to help the firm’s managers identify potential risks and opportunities.

Here are a few examples of how governance can be used to make a difference:

• Greater diversity: Studies suggest that companies with employees from more diverse backgrounds have better performance, especially at board level. A lot of the blind spots we see in leadership can be avoided. Representation creates a sense of ownership by business teams and ensures appropriate policies are created.
• Ethical business practices: These companies usually have policies in place to prevent bribery and avoid corruption, often not just internally but throughout their supply chain. There are cases where famous brands are negatively impacted because they did have full sight of their global supply chain and unbeknownst to them one or more of their suppliers were not aligned to their business principles. Consumers are a lot more aware today of such issues and these affect their buying choices, so severe reputational damage can occur.  
• Transparency on pay: Since excessive CEO pay comes right out of a company’s bottom line, it has been connected to future company performance, while the growing pay gap is also an issue for many stakeholders. To highlight potential reputational issues around pay scales, there needs to be transparency. This exists in the public company space, though much less so with private companies.  It has to be looked at on a case-by-case basis without being prescriptive – but any company has to be able to demonstrate that their policies in this regard are sustainable. Where pay gaps are too wide, there needs to be a valid explanation or policy in place to narrow it. Public companies have set the template for private companies to follow, and also have the leverage to require this of their supply chain and value chain.
• Stronger privacy and data security: Good governance also includes keeping customer data secure.

Performing Due Diligence

As public companies increasingly perform due diligence on their suppliers to ascertain whether those companies replicate their own corporate values, it is important that there be tools measuring the ESG level of such companies. Mazars has an online ESG health check on its website, which suppliers can be asked to complete. This information, which is voluntary, gives an ESG score. When Mazars engages with a public company we send the link to all its suppliers as part of that due diligence. The principle is that you should know who you’re doing business with.

If there are any red flags from this process, companies could as a first step engage with their supplier to effect change, or not deal with that supplier. Typically, the former is sufficient as it is something that had simply not occurred to the supplier and which they are willing to address.

The business case of governance applies equally to small and medium sized enterprises, though part of the process is a materiality check. At an SME level sustainability may be primarily about their competitive issues of service and price, but as they grow larger governance will become important.

*For more on ESG, please check out the latest publication, here

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