Why governance standards becoming No. 1 yardstick for equity investors

Investors like Warren Buffett find that the companies which observe environmental, social and governance standards in their strategies tend to outperform those that don’t by a significant margin

To begin, after the financial crisis, the regulators and funds came up with a new bunch of new governance structures and rules that they wanted their companies to practise and adopt. This new governance regime brought about new challenges for the chairman, the conscience keeper in a business. 

The world we operate in is entirely different to the time. Today, the increased focus on compliance and governance now permeate every aspect of the business. As an example, a board is expected to review all executive compensation schemes on a regular basis to ensure that they cannot be viewed as driving inappropriate behaviour. 

A board is also expected to review every compliance violations of their board members for a start in order to ensure the company maintains consistently high standards of ethics, especially when their members hold office elsewhere. Corporate culture normally permeates and influences every part of a company. Of particular importance is the role culture plays in corporate strategy and performance.
Culture is also increasingly on the agenda of regulators, with some, such as those in the United Kingdom, now holding boards directly responsible for oversight of corporate culture. Other companies are under deferred prosecution agreements or corporate integrity agreements from the US. 

Therefore, a board needs to play a key guardianship role as well as ensuring employees are fully aware of their obligations. The reason for this is the concept that good corporate culture, grounded in good core values based on corporate governance, helps to sustain business growth and attract and retain ethical employees and customers.

At a macro level, attracting investment requires protecting investors. Investor protection requires both the law and effective enforcement of law. However, in many developing countries, neither the quality of the law nor its enforcement is adequate. As to law, few developing countries have, for example, an enforceable concept of the fiduciary duties that controlling shareholders, directors and managers owe to investors – particularly to the minority shareholders.

To join the global capital market, developing countries will need to attend to these deficiencies. Because private capital is necessary for economic development but capital does not flow to badly managed markets. Investors, whether purchasers of equity or lenders, will not invest in a market or a company they view as unstable, corrupt or utterly lacking basic protections for their investment and contractual rights.

Thus, countries seeking to create a capital market – and private enterprises seeking to attract local or global capital – must develop a framework that assures the public investors that the assets they provide will be protected. That requires good governance at enterprise level and sound leadership.

Integrating governance
Corporate governance requirements can often be satisfied when it comes to the letter of the law but respecting the spirit of the law is a challenge for some companies. Much has been said and written about culture change since the financial crisis. 

For example, in Enron, analysts found a strong correlation between a failure to embrace the spirit of corporate governance and deep-seated organisational culture problems. Furthermore, it is now widely accepted that the CEO and top executive behaviour, attitudes and values determine organisational culture and no matter how many mission or value statements HR plasters on the walls, it is the top management that finally shapes the values in a business. This dimension is probably the biggest chink in an organisation’s corporate governance amour. 

Role of HR
Therefore, corporate governance in my view is an issue that encompasses an entire organisation but without a supportive board will most likely to be sidelined. As a result, HR is often the victim of a no-go cycle. Because in many businesses, corporate governance still lacks business perspective and HR lacks the standing within the organisation to talk governance. 

So, without that stature, HR often has trouble getting a foot in the door to discuss business challenges like corporate governance. Therefore, HR must and needs to play an important role to promote good corporate governance but to do that they should be well trained in the procedures and demonstrate the value of good corporate governance to business sustainability and for attracting and retaining talent. 

Today, the current governance debate in many companies is focusing not only on the changes and upgrades that need to be made to the processes but also on the different players who need to have a role in either driving good governance or monitoring governance within the enterprise. Therefore, within a company, focus is required from all the key functions to promote governance. 

However, HR can facilitate good governance within an enterprise by focusing on three main areas: firstly, HR can set and implement a framework for executive pay. Secondly, they can drive performance evaluation beyond the corporation and into the boardroom. Thirdly, they can ensure that there are good systems for succession planning. Lastly, help the enterprise to take a broader view of the relationship between long-term business success and practicing good ethics. 

Culture needs to become a standing agenda item for the board to make sure complacency doesn’t become an issue and that a strong culture remains a focus of management and employees. To help oversee that monitoring, a dashboard with cultural indicators from across the company is a useful tool. These tools motivate investors to move into companies that uphold ‘environmental, social and governance’ standards.
(Dinesh Weerakkody is an HR thought leader)