The world has seen a momentous change in the 21st century from consumerism and entrepreneurialism to a pandemic-led focus on ESG — environmental stewardship, social responsibility and purposeful governance.
For far too long, the human race chose to ignore the cries to save the planet. It now has a unique opportunity to take remedial action. The last 240 years saw more carbon emissions that the entire known history till then. The planet has limited capacity to warm beyond 1.5* C. Global warming will cross that danger mark in 5-6 years if dramatic action is not initiated. Biodiversity loss is frightening and humanity must rectify the damage it has done to the planet.
Evolving nuances of governance
History shows that governance has always been complex and nonlinear. It requires constant adaptation changing circumstances. Understanding change has become one of the most prominent challenges for contemporary governance. Governance policies must be set on the basis of understanding current comprehensive global ESG issues.
Evolutionary Governance Theory (EGT) is a framework for analysing and explaining governance and its evolution. A peep into history will show how governance has evolved over time from living in clans to an age of cloud governance. The world is on the threshold of another major transition. Today policies around the world have a lot of focus on sustainability, but is that enough? Have organisations around the world found a way to exploit the system again? Take the example of large organisations such as H&M and Decathlon that used this as an opportunity to greenwash society into purchasing their products.
READ I ESG is transforming businesses — slowly but surely
Hijmans van den Bergh, member of the board of Netherlands Authority for Consumers and Markets (ACM), said: “Consumers that wish to make sustainable choices must be able to have confidence in the veracity of the claims that businesses make on their products or websites.” Active participation of all stakeholders in the process of development is an indispensable condition for good governance.
Moving Schedule IV closer to ESG
Schedule IV of the Indian Companies Act acts as a guide to professional conduct for independent directors. The evolutionary nature of governance requires society to incorporate a sustainability lens in the process. ESG can be integrated into the code in the following way.
● ESG audits and due diligence: Independent directors shall implement processes to enable ESG audits and due diligence which will help improve processes such as production which have environmental and social implications.
● Balancing stakeholders’ expectations: Shareholders make investment decisions based quarterly profits of companies. While this is critical, it must be effectively balanced with long-term expectations of communities, environment, and regulators.
● Making ESG a board-level responsibility: The boards must be responsible stewards of shareholders, environment and society at large. Each board member must in their own capacity contribute to the ESG agenda.
● Appointment of board level ESG Champion: Each board must have an ESG champion who understands the science behind ESG. This person should lead the company in its ESG journey towards net zero.
● ESG-based board evaluation: Directors on the board need to be judged based on their ability to initiate and contribute to ESG initiatives, while causing significant improvements in CSR measures.
● ESG KPIs in executive compensation” Most large organisations are shifting a portion of executive pay based on sustainability activities to help adopt ESG initiatives in the organisation.
From shareholder primacy to stakeholder capitalism
The Business Roundtable published a declaration where 181 companies signed a new statement on the purpose of a corporation which is to ensure that the companies are run sustainably for the benefit of all stakeholders involved. “CEOs work to generate profits and return value to shareholders, but the best-run companies do more. They put the customer first and invest in their employees and communities. In the end, it’s the most promising way to build long-term value,” said Tricia Griffith, President and CEO, Progressive Corporation.
Companies must realise that the success of the system depends on long-term inclusive growth. Working ethically with suppliers to protect shareholders who invest money that help companies innovate and grow, each stakeholder involved is essential in the long-term success of a company.
The society needs to move past red tape and focus on acting rather than reacting to the destruction of the environment. A great example of evolutionary governance is the Patagonia success story in which the organization’s vision was recognised for upholding a dynamic mix of policies that have put sustainability at the core of its business model.
Designing durable yarns from recycled fabrics shows its commitment to protecting the environment. Not only are they ethically sourcing raw materials from relevant sources, but also helping small businesses and small farms by sourcing from them. The Body Shop founder Anita Roddick beautifully captured the power of little acts of impact when she said, “If you think you’re too small to have an impact, try going to bed with a mosquito.”
Breaking the resistance to change
Governance needs to be flexible as per the requirement of the situation. It needs to be able to account for the change in technology which is one of the driving factors for the evolution of governance. The resistance to change must be broken by incorporating governance policies that take into account present-day global crises. The ability to adapt to various situations will lead to superior strategic decisions and increased profitability.
The evolution of governance is critical in bringing out the best from all stakeholders. On the social front, employees can only be expected to perform at optimum levels when they are in a hospitable workspace environment. They need to have a sense of security and be fairly remunerated to give their best. For these reasons, there has been a shift in governance on the social front.
With consumers becoming prosumers and being more actively involved in the production process we see companies shifting their approach towards a sustainable one on all levels. Governance must be more than just a fiduciary responsibility toward shareholders; it needs to ensure the sustainability of the firm.
The path of any corporate is dependent on the governance policies set by the board. Brands such as Uniqlo or Nike focus on high-quality products that have longevity. Other brands such as H&M or Zara are considered fast fashion brands while yet other brands such as Patagonia are considered sustainable clothing brands. All these companies are profitable and follow different governance policies. Governance needs to evolve based on all stakeholders involved and this evolution and innovation in governance will be able to achieve sustainable profitability.
Boards should recognise that the companies no longer need to source cheap raw materials that destroy the environment. There are labour laws in place that make the lives of employees a living hell. They are ambiguous in their decision-making process and conceal information from the public to be profitable.
As Albert Einstein once said, “Problems cannot be solved at the same level of awareness that created them.” Just as humans evolve, they need the governance policies to evolve. Rohini Nilekani says, “We cannot be mere consumers of good governance — we must be participants; we must be co-creators.”
Shailesh Haribhakti is a Chartered and Cost Accountant, an internal auditor and a certified financial planner. He is a board chairman, audit committee chair and independent director at some of the country's most preeminent organisations. He is a thought leader on the Indian economy and public policy.