The evolution of corporate governance best practice
Corporate governance at the heart of our fundamental research
Strong corporate governance has always been one of our key focal points in corporate analysis, given its implications on our stock selection over the long term. Assessing corporate governance quality goes well beyond analysing board composition and the separation of CEO and chairman roles. Through our relationships with executive managements, we build a picture of a company’s culture of consistency, responsibility, accountability, transparency and efficiency.
The evolution of corporate governance best practice
High quality corporate governance manifests in such financial measures as return on invested capital (ROIC) as well as high levels of trust among stakeholders. In contrast, weak corporate governance often translates into poor financial measures over time. When capital allocation or strategy deviates from good corporate governance practice, investors can provide feedback via proxy voting or through direct conversations with management.
Over the past decade, best-in-class governance has increasingly included focus on environmental and social issues, particularly on greater sustainability. At the same time, corporate disclosure has steadily improved since the 2000 launch of the Global Reporting Initiative. More recently, the International Reporting Initiative and the US-based Sustainability Accounting Standards Board have helped advance sector-specific reporting and its relevance for investors. The ability to measure and track governance best practices is also key to identifying companies with strong CSR credentials. Similarly, such measurements could help avoid CSR-related disasters by enabling investors and the public to put pressure on management to improve their practices. While hindsight is always 20/20, one might wonder if past environmental disasters could have been avoided if we would have had the data availability and ESG accountability then as we do today.
This evolution in corporate governance behaviour tends to be driven by a combination of bottom-up and top-down driven initiatives. On the former, increased globalisation was instrumental in widening the scope of CSR in the 1990s, when the foundation was laid for how we understand CSR today. A wide array of international events and agreements also took place then, namely the adoption of Agenda 21, the United Nations Framework Convention on Climate Change and the Kyoto Protocol. These initiatives elevated CSR up the agendas of multinational corporate leadership and made businesses consider their broader impact beyond profitability. The scope of CSR has since broadened. Today, many companies design their CSR programmes around the UN’s 17 Sustainable Development Goals (adopted in 2015), which range from gender equality to protection of ocean life. CSR is also increasingly related to promoting diversity, equity, and inclusion initiatives, as socially responsible corporations should foster a welcoming work environment and combat discrimination.
Bottom-up driven corporate governance initiatives
Initially, many institutional investors were reluctant to embrace the environmental, social and governance (ESG) concept, arguing that their fiduciary duty was limited to maximising shareholder value. Indeed, such arguments are still being made by some even today. But as evidence grows that ESG issues have financial implications, the tide has shifted. One example of a bottom-up driven initiative is that of Unilever’s former CEO, Paul Polman, under whose leadership the company adopted the goal of decoupling its environmental impact from its growth. A Sustainable Living Plan was implemented to move Unilever towards more planet-friendly growth, including shifting to 100% renewable energy, substantially reducing plastic waste and water use, ridding deforestation from its supply chain and pressing world leaders to adopt the Paris climate accord. Investors did not always welcome such directives. But when Kraft Heinz, one of the worst-ranked companies for commitment to sustainability, made a hostile takeover bid for Unilever in 2017, Unilever’s management successfully used every tool in their possession to fend it off. Since then, Kraft Heinz’s stock has underperformed Unilever’s by 60%, in a sharp divergence of financial fate between the two consumer staples companies.
A top-down initiative case study: The Italian and European experience of diversity on the executive board
For generations, Italy lagged behind the majority of its EU neighbours on promoting gender diversity in the workplace, for which it paid both social and economic costs. In civil rights leader Jesse Jackson’s words, “Inclusion is not a matter of political correctness. It is the key to growth.” Awakening to the implications of this reality, the Italian government moved to mandate gender diversity in the boardroom in 2011.
Italy’s Gender Parity (Golfo Mosca) Law imposed the gradual adoption of a gender diversity quota among its publicly-listed companies. The law initially required quotas for three consecutive board renewal terms, with a 20% quota for the underrepresented gender for the first renewal and 33% for the second and third ones. Expanding upon this, a new law extending the period to six consecutive renewals to ultimately raise the quota to 40% for the less represented gender came into force in October 2020.
These measures moved Italy to the more stringent end of the European spectrum of diversity policies. Eight EU countries have adopted national mandatory gender quotas for listed companies, while 10 have taken a softer approach, using a range of measures and initiatives. That leaves nine EU countries that have yet to take any substantial action on facilitating board-level gender diversity.
The difference in outcomes to date from these various policy alternatives has been stark. Starting from a similar level of around 13% female representation on boards across the EU member states in 2011, the share of women on company boards has since risen:
- to 36.4% in countries that adopted laws to promote more women to top positions;
- to 30.3% in countries taking soft measures;
- to 16.6% in countries that have taken no action
On the surface, the mandatory approach has delivered impressive results. However, lurking just beneath the surface, a more intransigent diversity problem remains. Despite progress at the board level, women continue to be excluded from top corporate positions. Notably, fewer than one in 10 of the largest listed companies in the EU-27 have a female chair (8.5 %) or CEO (7.8 %).
Legislative quotas typically apply to the top board level, which tends to be mostly comprised of non-executives, meaning executive positions may not be affected. Indeed, the countries with binding gender quotas for board members have slightly lower levels of female representation among executives (18.3%) than those that took soft measures (21.8%) or no action (20.5%). It becomes clear that while legislative quotas have a visible impact on female representation among non-executive directors, it has not filtered down to the executive levels.
Women remain under-represented at the executive level, irrespective of policy action
In sum, despite progress at the board level driven by legislative action in several EU-member states, women in the bloc continue to be excluded from top management positions. This social issue has in effect merely moved ‘down’ a level, from the corporate board to the executives responsible for the day-to-day management of these companies. While quotas can be effective, we must recognise that entrenched social impediments (e.g., lack of childcare services) remain a hindrance to realising a truly diverse representation in the work place. Without holistically addressing these deeper structural social issues, such disparities are likely to remain. This reinforces the notion that achieving true systemic change requires collaboration from all levels of society, including policymakers, civil society and business leaders, working together towards the same outcome, from both the bottom up and the top down.
 Source: CERES, a shareholder advocacy nonprofit that pushes corporations to adopt robust corporate social responsibility policies
 Belgium, France, Italy, Germany, Austria, Portugal, Greece, the Netherlands
 Denmark, Estonia, Ireland, Spain, Luxembourg, Poland, Romania, Slovenia, Finland, Sweden
 Bulgaria, the Czech Republic, Croatia, Cyprus, Latvia, Lithuania, Hungary, Malta, Slovakia
 Source: according to the EIGE (European Institute of Gender Equality)