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Much of the attention around environmental, social, and governance (ESG) factors in recent years has focused on ‘E’ and ‘S’– but the ‘G’ should not be discounted, as it is at the foundation of a robust ESG program. Simply put, poor corporate governance practices will result in poor corporate environmental and social practices.

At a high level, corporate governance encompasses the structure and oversight of corporate boards and senior leaders and their relationship with internal and external stakeholders – shareholders, employees, customers, suppliers, business partners, regulators. Corporate governance also speaks to such areas as corporate ethics, transparency in reporting, and financial and risk mitigation measures.

On a more granular level, corporate governance addresses issues like board composition, executive compensation, political contributions, ethical and transparent business practices, accountability in the event of wrongdoing, and more. On a risk mitigation level, it covers such areas as regulatory compliance, cybersecurity, and health and safety.

Despite its important role, there is much room for improvement. According to a survey conducted last year by NAVEX, out of 1,250 managers and senior executives polled, just 31% of respondents rated their company’s performance against governance metrics as “very effective.”

That same survey also found that respondents were less likely to rate governance as important as environmental and social issues as it relates to business reputation. Specifically, respondents from France, Germany, and the United Kingdom were most likely to view environmental factors as most important to business reputation, while U.S. respondents were mostly likely to view all elements of ESG as equally important to business reputation, according to the survey results.

Governance factors

For companies seeking to improve their corporate governance practices, the World Economic Forum Global Future Council on Transparency and Anti-Corruption has developed a non-exhaustive list of governance factors – the intent of which is that they be executed in practice.

That list, and a few of their related subfactors, are discussed below:

Business ethics: This factor speaks to the business’ purpose, values, culture, and “integrity beyond compliance,” according to the World Economic Forum.

Corporate leadership: This speaks to the “tone-at-the-top”, knowledge and experience of senior leadership, compensation and oversight of the chief executive officer, sound decision-making processes, and “empowerment of the compliance function.”

Anti-corruption and integrity: This is the root of robust compliance practices and speaks to such areas as, as described in the World Economic Forum’s list, “training and communications, whistleblower protocols, due diligence, risk assessments, public procurement, government relations, gifts and entertainment, conflicts of interest, remuneration and payment procedures, record-keeping, financial controls, reporting and accounting, contractual obligations, public commitments, past incidents, internal investigation, and remediation.” Anti-money laundering practices can also fall under this bucket.

Board composition: This factor speaks to having a competent and diverse board, ideally one comprised mostly of independent directors and those with experience in the business’s specific industry and area of operations. There should also be separate board committees with formal processes in place tasked with overseeing specific risks.

Incentive structures: Relevant to ESG, a sound incentive structure is one in which executive compensation is tied to ESG performance. This factor also speaks to transparency in reporting structures; clear guardrails around prohibited misconduct; and having in place fair and accountable disciplinary measures that apply across all levels of the organization.

Risk and crisis management: This speaks to assessing emerging risks and mitigating current ones, including those under the ESG umbrella and having in place a crisis management plan. Other areas this factor speaks to include having in place robust measures around “regulatory compliance, segregation of duties, audit independence, shareholder rights, information governance, cybersecurity.”

Tax strategy: This factor speaks to tax compliance, anti-tax avoidance, and transparency in tax disclosures.

Political responsibility: This factor speaks to ethical practices around lobbying, campaign finance, and political contributions.

Fair competitive practices: This factor speaks to compliant practices in the areas of “anti-collusion, anti-exclusion, anti-monopoly, anti-coercion, and market-based pricing.”

Transparency: This includes reporting transparency in such areas as “business ownership, subsidiaries/holdings, open contracting, lobbying, charitable donations, countries of operation, and verifiability of disclosures.”

Stakeholder engagement: According to the World Economic Forum’s governance list, stakeholder engagement speaks to “understanding corporate impact and stakeholder priorities, and pursuing stakeholder-centered practices.”

Supply chain management: This factor speaks to integrating ESG principles into the supply chain; practicing robust vendor due diligence; and being fair and transparent with suppliers and with contractual obligations.

Final words

Because risks vary by industry, there can be no one-size-fits-all around governance factors – for example, misleading customer practices in the financial services industry, human rights abuses in manufacturing industries, emissions cheating in the automobile industry, physician kickbacks in the healthcare and pharmaceutical industries. The list goes on. Governance considerations must also weigh the unique risks faced by the business and its geographic regions of operation.

There is no shortage of case studies pointing to companies that have suffered significant financial and reputational damage resulting from poor corporate governance practices. Without a strong and ethical foundation that begins with the board and senior leaders and trickles down throughout the business, environmental and social commitments become just an afterthought.

NAVEX is committed to helping your organization establish and sustain best practices in corporate governance. To learn about how a Governance, Risk and Compliance Information System (GRC-IS) can help you do just that, watch the webinar, “GRC-IS: Next-Level GRC Management”.

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