Last week the FRC published its annual review of the Corporate Governance code. It found many companies failing to do more than pay lip service to the guidelines of the new Stewardship code. What does this tell us about the practicalities of the code or the authority of the regulator?
The new code effective from Jan 2020 states: “Stewardship is the responsible allocation, management and oversight of capital to create long-term value for clients and beneficiaries, which leads to sustainable benefits for the economy, the environment and society”. This is a reflection of rising demand for ESG reporting by pension funds and institutional investors. It puts pressure on corporate reporting to consider a wider range of stakeholder impacts. It is influenced by both the political and popular zeitgeist driven by environmental activism and sustainability issues.
The FRC report concluded that many companies were failing to implement a ‘clear purpose’ or effective corporate culture, instead substituting positive change for ‘slogans or marketing lines’. In other words ‘greenwash’ or ‘PR spin’ was more in evidence than effective culture change. Should we be surprised? Surely it depends on what the purpose of a business is and whom it exists to serve?
There are two polarising views on business purpose: at one extreme is the belief that performance is a financial output: business must be viable above all else, earnings exceed costs, a profit is made and shareholder dividend is paid to investors. Sceptics would say attempts to measure non-financial environmental or societal values only dilute business efficiency; some even say that competitive advantage is achievable only through resource exploitation – human, natural or technological. They would claim that this exploitation, however unpalatable, is fundamental to profitable business.
At the other polar extreme has always been the drive for Corporate Social Responsibility (CSR) within a lobby that has quietly grown over the past 30 years and is now unashamedly mainstream. Today it exists as Environment, Social & Corporate Governance (ESG) and has become an essential performance requirement for any institutional investor. Leading private equity firms now look for Total Societal impact (TSI) to determine the value of a business, and the new Stewardship Code from the FRC highlights how this has now become part of the regulatory framework in the UK.
The stewardship code introduces a requirement for companies ‘to deliver benefits to the economy, the environment and society’ when traditionally their primary focus has been on their own financial viability. Does this new broader accountability requirement create an impractical challenge? Is this perhaps why so many companies are only prepared to give lip service to the new code? Is the code not really compatible with the reality of running a business given the financial imperatives?
The drive for ESG compliance is understandable but, like that for CSR before, it can also represent a distraction from the primary purpose of a business which is to be financially viable. It remains to be seen whether there will be some kick back on ESG compliance, for while laudable, it comes at an opportunity cost for some.