It is clearer than ever before that sustainability practices can affect corporate value. That was the main thread of a panel that I led at the National Association of Corporate Directors’ 2016 Global Board Leaders’ Summit in Washington, D.C. My co-panelists Christianna Wood, director at H&R Block, and Seth Goldman, founder of Honest Tea, and I discussed the potential risks and opportunities that environmental and social issues pose to companies.
Sustainability is a broad term, and not every environmental or social issue belongs on the board agenda. But when an environmental or social issue has the potential to affect corporate revenue and earnings in the short and long term, sustainability absolutely should be on the table.
At the end of the day, it all comes down to materiality, and this is where corporate directors have a critical role to play.
Materiality is about determining a company’s priorities. As fiduciaries responsible for overseeing a company so that it not only survives but also thrives in the long term, directors have a responsibility to assess whether a company is making the right choices.
But the much harder question is: When does an environmental or social issue rise to the level of being material?
Here are some steps directors can take to drive discussions about whether sustainability issues are material to the companies that they oversee.
1.) Understand how sustainability is being integrated into your company’s efforts as a way to identify material issues.
There are a few ways to do this. Directors could point management towards the Sustainability Accounting Standards Board’s Company Implementation Guide, which provides a great starting point for companies to assess whether certain sustainability factors could be considered material for the purposes of the company’s financial filings. Directors could also integrate themselves more meaningfully into corporate efforts aimed at identifying material sustainability issues. They could provide perspectives on the connections between sustainability factors, corporate strategy, risk, and revenue.
2.) Include key issues being raised by critical stakeholders in the materiality exercise.
While a broader range of stakeholders is raising a variety of issues these days, the financial community is a particularly critical constituency to direct attention towards. As we discussed in our panel, the U.S. investor community is starting to make the connections between sustainability and the financial value of companies in their portfolios. During the 2016 proxy season, close to 400 shareholder resolutions on climate change and other sustainability issues were filed. Large investors including CalPERS, CalSTRS and State Street Global Advisors are asking their portfolio companies to put directors with climate expertise on their boards.
In addition to tracking broad sustainability trends that investors are paying attention to, prudent directors could consider opportunities to engage directly with key shareholders to get a sense of issues specific to the company and the industry. Directors could also track and engage with the broader activist and advocacy community as a risk management exercise.
3.) Weigh in on the time frame over which issues are considered to be material.
Since the board in particular is responsible for long-term corporate performance, directors play an important role in examining whether their company’s materiality process focuses on considering issues over the long or short term.
Overall, momentum is building to adopt a more long-term view to encourage companies and boards to think more broadly about sustainability and materiality. The recently released Commonsense Corporate Governance Principles, which are backed by major U.S. companies including JPMorgan Chase & Co., Berkshire Hathaway, and Blackrock, support the move to long-term thinking. And more companies including Unilever, Coca Cola, and National Grid are moving away from the practice of issuing quarterly guidance specifically to encourage investors and other stakeholders to adopt long-term thinking.
4.) Disclose details on what you consider to be your company’s material priorities.
Noting that determinations of materiality depend on whom the company considers to be its most significant stakeholders, governance experts are starting to call on corporate boards to release a statement noting critical audiences that the company is oriented towards and issues that the corporation is prioritizing. Companies like the Dutch insurance company Aegon have started to issue such statements.
The process of helping to identify the right issues is just a first step in a director’s responsibility on materiality. Directors have an important role to play in ensuring that material issues, when identified are integrated into board deliberations on strategy, risk, revenue and accountability systems. However, getting to the right issues lays an important foundation for the company and its key stakeholders to build on.
“Society needs financial wealth … but it matters how you make the money,” said Rajendra Sisodia, co-founder and co-chair of Conscious Capitalism Inc., and director of the Container Store Group. “Businesses not only create, they can destroy financial wealth, as well.”
Sisodia, a marketing professor at Babson University whose published books include Conscious Capitalism and Firms of Endearment, delivered a keynote address on capitalism’s transformative power Tuesday at NACD’s Global Board Leaders’ Summit. The four-day summit convened more than 1,300 attendees—the world’s largest gathering of corporate directors—in Washington, D.C. from Sept. 17-20.
Roots of Capitalism
One of the most significant conclusions of Scottish moral philosopher Adam Smith’s seminal 1776 book, An Inquiry Into the Nature and Causes of the Wealth of Nations (often referred to as The Wealth of Nations), was that places rooted in freedom tend to be more prosperous. Smith’s work became a foundational text on how capitalist markets work.
“That same year—an extraordinary historic coincident in some ways—the United States was born as a country, but more importantly, an idea. [It was] the only country born out of a set of ideas,” Sisodia said. “The ideas all revolved around liberty and freedom.” Entire segments of the American population, however, were not initially given access to that freedom—including African-Americans, native populations, and women—but the nation has extended freedoms steadily over the course of its nearly 250-year history.
“What is capitalism? Political and economic freedom,” Sisodia proclaimed. It’s rooted in the idea that free markets—or economic growth driven by individuals, rather than a centrally planned economy directed by the government or a political system—help people collectively elevate their material living conditions and boost prosperity, he said.
Poverty and Capitalism
A misperception about capitalism, Sisodia said, is that it exploits people of lower income brackets, locking them into poverty. Research, though, suggests that as capitalist markets have expanded, poverty rates have declined.
Data from the World Bank show that rates of extreme poverty have decreased considerably over the past three decades. More than half of people in the developing world lived on less than $1.25 per day in 1981, compared with 21 percent living on that amount per day in 2010.
Sisodia credited that decrease to prosperity derived from capitalism, saying that the key challenge for lifting the rest of the world out of poverty is not the unequal distribution of income, but the unequal distribution of freedom.
How the World Is Changing
“What will it take for companies to flourish in the future—and not just flourish for the purpose of making a lot of money, but actually be agents of flourishing in society?” Sisodia asked. The simple answer, he continued, is that you must be in harmony with the fact that people have changed over time to become, among other things, more:
The rate of serious violent crimes in U.S. public schools has dropped significantly to about one-third of what it was in 1994. Europe, Sisodia said, had experienced 1,200 wars in 600 years, but since 1945, inter-state wars on the continent have disappeared.
Sisodia described the so-called Flynn Effect, which suggests that there has been a consistent increase in IQ scores from 1930 to the present.
Embracing of “feminine” values. “I think the great story of this century is … the end of the suppression of the feminine [side of humanity],” Sisodia said. Women now earn more college degrees than men in the United States, and as a result, the expectation is that women will rise in positions of leadership—particularly in white-collar work settings. That will naturally mean that so-called feminine values, which he described as including cooperation, empathy, and compassion, will gain more traction in society.
Tenets of Conscious Capitalism
Accepting that the world is changing, Sisodia advised that businesses embrace the four tenets of conscious capitalism. That means to act with:
A higher purpose, or more specifically, a purpose beyond generating profits. Sisodia’s website provides a further explanation by quoting University of Virginia Darden School of Business professor and Conscious Capitalism, Inc. trustee, Ed Freeman: “We need red blood cells to live (the same way a business needs profits to live), but the purpose of life is more than to make red blood cells (the same way the purpose of business is more than simply to generate profits).”
A stakeholder orientation. Conscious businesses exist not only to maximize ROI for shareholders, but also seek to enhance value for all stakeholders, leading to a more resilient business.
Conscious leadership that demonstrates care for purpose and people; and
Conscious culture built on trust, care, and transparency—not rooted in fear and stress (the risk of having a heart attack is 20% higher on Mondays for men, 15% for women, and most research blames the stress of returning to work for these statistics).
Boards: Stewards of Well-Being
Sisodia offered several considerations aimed at helping boards—and companies—become more conscious overseers:
The primary duty of the board is to the corporation—which has its own significant role in society—rather than shareholders.
Understand and shape the company’s higher purpose. Ask your board to reflect on why the company would be missed if it were to disappear tomorrow.
Consciously seek to create value for all stakeholders.
Appoint strong leaders with a capacity for love and care. It is not healthy to appoint leaders who are analytically smart but lack empathy and other forms of emotional intelligence.
Build a culture of “full-spectrum” consciousness, meaning that you are not only concerned with service to people and a higher purpose, but also efficiency, effectiveness, and success.
Ensure youth and feminine perspectives are heeded when making business decisions.
Humanity is more aware of its challenges and problems than ever before, Sisodia said in closing, and the individual and collective capacity to respond to those challenges has never been higher. “We have to create the organizational forms and philosophies and build business on [the ideals of] purpose and caring. … [A]ll of those answers that we need to our crises are out there inside somebody. We just have to figure out how to liberate that.”
One of the board‘s key responsibilities is the oversight of a company’s conduct, including the strength of its culture and the effectiveness of its ethics & compliance (E&C) program. In recent years, that responsibility has become even weightier. Recent corporate scandals, such as Volkswagen, Unaoil, and Mitsubishi Motors, have created public skepticism about business ethics, and policy makers have responded with a new emphasis on accountability for both companies and responsible individuals, including directors who are either negligent in preventing fraud or willingly participate in it. Enforcement agencies now scrutinize a company’s E&C efforts before making prosecutorial decisions by inquiring about board oversight in the company’s approach to E&C.
Organizations around the world invest tremendous resources to establish internal E&C programs and prevent corporate wrongdoing. Although E&C was historically a U.S. focus, a number of international standards have heightened the importance of E&C programs globally: the UK Bribery Act; the new International Organization for Standardization (ISO) 19600 Compliance Management System Guidelines; and the OECD Anti-Bribery Convention.
Directors observe these developments and scratch their heads. What does an effective E&C program look like? How can we succeed with E&C without stifling our business? What is the board’s role in E&C oversight? Has any organization gotten it right?
There is good news for directors. There are exemplary organizations—representing a wide variety of sizes, sectors, and industries—that have raised the bar even higher than mere compliance with the law. These organizations have transformed their workplaces through their E&C efforts to yield stronger, more positive results. And even better, there is now a framework to help directors guide their own organizations in establishing such an E&C program.
The Framework: Principles and Practices of High-Quality E&C Programs
In May 2015, the Ethics & Compliance Initiative (ECI) convened a group of 24 thought leaders with E&C program experience, including corporate directors, former deputy attorneys general, former members of the United States Congress, business executives, senior E&C practitioners, and academics. The panel produced a new report with leading principles and practices for effective E&C program implementation: Principles and Practices of High-Quality Ethics & Compliance Programs. The report includes five key principles practiced by organizations not satisfied with “minimum” E&C efforts; these organizations are referred to in the report as high-quality programs (HQPs). The principles, which should be tailored to each company’s individual circumstances, are adapted below from the original report:
Principle 1: Ethics and compliance is central to business strategy.
E&C is both a function on the organizational chart and is considered to be an essential element within every operation.
A high standard of integrity and compliance is articulated as a business objective, and every strategic decision is evaluated for alignment with the organization’s values and standards.
An HQP ensures compliance with law and regulation, and is resourced to help leaders across the organization understand their critical role in setting and meeting the standard for integrity.
The E&C program is expected to provide an independent voice, and regularly updates the board on E&C objectives, risks, and progress.
HQP staff maintains excellence by dedicating themselves to continuous improvement in E&C through innovation, engagement with stakeholders (inside and outside the organization), and consistent consideration of employee feedback.
Principle 2: Ethics and compliance risks are identified, owned, managed, and mitigated.
While organizational values are the heart of any E&C program, risk assessments provide the foundation upon which HQPs are built.
E&C staff collaborates across the organization to support a risk assessment process that identifies, prioritizes, and mitigates risk consistently.
Compliance performance, strength or weakness of organizational culture, employee willingness or fear to report, and other key E&C areas are evaluated and reported to the board as potential risks to the organization.
Leaders at all levels assume ownership for the ongoing identification and mitigation of risks that are relevant to their areas, both inside and outside the organization.
The board is regularly briefed on emerging E&C risks and how the E&C program is monitoring and mitigating risks where necessary.
Principle 3: Leaders at all levels across the organization build and sustain a culture of integrity.
Culture is the largest influencer of business conduct, and leaders are recognized as the primary drivers of that culture.
Leaders throughout the organization are committed to, and responsible for, making ethical conduct and decision making central to the organization and its operations.
The board assumes responsibility for evaluating the performance of senior management in providing ethical leadership and setting a proper tone at the top.
HQPs equip managers and supervisors with the support needed to make those values relevant to their day-to-day operations.
Recognizing that employees at all levels make ethics-related choices every day, HQPs provide resources, guidance, and training that emphasizes to all employees the importance of acting in accordance with shared values, seeking help, and speaking up.
Principle 4: The organization encourages, protects, and values the reporting of concerns and suspected wrongdoing.
HQPs focus on establishing an environment where issues can be raised long before situations are elevated to the level of misconduct.
HQPs prepare leaders and supervisors to respond appropriately if/when employees do come forward with concerns about wrongdoing.
Managers understand the impact of their actions, and HQPs hold them accountable for contributing to a culture that does not support the reporting of concerns.
There are focused efforts to prevent and deter retaliation.
HQPs treat all those who report violations fairly and consistently, and effectively support employees who report suspected violations.
The board is regularly briefed on high-level trends in employee reporting, and management is expected to be transparent with the board when substantive “bad news” transpires.
Principle 5: The organization takes action and holds itself accountable when wrongdoing occurs.
Investigations are timely, neutral, thorough, competent, and consistent.
When a violation is confirmed, the organization responds with appropriate consequences, regardless of the violator’s position within the company.
The organization maximizes learning from every substantiated case of wrongdoing.
HQPs recognize that technology has increased reputational risk.
HQPs have well developed systems for escalating issues, with regular testing for crisis management and response.
When appropriate, HQPs disclose issues to appropriate regulatory and government authorities and work cooperatively to respond to their concerns.
The board is well informed when substantive issues arise that require organizational accountability to stakeholders.
As corporate directors know better than anyone, there is no one approach to effective ethics and compliance. Each company’s circumstances are unique; therefore, their E&C programs must vary accordingly. But there are some universals among organizations that “get it right,” particularly when it comes to implementing a proper E&C tone at the highest levels of the organization. The board has an essential role in setting the expectation that the organization will not be satisfied with upholding only the minimum standard. Understanding the principles and practices that characterize leading E&C practice will help board members engage with management to ensure that the highest standard of integrity is seamlessly aligned with the performance of the organization overall.
Patricia Harned is CEO of the Ethics & Compliance Initiative (ECI) and frequently speaks and writes about workplace ethics, corporate governance, and global integrity. Ronnie Kann is executive vice president of research and program development at ECI, having served chief ethics and compliance officers, general counsel, and chief human resource officers throughout his career. Harned and Kann both contributed as authors to the ECI reportPrinciples and Practices of High-Quality Ethics & Compliance Programs. The Ethics & Compliance Initiative (ECI) empowers its members across the globe to operate their businesses at the highest levels of integrity. ECI provides leading ethics and compliance research and best practices, networking opportunities, and certification to its membership, which represents more than 450 organizations across all industries. ECI is comprised of three nonprofit organizations: the Ethics Research Center, the Ethics & Compliance Association and the Ethics & Compliance Certification Institute. www.ethics.org