Boards Lack Social and Environmental Risk Governance

By Dr Raj Aseervatham

Boards are theoretically responsible for strategic direction and overall governance in corporations. Let’s look at the practice as it is applied to non-financial (such as social and environmental) issues, and see if they are likely to fulfill this promise in these areas.

The board setup

The average board composition for large corporations is seven to 12 members. The annual remuneration per board member might average US$120,000 to US$300,000, plus various committee duties and incentives (sources: Bloomberg (US), Deloitte (UK) and AICD (Australia) board statistics, 2014). Independent, non-executive board members tend to be in the lower range. That’s the floor level of shareholder investment in their boards.

The average time spent in board meetings, meticulously detailed in company annual reports, comprises 10 to 12 days per board member, per year. It is estimated (by conscientious board members) that conscientious board members spend two to three times that amount of time, in total, on preparation for meetings and in forming their own points of view on specific issues. That’s the effort for the money.

Where does the effort get focused? Before the global financial crisis, a lot of this time was spent on financial risk. After the crisis, this focus amplified. Debt, finance and the ability to maintain liquidity attracted even more attention than pre-2007.

The social and environmental gap

So, how and when are social and environmental issues raised, reviewed and considered today?

More often than not, they are raised through a compliance discussion. Often, the health and safety aspects of companies – now a mainstay for most corporations - have an environmental element added. As many board members have observed, the health, safety and environment considerations (or HSE) usually has a little ‘e’ for environment. It takes up comparatively very little time in HSE discussions. Where it is raised in these discussions, there is a large focus on regulatory compliance, fines, class actions and liabilities -- and not much else.

The tactical and defensive nature of this type of discussion is at odds with a board’s role in setting strategic direction.

The social element is largely addressed from a reputational perspective. These discussions can and do have strategic overtones, but they are more focused on the question, "How do we look to the outside world?," than the question, "What is our place in society, and how do we keep or enhance it?"

Clearly that is all a bit underwhelming. We seem to be operating under the assumption that corporations exist to fulfill a financial need. Oddly, nobody argues that good financial outcomes are largely a consequence of adequately fulfilling or exceeding societal needs and expectations -- but it seems our boards are not set up to operate that way.

Closing the gap

So, how would we address this? Let’s look at board mechanics. Two pivotal things make up board mechanics and performance – its people and its governance.

Firstly, the strength of a board depends on the characteristics of its people, and one generic characteristic is diversity of opinion. If there aren’t different perspectives, and they aren’t being brought to bear robustly on discussions, the board is free-riding and group-thinking at the shareholders’ expense. Many boards are heavily populated by experts in finance and law as well as industry experts, and thinly populated with other expertise. Of course, the industry, finance and legal experts have their own perspectives on social and environmental issues, but these are rarely perspectives based on professional strengths. Therefore, contrastingly, board expertise is relatively weakly anchored in in expertise outside of industry, financial and legal areas.

This is changing, but at a remarkably slow pace. Where change has occurred, more often than not, an external environmental or social advisory body is used to inform the board; but of course these bodies have no real power to make decisions in the corporations they advise. It would be optimistic to conclude that we have genuinely started to reflect knowledgeable board composition in this area.

Secondly, the effectiveness of the board (in other words, how the strength of its people is put to good use) depends on its governance.

Well-governed boards have systematic ways of addressing certain issues. Risk committees focus specifically on risk. The risk lens (which comes with its inverse, the opportunity lens) is one of the most insightful and adaptable tools for boards. Climate change and water scarcity can be addressed as social and environmental risks (and opportunities). Customer expectations, government policy changes, socio-political landscapes and many other external societal factors can be addressed as risks (and opportunities). Current, near/mid-term future and far future risks can be addressed for each of these risk types, provided there is an enterprise risk management process that considers risks other than financial and legal.

The state of today

Board composition is diversifying, with human resources and IT skills being increasingly recruited. However, the prevalence of social and environmental skills on boards today is miniscule.

And while it appears that there is a systematic and recognized means of addressing broader social and environmental risks using risk committees and enterprise risk management, the startling reality is that it is hardly used in board governance.

A Deloitte report published in 2014 provides information to illustrate this point.

The report looked at the top 50 companies, by market capitalization, in each of a number of countries around the world. It broadly divided the companies into two categories – financial services (including but not restricted to banks) and non-financial services companies (i.e., the rest).

It looked at the percentage of companies in each of the two categories that had a stand-alone or hybrid committee to look at risk. I will use the results from non-financial services companies (i.e., those companies that typically have a large social and environmental footprint) only, and illustrate a point with information from four countries.

• Of the top Australian non-financial service companies, 26 percent have no such formal risk governance at the board.

• Of the top U.K. non-financial service companies, a worrying 78 percent have no such formal risk governance at the board.

• Of the top Chinese non-financial service companies, a fearsome 87 percent have no such formal risk governance at the board.

• Of the top U.S. non-financial service companies, a gob-smacking 98 percent have no such formal risk governance at the board.

The Australian performance, while it may show what can be done, is frankly no consolation in global terms. The total market capitalization (TMC) of the top 100 U.S. companies is about 18 times the TMC of the Top 100 Australian companies (PWC, 2014). U.S., Chinese and U.K. companies typically have a much larger scale, as well as a larger social and environmental footprint; yet they have considerably more vague governance processes for these risks at the board level.

Of course the existence of a risk governance function at the board does not necessarily mean that social and environmental risks are well scrutinized, debated and strategically influenced by the board, but it’s a start.

The trouble is, not many corporations have started.

Image credit: Flickr/reynermedia

Dr Raj Aseervatham has over 25 years of government, consulting and corporate experience on social and environmental issues affecting corporations and their stakeholders. He has worked extensively in Asia, Europe, Africa and the Americas. He is a Fellow of the Institution of Engineers Australia and a graduate of the Australian Institute of Company Directors. (Image credit: licence by 123RF)