An Active Board Stays in Control
Stakeholder governance has been around for a long time, and especially in Europe. This is less true of the Anglo-Saxon model, but there too it has increased in recent years. There was an ‘ESG explosion’ after the coronavirus pandemic. Companies suddenly began reflecting on their very raison d'être or purpose. Why are we here? What should our legacy be? That goes much deeper than we traditionally learned in business school. The ESG discussion needs to be part of the discussion about the larger purpose.
The term ESG (environment, social and governance) is often used in the context of climate change, while that only covers the ‘E’ part. The ‘G’ for ‘governance’ is seen as compliance with regulations or the national code, while it of course encompasses much more: All aspects of leadership, including communication channels and structures, the strategy process and performance measurement. The ‘S’ for ‘social’ is often seen as part of Corporate Social Responsibility, but is in fact an integral part of business strategy, focusing on all stakeholders.
ESG does not compete with financial objectives
ESG also involves a discussion of purpose. This often focuses on the question of ‘how do I succeed as a company?’ but does not always align with the company's ambition. When ESG goals and the company's ultimate ambitions do not align, this results in criticism. An example of this is Unilever, which was criticized by some Anglo-Saxon shareholders who feared that certain sustainable objectives would come at the expense of profits. From an Anglo-Saxon perspective, ESG competes with business, but our view is that the two should instead be integrated. Financial objectives and ESG ambitions should be clear and formulated together in the strategy. We still notice that some companies first of all formulate their strategy and only ask themselves how they can fit ESG into that strategy afterwards.
No universal framework for ESG
The Board Practice has conducted a lot of research into ESG, and the main conclusion we can draw is that it lacks a universal framework. What can help is to ‘take ESG apart’: To look at the components and address them one by one. Standards are already in place for auditing and financial reporting, but not for ESG. How do you deal with that as a Board? The most important thing is not to just wait and use the pre-existing frameworks.
Currently, the most popular framework is the United Nations' Sustainable Development Goals. The 17 goals for 2030 serve as guidelines that companies approach in different ways. Some organizations try to do something for all 17 goals, while others focus on the goals that they can really contribute to and address them in detail. Working with the SDGs and reporting on progress provides temporary frameworks pending a universal standard.
Diversity: What is the culture?
For decades now, there has been a lot of pressure to increase diversity within organizations. It started out as a gender debate, which in some countries is being enforced with regulations. In the Netherlands, for example, listed companies have a quota of at least 30% men and women on Supervisory Boards, and in Norway that quota is as high as 40%. That diversity was therefore driven and enforced by outside pressure.
External enforcement is more difficult with inclusion. An inclusive climate – where there is no need to conform to the dominant culture and where everyone feels free and safe to come forward with their unique contributions – is often considered a prerequisite for diversity. After all, diverse talent quickly departs again if the climate is not inclusive. Inclusion has to truly come from within the organization and be embedded in the culture. An organization can seem really diverse from the outside, and yet its culture may still be defined by one specific group. For that group, allowing everyone's voice to be heard may feel like an erosion of their own position.
What is the role of the Board in this? The Board cannot change the organization’s culture on its own, but it can help the Board by providing a framework for cultural change. This requires a constant focus on the company’s internal structure and how the culture is evolving. The Supervisory Board therefore needs to be familiar with the deeper layers of the organization. Through conversations at different levels, the Supervisory Board can become aware of the various perspectives.
The right leader in the right place
Familiarity with the layers below the Board is also important for another aspect of good governance: Talent management. The role of the Supervisory Board with regard to talent management is to ensure that the organization always has the right CEO at the helm. It is not just about the current CEO – succession also matters. We consider CEO succession to be a continuous process, so that leaders are available to take over the top position at any given time.
What does this continuous process look like? That is the Supervisory Board’s concern. All thoughts and ideas have to be presented to the Board, which has to make a judgment. We often find that Supervisory Boards do not have a detailed consensus on the profile of the next CEO. If the company's strategy is successful, it will look different in five years’ time. The next CEO may therefore need to be a very different person than the current CEO.
It is important that talent management within the organization aligns with the CEO's succession process. An HR Director is therefore a key player who can ensure that the CEO's accession process and the talent management process constantly align. Talent development is, in fact, development toward a potential CEO. It ensures that you always have the right person in the right place for maximum Board effectiveness.
Evaluation
The goal of evaluating Board effectiveness should really be to find out how a Board is performing and what effective performance means. On the one hand, of course, it is about compliance: Ensuring compliance with all of the laws, reporting on time and monitoring processes and structures. You can audit that, but that does not mean you work well together and are effective. Purpose, strategy, relationships, communication and culture are elusive – there is no such thing as a recipe for success. That is why it is important that an external observer takes a look from time to time. Internal evaluations can be effective but also limited, as it is the Board's own vision.
Involving stakeholders and bringing in analysts to observe can also provide valuable information for benchmarking purposes. How do our Board structures compare to those in our industry? Who are we placing on our committees? Another option is to compare skills and experience within the Board with skills and experience within similar companies so that we can learn from that. For example, we recently conducted a benchmark of Board skills in the construction industry in one country and spotted an increase in the appointment of legal expertise. The reason for this appeared to be a growing multidisciplinary strategy and internationalization resulting in work across multiple jurisdictions. These kinds of considerations provide valuable input when it comes to Board composition.
Ready for the future
The Board has quite a lot on its plate. A proactive attitude is very important in order to be future-proof: No waiting around for ESG standards, constantly monitoring diversity, inclusion and talent management, occasionally inviting an outsider’s perspective. This prevents you, as an organization, from being led by outside pressure and allows you to work on your own ambitions on your own terms. The Board therefore acts as a pillar of support for the organization in an evolving world.
This essay was published in Management Scope 08 2022.