Views on improving the integrity of global capital markets
26 April 2021

Sustainable Corporate Governance: Creating Incentives to Integrate Sustainability Interests into Business Operations

In the upcoming months, the European Commission is expected to launch a new legislative initiative and a possible guidance on sustainable corporate governance, with the aim to better align shareholder and stakeholder interests, and to encourage organizations to have a long-term view in their decision-making process. The Commission also launched a public consultation on the topic, to which CFA Institute provided its comments.

CFA Institute recently published the report “Corporate Governance and ESG Disclosure in the EU”, which looks at how corporate governance practices have evolved over the past years and examines the impact of sustainability measures that have been introduced in the European Union in the context of the Renewed Sustainable Finance Strategy and the Action Plan on Financing Sustainability Growth. The study also focuses on how companies can take into account open market perspectives while continuing to seek corporate success and create shareholder value.

Businesses can maximize shareholder wealth in the long term while also considering stakeholder interests. By establishing a long-term horizon, it is possible to satisfy society needs without harming shareholder value or their rights. An increasing number of organizations have started looking at ways to deliver benefits to the wider society. A case in point is Danone, the French multinational company, which added a social mission in its bylaws. The firm claims to operate by bringing benefits to stakeholder’s health. The company has been recently criticized, however, for making a series of investments and business decisions to increase its short-term profits. Activist investors also raised the company’s poor governance practices, such as the fact that Danone’s chair was also the chief executive until few weeks ago.

In a recent CFA Institute webinar, investors and stakeholders discussed how corporate governance frameworks could strengthen the link between companies and society. Josina Kamerling, head, Regulatory Outreach, EMEA, CFA Institute, stressed that both shareholders and stakeholders expect organizations and professionals to increasingly address environmental and social issues and that they also should operate for the benefit of society. The 2021 Edelman Trust Barometer seems to confirm this view as CEOs are expected to step in to address societal issues if governments do not intervene. The survey also found that CEOs and companies should consider themselves accountable not only to shareholders but also to the public.

Armand Kersten, head of sustainable investment, VEB, highlighted that organizations cannot be sustainably valuable if they cannot achieve long-term sustainable financial value. The latter can be obtained only if returns are greater than capital costs.

Aleksandra Maczynska, executive director, BETTER FINANCE, emphasized that companies should have more sustainability experts in their board. More diverse, knowledgeable, and independent board members are necessary to improve companies’ governance. Organizations can achieve better results in terms of sustainability by setting up employment share ownership schemes, which would increase employee’s long-term engagement with their company.

Michel de Fabiani, chair, ecoDa’s Policy Committee, remarked that businesses should pursue profit and performance both in the short and long term. Boards could be better diversified if they include directors with different experience and diverse background on sustainability. The board, as well as its subcommittees and management, should regularly consult and engage with experts on environmental, social, and governance matters to discuss the sustainable approaches the firm may adopt.

Dual-class shares

The CFA Institute report also highlights the increasing practice of dual-class shares in Europe. Several EU countries, such as France, Italy, and the Netherlands, allow the issuance of this type of share to incentivize long-term engagement. Multiple-class shares, however, bring more benefits to controlling shareholders than to minority investors. Company founders can use this instrument to maintain control of the organization, even though they may not have majority ownership. Conversely, noncontrolling shareholders would not enjoy sufficient protection.

The United Kingdom also may change its approach to dual-class shares. Lord Jonathan Hill recently published its recommendations on the UK Listing Review, which was a process launched by the Treasury in November 2020. Following Brexit, the report proposes a relaxation of the UK listing requirements to make the British capital market stronger and more dynamic. In particular, one of the recommendations suggests allowing dual-class structures in the premium listing segment. Although the report also raises some limitations to dual-class shares (e.g., a five-year maximum period), this measure risks harming corporate governance practices in UK capital markets. The Financial Conduct Authority is expected to launch a consultation on some of the recommendations this summer.

The UK deregulation approach may affect the ongoing Brexit agreement covering financial services and trigger a reaction from European regulators. One of the main takeaways of our report is that EU member states should, instead, continue to improve their governance standards.

Due diligence across the supply chain

The European Commission also has been assessing whether to introduce a corporate due diligence duty, which is defined as a requirement for companies to establish and implement adequate due diligence processes in their own operations and supply chain to prevent, mitigate, and report health and environmental issues, including climate change and human rights. Already in January 2020, the Commission published a thorough “Study on Due Diligence Requirements Through the Supply Chain,” which looks at the possible impact of different regulatory options. The most effective measure would be to include a due diligence reporting requirement in the director’s duty of care, which would produce the greatest social impact. Businesses believe, however, that a less burdensome, voluntary approach based on principles also could lead to good results.

Elisabeth Gambert, director of corporate social responsibility and international affairs at AFEP (the French Association of large companies), emphasized that she would be in favor of a principle-based approach on due diligence. According to Gambert, reporting requirements should concern only the main risks related to a firm’s activities and should be proportional to the size of the companies.

Conversely, Matthias Meitner, member of CFA Society Germany, stressed that many investors would prefer to see a legal requirement that would encourage good stewardship. Currently, businesses are not motivated to report their due diligence activities, and a voluntary mechanism may not work. To combat this reluctance to report, the German government has proposed a mandatory due diligence law, which is expected to become law by the end of this summer.

Luca Grassadonia, member of CFA Society Italy, underlined the big challenge for companies (especially multinationals) to go through every layer of their supply chain. In addition, because the supply chain is global for large firms, it would not be possible to regulate those processes occurring outside the EU. A voluntary disclosure system would be more feasible and face fewer challenges.

Discussions on corporate governance are expected to be on top of EU policymakers’ agenda as the Shareholder Rights Directive II, the current legislation on the protection of shareholders and their rights, will be revised in the coming years in the context of the new Action Plan on Capital Markets Union. We found that, although the Directive addressed several issues, such as fixing the plumbing of cross-border proxy voting, protection of minority shareholders remains insufficient. Our report concludes that EU regulators should improve the rules on the exercise of shareholder rights and accountability for small investors.


Photo Credit @ Getty Images / Klaus Vedfelt

About the Author(s)
Roberto Silvestri

Roberto Silvestri is EU Policy Specialist, Capital Markets Policy EMEA at CFA Institute. He helps reach out to regulators and stakeholders about the positions that CFA Institute holds and unravel the complexities of EU regulation for CFA Institute members.

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