Boards, Get on Board!

Silence that surrounds the closed and hushed world of boards of directors is sometimes broken. On several occasions recently, their decisions have been exposed and questioned in the press. What is the purpose of this new tone of attention? A questioning of their ability to integrate sustainable development issues and to chart a course for the company they are responsible for managing. How then should modes of governance be reinvented to accelerate change?

On 1^st March 2021, Emmanuel Faber, the CEO of food giant Danone, was ousted from his position as chief executive by the group's board of directors, and on 14 March from the non-executive chairmanship, for poor performance against its competitors. While Danone has ambitiously constituted itself as a "company with a mission" (« société à mission ») since June 2020, a status made possible by the PACTE law (Action Plan for the Growth and Transformation of Companies) of 2019 in France, which implies the inscription in the statutes of a company of its raison d'être and social and environmental missions, this sidelining of a CAC40 company boss has raised questions about the viability of the statute and fuelled doubts about the ability of boards to make the necessary change of model by placing social and environmental objectives at the centre of their thinking. In short, beyond the sole financial compass, the famous triple bottom line must be taken into account: people, planet, prosperity.

This very year, the board of another giant, the multinational energy and petrochemicals company Shell, has come under fire on several occasions. Its directors are being sued personally for their "flawed" climate strategy by a UK environmental organisation, ClientEarth, which is itself backed by a group of investors holding £450 billion worth of shares in the company. The accuser claims that the eleven board members failed to adequately prepare the company for the risks posed by climate change and the transition to alternative energy sources to fossil fuels. In another lawsuit, nearly 14,000 people from two Nigerian communities are seeking justice in London's High Court against Shell, which they accuse of being responsible for the devastating pollution of their water sources and the destruction of their way of life.

As the world shakes, changes and searches for solutions, the eyes of the world turn to boards of directors. Can they disprove the criticism of a general wait-and-see attitude and a preference for the status-quo that they are often subjected to? Faced with the new challenges, how can they rethink their role and play their part in accelerating the transition to sustainable business models?

Boards as guardians of business performance and resilience

The business case for a corporate sustainability strategy is well established. There are countless studies and research studies that establish the performance and resilience case for sustainability. A Harvard Business Review study (2016) summarises it in five key benefits: driving competitive advantage through stakeholder engagement; improving risk management; fostering innovation; improving financial performance and attracting investors; building customer loyalty; and attracting and engaging employees.

In particular, a November 2019 McKinsey Quarterly article beats back the common notion that a sustainability strategy is sub-optimal for corporate finances. "How can a strong ESG proposition make financial sense? By facilitating top-line growth, reducing costs, minimizing regulatory and legal interventions, increasing employee productivity, and optimizing investment and capital expenditures."

This was demonstrated in the 2023 edition of the global ranking of the 100 most sustainable companies in the world, conducted by Corporate Knights and for which Ralph Torrie, the research director, emphasises the favourable background dynamic. He points to the rise in fossil fuels driving the growth of renewables, but also of all the related offerings: smart buildings, electric vehicles and the whole circular economy. The company topping the list, Schnitzer Steel, is a metal recycler. "Global 100 companies are providing the products and services that are needed for the transition to sustainability and that will form the basis of the emerging economy of the 21st century," he explains, "They have outperformed the market over the past few tumultuous years.../...companies that take sustainability seriously are thriving financially."

And investors seem to have understood this. In the last quarter of 2022, for example, according to Morningstar, global sustainable fund flows attracted $37 billion in net new money, a 50% jump from the previous quarter, in stark contrast to the $200 billion withdrawal of cash across the fund universe.

As a criterion of economic and financial performance and a prism for assessing the risks incurred by the company, sustainable development is tending to make its way onto the agenda of boards of directors. For example, according to ecoDA and Ethics & Boards' Corporate Governance Barometer - Europe 2022, ESG issues are entering European board committees and, although not legally required, ESG committees have increased by 54% in the last three years. An Ernst & Young survey published in 2022 also indicates that the amount of time boards spend on ESG issues has increased significantly. Now 49% discuss this agenda at every meeting (up from 15% two years ago), and 33%  discuss these issues frequently. And this is just the beginning of a trend...

Also, in Luxembourg, the report The State of the Luxembourg Boardroom 2021 published by the Institut Luxembourgeois des Administrateurs (ILA) and Diligent indicates that more than 60% of boards intend to put more emphasis on sustainability and ESG over the next 12 months.

From shareholder capitalism to stakeholder capitalism: a broader scope of analysis for boards

The future is open governance. "The board of a company can only fulfil its role today by working with an agenda that covers the issues raised by the company's many stakeholders," says Mads Ovlisen, chairman of the world's leading pharmaceutical company Novo Nordisk. These, defined by R. Edward Freeman in "Strategic Management: A Stakeholder Approach" in 1984 as "any group or individual who can influence or be influenced by the achievement of the firm's objectives", are the voices to be listened to when considering the various strategic and sustainable aspects of a company.

This is also the spirit of the recent generation of company statutes wishing to commit to a sustainable impact, such as the "Societa Benefit" since 2015 in Italy, which places the emphasis on "common benefit"; or the "société à mission" since 2019 in France, which obliges companies to declare their social and environmental objectives.

The forerunner of this transition towards a stakeholder governance mode is the B Corp movement, launched in the United States in 2006 and which today includes more than 6,000 companies in 159 sectors and 86 countries. Its certification implies a compulsory change in the company's articles of association, which makes it possible to perpetuate its commitment despite possible changes in management, in order to integrate its raison d'être and the taking into account of its stakeholders. This new governance makes certified B Corp companies legally responsible for the balance between profit and purpose. This approach is welcomed by consumers, since 78% of them believe, according to a study by the Capgemini Research Institute, that companies have a more important role to play in society than just looking after their own interests.

On the investor side, there are similar signs of agreement. The world's largest asset manager, the American multinational BlackRock, announced in January 2022 through its CEO Larry Fink in his annual letter to company directors that it now supports a new type of capitalism: "It is through effective stakeholder capitalism that capital is efficiently allocated, companies achieve durable profitability, and value is created and sustained over the long- term". Although seen as opportunistic by NGOs, this position is nevertheless indicative of the recognition that a change of model is needed at the highest levels of the global economy.

As a sign that this approach is becoming standardised, the Corporate Sustainability Reporting Directive (CSRD), which will be phased in from 1 January 2024 for listed companies with more than 250 employees, is moving in the same direction, aiming to ensure that environmental and social impacts are fully communicated in standardised reports, notably through the principle of double materiality.

New duties and responsibilities

What are the duties of board members? There is often a misconception, common even among directors, that they have a fiduciary duty to put the interests of shareholders first. This is the finding of the Harvard Business Review, which belies this belief in an article entitled "The Board's Role in Sustainability". After compiling legal memos on fiduciary duty from all G20 countries and 14 others, the authors found that none of these jurisdictions have come out in favour of shareholder primacy.

This idea will soon be definitively undermined as the law becomes more specific on the subject. In particular, the European Commission has specifically addressed the nature of the due diligence burden on directors by proposing a new directive in February 2022, the Corporate Sustainability Due Diligence Directive (CSDD), which is currently under review. If adopted, directors will be responsible for planning and overseeing specific due diligence actions, with due regard to relevant stakeholder input. They will report to the Board in this regard. Member States will therefore need to amend their laws, regulations and administrative provisions to sanction breaches of such obligations, taking into account the impacts on human rights, climate change and other environmental issues.

There is thus a growing trend to see sustainability as a fundamental part of the management and fiduciary role of directors, and their responsibility to address environmental, social and societal challenges. Climate change litigation against companies is on the rise, and claims are now being made against directors and officers. The cause? Their poor decisions or apparent inaction on climate issues in governance, disclosure and oversight of risk management and strategy. As revealed by the Climate Governance Initiative and the Commonwealth Climate and Law Initiative, the main types of legal actions identified are fiduciary duty claims, greenwashing and misleading disclosure claims, climate damage claims, human rights-related claims, etc., in addition, of course, to litigation against governments over their climate policies.

The warning came in May 2021, when a Dutch court ordered Shell to reduce its group's CO2 emissions by 45% by 2030, compared to 2019 levels. Since then, the plaintiff NGO has informed 30 other multinational companies that it is ready to take them to court if they do.not produce transition plans. Since then, more and more cases have been brought to court on these new grounds. This is just the beginning..

Widespread wait-and-see attitude in boardrooms

There seems to be a clear consensus on the key role of boards of directors in guiding a company through the challenges of sustainable development... but - and this is where the problem lies - not so much among those involved. "It is an unfortunate truth that directors tasked with securing their company’s future are often holding the enterprise back with an outdated emphasis on short-term value maximization." write the authors of the Harvard Business Review article "The Board's Role in Sustainability". McKinsey & Company, in its podcast on the subject, points to the general slowness of change and awareness at board level: Lack of transparency and conviction that this is really happening have slowed things down over the last ten years with questions within boards such as "can we trust that climate change is here for real? or 'shouldn’t we just focus on profit and growth ?". Worse, a 2019 PwC survey of more than 700 public-company directors found that a particularly comical 56% felt that boards were spending too much time (you read that right) on sustainability.

The conclusions of the recent Ernst & Young study "How can boards strengthen governance to accelerate their ESG journeys?" are no less stark. "The main internal challenge facing companies today when it comes to generating long-term value through a strong ESG proposition is the "lack of board commitment to making decisions that fully integrate ESG factors and create long-term value". Even today, only 43% of respondents consider this to be a significant challenge.

There is therefore a huge gap, and paradoxically a lack of direction by the very people who are responsible for giving it. What is wrong with the current mode of governance? What changes need to take place so that boards can fully play their role in the much-needed and much-awaited business model transition? How can they make their revolution?

The composition of boards, the first transition lever

The profile of those sitting on boards is very homogeneous. Too homogeneous, it must be said, as it does not reflect the plurality of perspectives and the variety of stakeholders that have been emphasised as the alpha and omega of good governance.

A recurring theme of criticism is the lack of parity on boards. In 2021, only 31% of the board members of the largest European listed companies were women, with significant differences between Member States (from 45% in France to 9% in Cyprus). Luxembourg is below the European average with 22% female representation on its boards. In order to correct this imbalance, the European Parliament officially adopted in November 2022 the "Women on Boards" directive, a new European legislation on gender balance on the boards of listed companies with more than 250 employees. By 2026, these companies will have to have 40% of the under-represented gender among non-executive directors or 33% among all directors. Diversity of gender, but also of age, language, disability, ethnic, cultural, social, educational, academic, professional, etc., is needed to reflect the variety of markets and stakeholders the company serves. "Evidence shows that a wide range of talents and skills and an inclusive and diverse approach in the boardroom contribute to better corporate governance decisions, increase public confidence in companies and stimulate economic growth," commented Helena Dalli, European Commissioner for Equality.

Board diversity is no longer an option: several studies have established that there is a correlation between diversity and companies' financial performance. In a 2018 study, the Boston Consulting Group reported that companies with above-average diversity at the board level generate 19% more innovation revenue than others.

A complementary approach to enable councils to keep abreast of these issues is to set up advisory groups, including academics, scientists or representatives of non-governmental organisations with particular knowledge of environmental or social issues.

Some companies have also set up 'shadow boards'. This shadow board is a group of young non-executive employees who work together (or in parallel) with senior managers and management on strategic initiatives. They bring a fresh perspective and diversify the perspectives to which managers are exposed. According to the Harvard Business Review, organisations that had adopted a parallel board prior to the pandemic were better able to respond to the impact of Covid-19 and the accelerating digital transformation in the workplace. The board can help reinvent the business model, cultural transformation and process redesign. And in this sense be a useful body to bridge the sustainability skills gap?

An acute need for training of boards on these issues

What are the duties of board members? At a time when awareness is growing and organisations are expected to take action, the mastery of skills related to sustainable development by decision-making bodies is becoming crucial. Recruiting expert profiles on these issues within its board is a must for any organisation wishing to optimally manage its transition to a virtuous economic model. The trend is emerging, and boards are progressively acquiring these new skills, in particular through the increasing use of specialised headhunters such as Acre in the UK, Seewhy in Belgium or Birdeo in France.

However, beyond these key expertises, it is all directors who need to be trained in these issues. Upgrading is all the more necessary as the sustainable development agenda and its integration into companies is transversal, covering all the functions of an organisation, whether it be human resources, facilities, purchasing, commercial development, production, etc. In the Grand Duchy, 67% of boards of directors believe that they do not have all the expertise they need to deal with ESG and sustainability issues, according to the report The State of the Luxembourg Boardroom 2021. A real structured programme of support, training and annual evaluation of skills development should be put in place with professional development objectives for directors. According to the Corporate Governance Barometer - Europe 2022 by ecoDA and Ethics & Boards, less than 40% of European companies publish a matrix of directors' skills in their annual report, and with the exception of France and the Netherlands, less than 30% of companies declared directors' CSR/sustainability skills in 2021. In order to support Luxembourg organisations in this process, ILA provides a Board Sustainability Competency Assessment questionnaire. This is a reflective tool supporting Board members - both individually and collectively - to think about and articulate their views and develop a shared understanding of sustainability.

Results measurement and financial incentives

What gets measured gets done. Introducing specific targets and key performance indicators to monitor the company's progress in the area of sustainable development is a crucial aspect that directors should pay close attention to. Taking into account the triple bottom line provides a more holistic view of the organisation's performance and impact, which refers to its vision, mission and values.

However, 52% of respondents to The State of the Luxembourg Boardroom 2021 survey say that they have not yet defined their ESG objectives, let alone measured them... It is true that organisations face many difficulties when it comes to collecting relevant monitoring data. The scarcity and reliability of data is a recognised problem. It needs to be specific, science-based, measurable and comparable. Faced with this complexity, international tools and standards are nevertheless being perfected and are gradually being established as a common reference framework, such as the Global Reporting Initiative since the end of the 1990s and more recently the new ESRS (European Sustainability Reporting Standard) developed by EFRAG (European Financial Reporting Advisory Group), which takes into account the EU Taxonomy Climate Act, and the IFRS (International Financial Reporting Standards) developed by the ISSB (International Sustainability Standards Board) at international level. They will serve as a compass for boards to assess the impact of their organisation and optimise risk governance.

Performance indicators usually also mean financial incentives. According to the Corporate Governance Barometer - Europe 2022 by ecoDA and Ethics & Boards, ESG is becoming an important remuneration criterion when designing incentives for CEOs. In 2021, almost 2/3 and 40% of companies have integrated at least one ESG criterion in the STI/LTI plan of their CEO. It remains to be seen how ambitious and rigorous this is, but the trend has clearly begun... 

It’s all about leadership 

At the heart of the board's responsibility lies the development and validation of the company's strategy, which by definition includes the assessment of the strategic risks and opportunities facing the company. Now, taking into account the present with its inherent conditions of uncertainty and limited resources in order to build the future is precisely at the heart of sustainable development. This makes it a vital topic on the board agenda, no longer optional but mandatory, to ensure the long-term survival and success of the company. The definition of this long-term success perspective, combined with the notion of stakeholder capitalism and the concept of purpose described above, is the ultimate responsibility of boards of directors, with a duty to adopt an intergenerational perspective that extends beyond the mandate of any management team.

Long-term, interdependence and impact are inherent notions to sustainable development. As they are to governance. It is high time for boards to fully embrace their assigned role and their primary obligation, which is by definition to act in the best interests of the organisation. A company will not succeed in its transition without the full involvement of its governing bodies: it is a question of change management, culture and leadership.

To be read also in the dossier "Will there be a revolution in the boardroom?"

• Questions to John Elkington : "The best of today's board members acknowledge that the role of business in society is changing and skewing towards more active engagement at every level".