The “G” in ESG stands for Governance. Governance can be defined in several ways, depending on the context. For some entities, Governance can be defined as the rules and regulations that a company or business must adhere to. A good example of this could be how local governments conform to rules from larger bodies, such as the European Union, strictly following policies and governing with these laws and rules in mind. However, for the most part, Governance in ESG refers to something entirely different.
For business leaders or real-estate portfolio managers, Governance applies to how a company or asset is managed from the top down. In terms of Governance, a company’s leadership is under the microscope, and leadership styles, the level of transparency and openness, and support for workers’ rights are hugely influential factors.
Governance, as the name suggests, is all about the top-level management of a company and how these executives act and behave towards their employees, and their attitudes towards other major concerns, such as those from the Environment and Social pillars too. Compared with Environment, which is always in the headlines, or Social, which should always be in the front of all business leaders’ minds, Governance is often neglected since it’s harder to regulate. How do you assess how a company conducts its business? How can companies ensure that they are keeping their promises? And why is this important? First, let’s get a better understanding of what Governance really means.
What does “Governance” really mean?
We know that we’re talking about a company’s management, executives, and board of directors, but what is it about their actions that affect ESG? In short, it’s how these players shepherd a company’s values and protect the interests of all of their stakeholders, including employees, shareholders, suppliers, customers, and the wider community.
Good leaders are honest and trustworthy leaders, and in terms of Governance, these leaders need to be transparent, honest, and accountable for their actions at all times. They must take care that a company steers away from any unsound business practices, doesn’t associate or deal with questionable businesses, and avoids any conflicts of interest that may compromise a company’s integrity.
This much should be obvious. But there’s more.
Governance also concerns wider topics that spill over into Environmental and Social principles. From the environmental perspective, Governance concerns a company’s attitude toward climate change and the steps that the management is taking to reduce carbon emissions or reduce their energy consumption. From the Social side of things, Governance can focus on diversity and inclusivity in the workplace, fair salaries, and benefits that help employees or tenants enjoy a better quality of life.
There’s also the financial angle. How executives reward themselves in the form of bonuses can be something that ESG assessors often scrutinize. For example, a company should evaluate the necessity for big bonuses to management while other employees suffer a pay freeze. Naturally, there are times when bonuses are deserved, but a company must decide whether they are appropriate and that the executive in question genuinely cares for the satisfaction of their employees, tenants, and customers, and the overall health of the company, rather than just a short-term pay-off.
Why Governance Is Important For Investors
Governance is a broad term, but it’s incredibly important to investors. Investors depend on those in power to make sound decisions, and poor leadership can lead to disastrous situations. Poor governance results in scandals and scandals can break a company or destroy reputations that have taken years, and in some cases generations, to build.
A prime example of poor Governance would be the Volkswagen emissions scandal, more commonly known as “Dieselgate.” Due to poor leadership, a scandal emerged that caused trust in one of the world’s largest brands to dissolve almost instantly. The result was a significant loss of trust, huge financial implications, and the shake-up of an entire industry. Facebook’s misuse of data scandal is another example of what can happen when Governance isn’t taken seriously.
Curiously, surveys have found that companies that score below average in terms of governance factors often fall victim to mismanagement, which significantly harms their reputation and prevents them from cashing in on profitable long-term business opportunities. Savvy investors don’t take risks. They make decisions based on data, and a company with a poor track record will not be an attractive investment prospect.
Measuring Governance can be difficult, but it is measurable. Many benchmarking tools and questionnaires focus on a range of sub-topics, such as structure and oversight, transparency, cybersecurity, and morals and ethics. Scoring highly in these fields will attract investors and keep your company’s leadership in line.
It’s All About Accountability
At the end of the day, the Governance pillar is all about accountability. Executives and managers sit in leadership positions, and employees, tenants, communities, and other stakeholders rely on them to make sound decisions, but even the best leaders make mistakes. We’re all human, after all. However, taking ownership of these mistakes is also very important. Knowing when to hold yourself accountable and make amends is just as important as working to avoid making those mistakes in the first place. As the saying goes: “If you’ve never made a mistake, then you’ve never made anything.”
Admitting mistakes and working to right wrongs is all a part of the Governance journey. However, it’s always a good idea to put measures in place to prevent damaging decision-making failures or conflicts of interest from clouding the judgment of those in power in the first place.
Governance For The Greater Good
As you can see, it’s important to understand the Governance element of ESG and foster a reputation for trustworthy leadership, with decision-making policies that are built on positive morals and ethics. By investing in strong leadership that’s guided by an ESG-compliant moral compass, businesses and portfolio managers can add significant long-term value to their concerns. It’s a slower game to play, and while it can be tempting to make bad decisions in search of short-term profit, the risks far outweigh the rewards. Always consider the consequences of the Volkswagen Dieselgate scandal. But also consider more than the just financial aspect. Good governance helps protect the environment and create socially just communities and workplaces. The fact that it adds value is an added bonus. This is why Governance should be a key focus for any company’s ESG strategy.
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