How corporate governance is evolving

Milton Friedman was wrong.

In his seminal 1970 essay, the Nobel Prize-winning economist wrote that corporations have no social responsibility beyond making money for shareholders. This doctrine of shareholder primacy has guided generations of business leaders, board members, and policymakers who have ensured that companies move forward in the free market with the sole focus of profit.

Perhaps Friedman, who died in 2006, would have been surprised when the Business Roundtable – an association of the country’s top executives – issued a statement in 2019 that revised a company’s goal as promoting an “economy that serves all. Americans ”, including customers, employees, suppliers and communities.

“It’s amazing how much governance has changed,” said Luke Taylor, professor of finance at Wharton. “My take is that companies shouldn’t be maximizing shareholder value. Instead, they should maximize the welfare of shareholders. There is a difference there because shareholders can care about more than profits. “

Taylor spoke at a panel discussion on November 16 titled “Redefining Corporate Governance”. The virtual event was part of the ongoing program Beyond business series, which explores the most complex and pressing issues affecting organizations and individuals around the world. An extension of the Wharton School Dean of Tarnopol lecture series, Beyond business is broadcast live on Wharton’s LinkedIn page. (See the video below.)

Wharton Dean Erika James led the discussion, which also included Mary-Hunter “Mae” McDonnell, professor of management at Wharton, and Brian Stafford, graduate of Wharton and CEO of Diligent Corporation, the world’s largest corporate governance, risk, compliance and ESG SaaS.

Panelists said that even a quick look at the makeup of modern planks reveals how much they have changed. Environmental damage, social and racial injustices, gender inequalities, the COVID-19 pandemic, technological disruption and other pressures are pushing companies to take a broader look at their purpose and mission. They want board members with specific expertise in areas such as impact investing, human resources, auditing and accounting, crisis management, and AI.

“Many boards are not equipped to offer strategic advice on these types of non-market crises that pose arguably the most business risk for companies today,” McDonnell explained. “The companies are [adapting] by adjusting the profile of the administrators they integrate. This change allows boards to better understand and guide companies in more turbulent social and political environments. “

Companies are moving away from a model in which board members have an almost adversarial relationship with managers, towards a model of greater collaboration. McDonnell compared the transformation of board members to a change from “police” to “arbitrators.”

Stafford agreed and said, “We have found that many board members are just leaning over. When they have expertise, they come much more directly to management and actually help management solve any problems. ”

These changes not only help businesses navigate rough waters, they also help businesses meet customer and employee demands. These stakeholders want companies to be transparent and authentic with regards to environmental, social and corporate governance (ESG) objectives. The chief executive should now serve as a sort of political statesman, Stafford said, and boards of directors are quick to step in if the CEO speaks against the grain of the company’s views.

Compensation matters

Consumer attention to ESG has also shone the spotlight on executive compensation. Panelists said compensation is a hot topic because it is directly linked to the values ​​of the company, at least in the eyes of customers and employees.

“Does this relate to the conversation about what you’re trying to maximize?” Are you trying to maximize value for your stakeholders or are you trying to maximize value for your shareholders, ”Stafford said.

“It’s helpful for boards to understand why pay inequity matters. ” – Mary-Hunter “Mae” McDonnell

Executive pay, McDonnell says, is skyrocketing based on the notion of pay-for-performance that does not extend to core employees who also contribute to the success of the company. Research has linked this disparity to negative outcomes within business and society at large, including lower morale, reduced collaboration, underinvestment in public goods, and higher crime rates. students.

“It’s helpful for boards to understand why pay inequity matters,” she said. “We need to pay attention to the broader social effects of a salary that only those at the top of the hierarchy enjoy.”

McDonnell said companies can incentivize executives to strive for social or environmental performance by using the long-term incentive portion of compensation programs to reward executives for meeting non-financial performance goals, rather than addressing ESG goals. as a “kind of bonus”. About half of S&P companies currently tie some measure of executive compensation to social and environmental outcomes, she said, and research suggests this helps advance ESG goals.

A greener investment strategy

While compensation can be a powerful lever for influencing ESG performance, it is overshadowed by the power of investment strategies. Taylor has studied ESG investments, which have performed well in recent years. Indeed, environmental concerns have increased more than expected, increasing investor demand for green stocks and customer demand for green products.

“ESG investors alone won’t save the world. ” -Luc Taylor

But there is no indication that ESG returns will remain high, Taylor said. Green stocks are expensive because ESG investors have raised their prices.

The boom in ESG investing has made capital cheaper for green companies and more expensive for non-green companies. Taylor said he expects all companies to go greener in order to increase the price of their shares and for capital to be reallocated to green companies.

“We should see fewer coal mines. We should see more solar farms, thanks to the rise in ESG investments, ”Taylor said.

But he warned that the free market cannot solve all problems; policymakers need to write better regulations. “ESG investors alone will not save the world,” he said. “We need more than ESG investors. We also need smart rules. We need smart laws on the books.

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