Assessing the board

The board of directors is the highest governing authority within the management structure at any publicly traded company. The primary responsibility of the board is to protect the shareholders’ assets and to ensure a decent return on their investment. Yet, most investors do not take into account the importance of the board.

This lack of awareness is prompting a few outspoken individuals and institutions to start an unofficial educational-style campaign: to get investors interested and aware of the role and responsibility of the board of directors.

Part of the impetus is the plethora of information now available, through media, financial professionals and a variety of institutions. The other part is an awakening awareness that investors can and do have a say in how a company is run – an awareness that was nurtured by environmental, social and governance proponents both within and outside of the financial profession.

“The board performs the serious work of connecting the owners to the managers,” explains David Beatty, CFA and former managing director of the Canadian Coalition for Good Governance (CCGG), whose 46 institutional investment members manage, in total, approximately $1.4 trillion of assets on behalf of Canadian investors.

“The board’s responsibilities can be thought of as relating to the past, the present, and the future,” Beatty explains while speaking at a mid-summer Toronto CFA Society event. “In terms of the past, the board is responsible for ensuring the accuracy of the company’s accounts. With regard to the present, it has the responsibility of the company’s activities. Finally, in terms of the future, the board is responsible for working with management on strategy, as well as cultivating the pool of managerial talent.”

THE SOCIAL FACTOR Yet, mention the phrase ‘board of directors’ to the average investor and it is likely to conjure up images of smartly dressed men and women standing around a mahogany table, smiling congenially – images typical of annual reports.

It is an image that often leaves investors with the impression that the board is unapproachable and unreceptive.

“This is changing,” explains Michael Jantzi, president and founder of Jantzi Research and leading spokesperson on social investment and corporate social responsibility issues. “The concept of fiduciary responsibility has expanded,” and so has an investor’s perspective on the board and their relationship to the board and the company.

The most notable example of these changes is the level of consideration many boards are giving to environmental, social and governance (ESG) issues. Jantzi, a 20-year veteran in socially responsible investing (SRI) has, in fact, noticed a dramatic change in how investors relate to boards and companies, and how this has increased the profile of ESG issues in the corporate boardroom.

“Investors don’t expect perfection or perfect performance,” says Jantzi, “but they expect board members to pay attention.”

This does not mean that boards have abdicated their primary role as a fiduciary watchdog, says Jantzi. It means the board is listening to the owners and integrating ESG into the day-to-day corporate decisions. “ESG requires boards to capture opportunities that these factors present to senior management. [As a result] board members [are now] dealing with social and environmental issues from a strategic level. That’s because SRI is now mainstream.”

ESG PROMPTED CHANGE ESG is mainstream because consumers placed it there, says Jantzi; ESG is in the boardroom because investors placed it there.

A recent report by the Conference Board of Canada supports this assessment. Report author Coro Strandberg writes: “Corporate social responsibility is directly linked to a firm’s future and needs to be elevated to the board level as a governance issue.” She continues by saying, “firms are coming to understand the importance of corporate social responsibility and sustainability [in relation to] competitive performance, but their focus on CSR at the operational level has kept these issues out of boardroom strategy. Increasingly, boards are starting to understand that environmental, social and ethical issues can be of material significance. Therefore, they are starting to exercise their fiduciary responsibility in this area.”

LONG – NOT SHORT-TERM However, a board’s participation in long-term corporate strategies is actually a relatively new concept for most businesses in developed nations.

In a report released by McKinsey Global Institute the shift from short-term compliance to longterm strategy was the number one desire of the board members that responded to the survey.

“Most developed countries’ corporate boards have spent a great deal of time focusing on meeting regulatory requirements and other short-term goals. This survey suggests that directors now want to focus on the long term, including analysis of trends, future scenarios, and global forces,” write the report’s authors, Andrew Chen, Justin Osofsky and Elizabeth Stephenson. They continue by saying that “as competition for consumers and talent intensifies worldwide and executives increasingly expect social and political trends to influence the bottom line, this shift in focus seems timely.”

Yet a gap continues to exist in the desires and actions of board members. Strandberg, a 25-year veteran in the field of sustainability, asserts: “In Canada and elsewhere, a gap exists in board oversight and the strategic direction setting of corporate environmental, social and ethical performance – with more firms focused at present on operations than on governance.”

She reports that last year fewer than 10 Canadian firms reported having CSR or sustainability explicitly in their governance mandates. This is disconcerting, says Strandberg, since “it has been clearly established that companies that consider their social and environmental performance are more successful over the long term.”

Strandberg continues, “Boards, with their responsibility to protect and enhance shareholder value, must consider all aspects of their firms’ performance – non-financial as well as financial.”

WHAT GOOD BOARDS DO TO BECOME BETTER According to the McKinsey report, only 70% of the respondents on “highly influential boards” admit to engaging management in “substantive debates about strategy.”

While this obviously shows room for improvement, the striking difference is the comparison to boards that have little or no in- fluence on creating values.

Only 10% of their board members admitted to engaging management in discussion and debate. Perhaps this is because only 29% of ineffectual boards had access to executive beyond the most senior level – compared to over half the respondents in highly influential boards who reported “significant” or “unlimited” access. In relation to this, 60% of influential board member reported having “good or optimal” access to leading industry indicators and data (about employee and customer satisfaction). Only a third of respondents on boards with little influence have access to this information.

As long as 11 years ago, a Net Impact study found that more than 50% of graduating MBA students would accept a lower salary to work for a socially responsible company.

By incorporating ESG values into the business model, companies “can attract capital and partners, and ease discussions with community,” explains Dr. Randall Gossen, division vice president of Health, Safety, Environment and Social Responsibility at Nexen Inc., in a report released by the Conference Board of Canada last August.

In the same report Gossen listed five elements of corporate responsibility: business practices, employee relations, partner/supplier & customer relations, safety & environment and community involvement.

“It’s not a question of choosing profitability or responsibility,” explains Gossen. “The growth of socially responsible investment funds over the past two decades has been one of the most obvious manifestations of how investors and society at large increasingly expect companies to behave in more responsible ways.”

Yet, Gossen emphatically believes that incorporating responsible values into the business model is “only words if actions don’t match up.”

He adds that “clear structures and accountability are key.” This requires boards (in conjunction with executives) setting objectives, measuring performance and providing transparent reporting to stakeholders.

WHY IT MATTERS TO THE INVESTOR As the highest governing authority within the management structure of a company, the board of directors’ primary responsibility is to protect the shareholders’ assets and ensure they receive a decent return on their investment.

As investor, boards need to be taken into consideration, as they either dictate or showcase the level of transparency and the amount of accountability a corporation has to the stakeholders and to their surrounding communities.

“If the goal is to balance economic, environmental and social imperatives, today’s business decisions need to carefully balance all three,” says Gossen. Investors need to assess a company, by assessing the board, to determine if attention is being paid to all bottom-line factors, financial and otherwise. “Studies have proven that, in the long term, companies that follow sustainable business practices outperform those with narrower priorities,” states Gossen.

Bruce Simpson, managing partner, McKinsey & Company Canada, also believe that Csuite executives need to be “fully committed… [not] half-hearted or cynical,” about investor values and adhering to financial and non-financial factors that affect the bottom line. “Business sustainability must be a central element of the corporate strategy to ensure it is in sync with the company’s other business concerns. That requires a CEO’s personal involvement.”

Advisors can help investors by determining which companies are steered by boards and C-suite executives engaged in broader fi- duciary responsibilities, explains Peter Sinclair, senior director of CSR at Barrick Gold Corporation. “Is [ESG] a burden? Not if different individuals and entities see that different opportunities exist. The extent to which a company or a board capitalizes on these opportunities is the extent of differentiation in the marketplace.”