HomeReviewsGood governance ‘pays’

Good governance ‘pays’

The question of correlating good governance with good performance is as old as the corporate governance discussion itself, but conclusive empirical evidence is sparse.

Some 30 years ago researchers at The Conference Board (it’s a global business membership/research group) tried to correlate good governance with good performance by looking at individual indicators of good governance, such as the split of the roles of chairman and CEO, or the number of independent directors. But it soon became obvious that there was no agreement as to which indicator was best and that it was unreasonable to link the entire performance of a company with only one of these governance indicators.

Some 15 years later, when there was a sufficient track record of good governance measures being adopted, a number of (financial) institutions started to link an entire series of typically about 20 indicators of good governance with performance as measured by shareholder returns or some other indicator. This proved more fruitful and statistically promising. But after a few years, markets started anticipating and discounting good governance related to this array of indicators.

Today’s focus is on engagement with shareholders as a measure of good governance. According to a recent study, the benefits of board-shareholder engagement are convincing enough that we should consider proposals that would effectively incentivise or even mandate such engagement.[1] Many stewardship codes for institutional investors now strongly encourage engagement, including the Swiss Guidelines for Institutional Investors issued in 2014.

Nestlé’s approach

At Nestlé the evidence that good governance ‘pays’ is convincing. Good governance allows the company to hire the right employees, because good people want to work for well-run companies. This is evidenced by regular ‘Nestlé and I’ employee surveys. Investors want to invest in well-run companies, as evidenced by the great interest in the company’s regular chairman’s roundtables and governance engagement meetings with investors and proxy advisors. Even customers and consumers care, as evidenced by surveys of millennials, which emphasise the value they attach to buying products from well-run companies.

Therefore, Nestlé’s board of directors is highly engaged in steering the long-term strategy and providing oversight based on strong principles of governance. It has demonstrated in recent years that shareholder dialogue in a diversified shareholder structure is both possible and beneficial. A dedicated sustainability committee and integrated reporting have proven to be valuable additions. The board’s focus is on how strategy, governance and performance leads to the creation of value.

The board recently reconfirmed Nestlé’s value creation model, delivering both top and bottom line growth as well as capital efficiency to drive continuous shareholder value creation. It stated commitments to margin expansion, streamlining the portfolio and a prudent approach toward capital allocation and M&A. It approved a share buyback programme. It facilitated the transition to a new chairman and a new CEO. A rigorous succession planning process brought in five new directors in three years.

Investor support

Board engagement and a focus on long-term strategy bring back the purpose of governance from a compliance exercise to a value adding mechanism to ensure the company’s sustainable long-term growth. Hence the benefits are recognised not only at Nestlé.

Major index funds have clarified their expectations for boards to focus on long-term value creation. Boards are asked to focus on strategy and how its actions create value. According to a 2016 report from a global roundtable series by Frank Bold and the Cass Business School, boards play a key role in steering corporate strategy, influencing corporate values, culture and risk appetite, and determining the attentiveness of the corporation to the interest of its stakeholders and its purpose.[2]

Consequently, board composition has become a new focus topic. According to a 2017 study by Russell Reynolds Associates based on interviews with investors, company directors and governance professionals, an overriding theme was the importance of board quality. Investors and proxy advisors are relying on traditional metrics (e.g. tenure, over boarding) to assess board quality, but are also asking for greater insights into the boardroom.[3]

Related regulatory developments

Under Swiss law, governance and long-term strategy are ‘inalienable’ obligations of the board. The Swiss Code of Best Practice of Corporate Governance of 2014 highlights the board’s duties to determine the strategic goals, but also to shape the company’s corporate governance and ensure the fundamental harmonisation of strategy, risks and finances. It should be guided by the goal of sustainable corporate development.

“BOARD ENGAGEMENT AND A FOCUS ON LONG-TERM STRATEGY BRING BACK THE PURPOSE OF GOVERNANCE FROM A COMPLIANCE EXERCISE TO A VALUE-ADDING MECHANISM TO ENSURE THE COMPANY’S SUSTAINABLE LONG-TERM GROWTH”

The proposed revisions to the UK Corporate Governance Code published in December 2017 include as a very first principle: “A successful company is led by an effective and entrepreneurial board, whose function is to promote the long-term sustainable success of the company, generate value for shareholders and contribute to wider society. The board should establish the company’s purpose, strategy and values, and satisfy itself that these and its culture are aligned.” The board should assess the basis on which the company generates value over the long term and report on this in the annual report.

Under the revised UK Companies Act, the board should consider the impact of the company’s activities on five stakeholder matters and report on aspects that are material to the long-term success of the company, including environmental matters, the company’s employees, social matters, respect for human rights and anti-bribery matters. The information must include a description of the related policies, principal risks and non-financial KPIs.

Pursuant to the new EU Shareholder Rights Directive, institutional investors will have to report annually about their engagement with issuers and how this is integrated into their investment strategy. They must also disclose their voting behaviour and explain significant votes and their use of proxy advisor services.

Conclusion

All of this confirms what Nestlé’s shareholders have known for some time. Ninety-nine per cent of Nestlé’s shareholders supported the revision of its Articles of Association in 2008, which modernised its corporate governance and included a new ‘purpose clause’. Accordingly, Nestlé shall, in pursuing its business purpose, aim for long-term, sustainable value creation. The board verifies this through its sustainability committee and reports on it in the annual Nestlé In Society Report. For the first time this year, the highlights of that report are fully integrated into the annual review of the past business year.

The regulatory developments are promising as well. The governance debate is moving on to board composition and engagement. Perhaps the momentum is shifting from tick-the-box compliance to value creation and growth. Public corporations remain the best hope for reigniting sustainable growth. Good governance can be an important driver for it. The Ethical Boardroom’s 2018 award is a welcome recognition of Nestlé’s efforts in this regard.

Footnotes:

1.Mandating Board – Shareholder Engagement?, Lisa M. Fairfax, University Of Illinois Law Review, April 23, 2013.

2.Corporate Governance For A Changing World, Jeroen Veldman, Filip Gregor and Paige Morrow.

3.Global And Regional Trends In Corporate Governance For 2018, Jack O’Kelley, Anthony Goodman, Melissa Martin

ethicalboardroom

Ethical Boardroom is a premier website dedicated to providing the latest news, insights, and analyses on corporate governance, sustainability, and boardroom practices.

Previous article
Next article
ethicalboardroom
Ethical Boardroom is a premier website dedicated to providing the latest news, insights, and analyses on corporate governance, sustainability, and boardroom practices.
RELATED ARTICLES

LEAVE A REPLY

Please enter your comment!
Please enter your name here

- Advertisment -

Most Popular