Good CSR practice is built on sound corporate governance,
says Craig Mackenzie
Good corporate governance is a prerequisite for truly effective
corporate responsibility, and there is one particular reason for this.
It is now widely accepted that at least some corporate responsibility
initiatives have significant positive pay-offs for companies over the
long term. For example, they can reduce litigation and reputation risk,
reduce costs and increase customer trust and employee motivation. The
problem, however, is that while corporate responsibility initiatives
create long-term shareholder value, they sometimes do not serve the
personal financial interests of a company’s directors. In other words,
there are circumstances in which firms, their investors and society
share a common long-term interest in corporate responsibility, but
company directors and managers do not.
This problem
arises primarily because the financial interests of company managers
are geared to shorter time horizons than those of companies and their
shareholders. Managers frequently have strong financial incentives to
care about what happens next year, but only weak incentives to care
about what happens in five years’ time. Short-termism has particular
implications for corporate responsibility because, unfortunately, many
of the benefits of corporate responsibility arise over the long term
while many of the costs arise today. Why should an executive back
initiatives that will create long-term benefits for the company and
society, but at the expense of short-term profitability – to which the
value of his or her share options is closely linked? The problem is
exacerbated by the short tenure of managers in many companies today.
Why care about long-term shareholder value if you are unlikely to be
around for long?
One might retort that managers should
back corporate responsibility because it is the ‘right thing’ to do.
Only a cynic would say all company managers and directors are motivated
solely by money. However, misaligned financial incentives are surely
important in preventing managers from supporting serious corporate
responsibility initiatives.
This is why corporate
governance matters. Strong remuneration policies, produced by
independent-minded directors and scrutinized by attentive shareholders,
can help ensure that directors and managers do not have overly
short-term incentives. Good governance practices– such as effective
long-term risk management – can also help create the checks and
balances that make it harder for managers to take inappropriate risks
with the company’s future.
Some of the most entrenched
corporate responsibility problems will only be solved when the effect
of misaligned management incentives – and the crucial role of strong
corporate governance in this regard – is better understood. It is time
for the quality of a company’s governance to become a key part of
assessing what commitment it has made to corporate responsibility.
Craig Mackenzie is head of investor responsibility at Insight Investment
www.insightinvestment.com/responsibility
