What every manager should know about (5/5): Non-Financial Disclosure

Introduction

This ‘What Every Manager Should Know About’-series is intended for managers whose businesses have to disclose (or feel the need or pressure to disclose) non-financial information. The needs or pressures to disclose non-financial information are manifold. Regulatory compliance such as EU directive 2014/95/EU, NGO pressure, ESG-risk management, demands from investors, and many other factors can all be reasons for a firm to start on a journey of non-financial reporting. Different non-financial topics have in common that they arguably feel unfamiliar to business managers who are trained to mainly think in financial terms. Now that the business case for non-financial reporting is well established (see The Business Case for Non-Financial Reporting), it is time for managers to familiarize themselves with the non-financial aspects of their business operations. In this series, I covered climate change, human rights, new governance, and corruption and bribery. Of course, these merely scratch the surface of non-financial aspects. The range of topics discussed, however, allow us to draw a number of general recommendations that will help you make a plan for implementing non-financial disclosure for your organization. After summarizing these general recommendations, pulled from previous posts in this series, I offer you an additional important point for consideration: which organization function should ultimately be responsible for non-financial reporting?

What we can take from previous posts in this series

  1. Non-financial reporting is tied to risk management. The first thing that you should be aware of is that non-financial reporting is closely tied to environmental, social, and governance (ESG) risk management. Focusing on non-financial aspects will tell you much about the risks your firm is facing in these non-financial areas. In the post on climate change for example, the case was made that focusing on climate change offers your firm the chance to gauge asset and infrastructure risk, price and yield risk, government regulation risk, and reputational risk. Reputational risk was also discussed in relation to human rights. Not adhering to human rights principles, can furthermore lead to risks of disruption in your supply chain because of strikes, bad quality of products, or drops in productivity for example. Managing governance or anti-corruption (discussed in two other posts) in an insufficient manner can lead to anything from reputational risk, to profitability risk, to ultimately risking your firm’s license to operate.
  2. Involving stakeholders is key. In the post on governance, we saw that both an explosion of advocacy groups since the 1970’s and increasing globalization lead to ever more importance and influence of a multitude of stakeholders on your business operations. It makes sense to involve your most important stakeholders when you select the most material non-financial topics for your reporting effort.
  3. Don’t reinvent the wheel and use existing guidelines, certification schemes and overarching (inter)national policy goals. A number of authoritative sources for your ESG-policies are readily available. Posts in this series referred to, among others, the OECD Principles of Corporate Governance, the UN Guiding Principles on Human Rights, and the Anti-Corruption Ethics and Compliance Handbook for Business drafted by the UN and World Bank. In the environmental realm, there is a plethora of multi-stakeholder initiatives that can help your business implement proper policies. For example, WWF endorses a number of multi-stakeholder initiatives, such as the Forest Stewardship Council (FSC) for wood and other forest products, Marine Stewardship Council (MSC) for seafood, the Roundtable on Sustainable Palm Oil (RSPO), the Roundtable on Responsible Soy (RTRS) and the Better Cotton Initiative (BCI). Multiple actors offer tools to help you pick the certification scheme that fits the needs and demands of your business, focusing on social, environmental and governance elements. Beyond certification, your company should be aware of overarching goals set by for example the United Nations (see the Sustainable Development Goals) and governments (see for instance the Dutch push for a circular economy in 2050 which is, in turn, based on an action plan for a circular economy drafted by the EU). Aligning your efforts with those grander (inter)national schemes will help structure your message to stakeholders.
  4. Use a step-by-step implementation plan for your ESG-policies. In both the post on human rights and the post on governance, an 8-step approach to implement a policy on any ESG-topic in your company’s operations (including your supply chain) was proposed:

1) Analyze and prioritize. First, perform a risk analysis and determine where your priorities need to be.

2) Engage stakeholders. Engage widely with stakeholders and formalize the dialogue. The engagement should lead to a decision on a compliance strategy: a code of conduct or certification scheme that has the support of your stakeholders.

3) Select suppliers. Select suppliers that are willing to work together on your priority ESG-topics and are willing to work towards compliance with your targets.

4) Develop KPIs & implement processes and policies. Develop KPIs together with suppliers and other stakeholders. Important: do not forget to design and implement processes, policies and systems that can actually deliver on your KPIs.

5) Evaluate. Evaluate your (and your suppliers) efforts on a regular basis. Follow-up frequently to see if expectations are being met and evaluate progress.

6) Enhance performance. Use supplier development strategies to enhance performance. Implement collaboration and training programs at the supplier, invest in assets, or offer technical and (potentially) financial assistance. Informal evaluations and audits could encourage suppliers to take initiative.

7) Report. Communicate your efforts and results according to the compliance strategy you chose in step 2 or integrate the results in your current ESG-report. Reach out to all stakeholders involved in step 2 and get their feedback.

8) Review. Set-up a periodic review board. Make sure it is composed of in-house professionals and external academic, NGO expertise, and worker unions. Review performance evidence quarterly to identify patterns and explore possible solutions

Assigning non-financial reporting to the CFO

Now that we have a number of guidelines on how to implement non-financial policies and reporting in your organization, the next question would be: ‘who should be in charge?’ For a number of reasons, the answer to that question is unequivocal:

  • Non-financial reporting may not be financial reporting, but it is reporting. Consequently, the person in charge should know how to deal with data gathering, reporting processes, reporting systems, compliance and auditing.
  • Non-financial reporting is closely tied to risk management. The person in charge should have strong knowledge of enterprise risk management.
  • Non-financial reporting has implications for the firm’s strategy and vice versa, the person responsible should have a role in which she can influence decisions on both fronts.

For all these reasons, I propose to hand final responsibility for non-financial reporting to the Chief Financial Officer. Ioannis Ioannou, of London Business School, who has published widely on corporate strategy in relation to ESG-topics, tends to agree in an article in The Guardian:

There are important implications in terms of organisational design and structure. How separate should the strategy and sustainability functions be within a corporation? What should the relationship between the CFO and the Chief Sustainability Officer (CSO) be? Current corporate mindsets consider CSSR [corporate sustainability and social responsibility] issues as peripheral or at best, as separate issues, and therefore there is a clear distinction between strategy and CSSR functions. This is an artificial and dangerous segregation. In fact, for a company that truly understands what strategy will look like in the age of sustainability, the CFO and the CSO should be the best of friends, or even, the same person.

Conclusion

This last installment summarized the main takeaways from previous posts in the series ‘What Every Manager Should Know About’ that focused on non-financial reporting. These takeaways should give you an advantage in implementing both regulatory reporting and voluntary reporting. I covered a number of ESG-topics in relation to non-financial reporting and concluded that 1) non-financial reporting should be tied to risk management; 2) involvement of stakeholders is key; 3) you should use existing guidelines, certification schemes and overarching (inter)national policy goals; and 4) a step-by-step implementation plan for each of your ESG-priorities is needed. In addition, I argued that non-financial reporting should be the responsibility of the C-suite: if not the CFO, then a CSO (Chief Sustainability Officer) that works closely together with experts in governance, compliance, risk and reporting that resort under the CFO. What I failed to discuss is the difference in actual frameworks that structure your overall non-financial report. Again, there is an abundance of frameworks available – e.g. GRI, IIRC, ISO 26000, CDP, SASB – and I hope to give an overview of their respective uses in a future blog entry.

What every manager should know about (4/5): Corruption and Bribery

Introduction

Now that large corporates have to adhere to EU regulation 2014/95/EU, managers should be more familiar with a number of non-financial topics. The EU regulation on the disclosure of non-financial information asks firms to provide information on environmental, social and employee matters, respect for human rights, anti-corruption and anti-bribery matters.

In this post, the spotlight will be on corruption and bribery. I will give you definitions of bribery and corruption, explain why businesses can benefit from fighting corruption and bribery, and will show you how to implement an anti-corruption policy.

Corruption and bribery, an attempt at a definition

Transparency International (TI) defines corruption as ‘the abuse of entrusted power for private gain’. In addition TI says: ‘It can be classified as grand, petty and political, depending on the amounts of money lost and the sector where it occurs.’ I use TI’s definition of corruption, and not the definition given by the EU in its regulation, because the EU regulation does not include a definition. Nor does the EU provide a definition of bribery. So, instead, to find a less concise definition than the one used by TI, I consulted the anti-corruption convention endorsed by the highest number of states, the United Nations Convention against Corruption (UNCAC). However, UNCAC also couldn’t agree on the right definition…

According to Leslie Holmes, the reason why defining corruption (and bribery) is so difficult is threefold. In Corruption, A Very Short Introduction, he writes that cultural reasons, jurisdictional reasons and scholarly reasons all contribute to definitional confusion.  To solve this – and to elaborate on the definition offered by TI – Holmes proposes a 5-step approach to identify corruption, which I will use in the remainder of this blog:

  • the action (or omission) must involve an individual (an official) or a group of officials occupying a position of entrusted power;
  • the official has a degree of authority in decision-making;
  • the official must commit the act (or omit to do what he should) at least partly because of personal interests or the interests of an organization to which he belongs, and these interests must ultimately run counter to those of the state and society;
  • the official acts in a clandestine manner, and is aware that his behavior is or might be considered illegal or illicit. If uncertain about the level of impropriety, the official opts not to check this because he wishes to maximize his own interests;
  • the action or omission must be perceived by a significant proportion of the population and/or the state as corrupt.

Corruption encompasses both economic improprieties, such as embezzlement and bribes, and social improprieties such as appointing family (nepotism) or friends (cronyism). (Please note that cultural norms might label the same activities as corruption in one culture, but not in another; this is the reason for including the last step — i.e. the action must be perceived as corruption — in the approach to identify corruption.)

The difference between corruption and bribery, thus, becomes clear: bribery is a form of corruption. The OECD further defines bribery by listing some instruments for bribes: gifts, hospitality and entertainment, customer travel, political contributions, charitable donations, sponsorships, facilitation payments, and solicitation and extortion.

Considering the possible elements of corruption above (i.e. bribery, embezzlement, nepotism and cronyism), bribery is arguably the salient form of corruption in the business world. This is perhaps the main reason why the terms ‘bribery’ and ‘corruption’ are almost used interchangeably in guidance documents targeted at the business world. The OECD Good Practice Guidance on Internal Controls, Ethics, and Compliance, for example, uses ‘ant-bribery’ exclusively. When the same OECD joins forces with the United Nations and the World Bank to draft the Anti-Corruption Ethics and Compliance Handbook for Business, however, the nomenclature is ‘anti-corruption’ instead of ‘anti-bribery’. This confusion of terms should not deter us, though. Bribery is a form of corruption. When a guideline calls for business to implement procedures to combat corruption, I think it’s a safe bet that they want you to implement procedures to combat bribery. In the remainder of this post, I will use the terms interchangeably.

Why should businesses care about corruption and bribery?

Your business should obviously comply with rules and regulation (such as EU regulation 2014/95/EU) on the disclosure of your policies and results in preventing corruption and bribery. There are a number of reasons why governments and international organization would push for such regulations (all that follows is, again, from Corruption, A Very Short Introduction):

  • Societal reasons. Corruption can lead to reduced aid. It can lead to increase inequality and a sense of ‘them and us’, or to reduced social capital and low levels of trust, and higher (organized) crime rates. A specific example where society pays the price for corruption relates to the construction industry where corrupt safety inspectors ignore malpractices in return for bribes, leading to unsafe buildings. (Also see my blog on human rights and the Rana plaza disaster.)
  • Environmental reasons. Corruption and bribery can be a problem in issuing permits for natural resource exploitation. One problem that you have surely heard about is illegal logging in countries like Brazil and Indonesia.
  • Security reasons. ‘For a state to exercise its defense, law enforcement, and welfare function properly it needs adequate funding; if corruption reduces government revenue, this has detrimental effects on the state’s overall capacity to protect its people. There is a strong correlation between weak states and high levels of corruption.
  • Economic reasons. Countries that score high on perceived corruption (see for example the corruption perception index 2016 from Transparency International) face lower levels of Foreign Direct investment, have lower tax revenues, and often face issues like ‘brain drain’.

In addition to the reasons that governments and international organization would offer to combat corruption and bribery, surely there is a conspicuous reason for business to do so as well: free competition. Businesses depend on free markets and free competition. Without it, your firm could lose out on business unfairly. It is one thing to lose business to a competitor where there is a level playing field; it’s an entirely different thing if you lose business to a competitor who engages in bribes to secure sales. The UK Secretary of State for Justice, in his foreword to the guidance for business to the UK Bribery Act (2010), says:

Addressing bribery is good for business because it creates the conditions for free markets to flourish.

A second reason why business should care is to maintain its reputation. The numerous corporate corruption cases which surfaced in the last years didn’t do much good. Holmes gives some examples:

The focus so far has been on the negative impact of corruption in the narrow sense (i.e. that involves state officials). But in the 21st century, the general public has become far more aware of the potentially devastating effects of corruption in its broad sense. As one Western corporation after another – Enron (USA), WorldCom (USA), Parmalat (Italy), Siemens (Germany), AWB (Australia), to name just a few – has been shown to have been engaging in misconduct, including bribery and kickbacks to secure overseas contracts, so the public’s trust in the corporate sector has plummeted.

The Economist, in a review on a new book about corruption, puts it like this:

Corruption is never far from the front page. In recent weeks, thousands of Romanians protested against plans to decriminalize low-level graft, and Rolls-Royce was hit with a [$835m] penalty for alleged bribery. Meanwhile, long-running corruption scandals continue to roil political and corporate leaders in Brazil and Malaysia. The growing attention has spurred governments to pledge action, as dozens did at a global anti-corruption summit in London last year.

Anti-corruption policies thus help companies (i) to defend free markets and (ii) build their reputations as trustworthy and reliable business partners. One way to do this is to explicitly report on bribery and corruption (just as the EU directive demands). Some see this as an extension of corporate governance reporting (see my blog on new governance) and propose to add it to other corporate governance disclosures. Holmes describes the evolution to a quadruple bottom lining as follows:

Since at least the early 1990s, more and more companies have been presenting their annual reports not merely in terms of financial performance – the traditional ‘bottom line’ – but also of their social and environmental achievements. (…) This triple bottom lining – also known as the 3Ps approach, namely ‘people, planet, and profit’- is usually presented as ‘sustainability reporting’. But in recent years, there has been a push to add a fourth bottom line, governance. This would include reporting on what a company has been doing to reduce bribery and corruption. It is argued by proponents of this ‘quadruple bottom lining’ that firms would benefit from reporting a fourth line, since it should enhance a company’s reputation.

To be able to report on your efforts to prevent bribery and corruption — as Holmes describes, and the EU regulation demands — you first have to implement the proper procedures within your firm. This is the subject of the next paragraph.

How to implement an anti-corruption policy

In implementing an anti-corruption policy, you could revert to one of the many guidance documents available. I already mentioned the UK Bribery Act Guidance and the OECD Guidelines. What follows is a (very) short overview of best practices from the Anti-Corruption Ethics and Compliance Handbook for Business drafted in a joint-effort by the OECD, the World Bank, and the UN Office on Drugs and Crime (UNODC). This is not so much a step-by-step guide on how to implement an anti-corruption policy, but an exhaustive list of things to keep in mind while drafting, implementing and following up on your policies and procedures to combat corruption.

  1. A risk assessment, addressing the individual circumstances of the corruption and bribery risks faced by your firm and its business partners, should be the basis for any anti-corruption program.
  2. Support and commitment from senior management for the prevention of corruption. Senior management’s involvement should be strong, explicit and visible.
  3. Develop an anti-corruption program. The program should at least include your firm’s anti-corruption efforts, including values, code of conduct, detailed policies and procedures, risk management, internal and external communication, training and guidance, internal controls, oversight, monitoring and assurance. The program should be applicable to all employees.
  4. Oversight of the anti-corruption program. Top management appoints a senior officer to oversee and co-ordinate the compliance program with adequate level of resources, authority, and independence. The senior officer in charge, reports periodically to top management.
  5. Clear, visible, and accessible policy prohibiting corruption. Here, you can think about preparing and disseminating an internal anti-corruption manual.
  6. Detailed policies for particular risk areas. Areas often mentioned are: gifts, hospitality and entertainment, customer travel, political contributions, charitable donations and sponsorships, and facilitation payments.
  7. Application of the anti-corruption program to business partners. Here, you should consider all business partners you may need to include in rolling out your compliance program, such as contractors, suppliers, agents, lobbyists, consultants, auditors, representatives and distributors.
  8. Internal controls and record keeping. This refers to proper financial accounting procedures and other checks and balances.
  9. Communication and training. Periodic communication and periodic documented training for all employees.
  10. Promoting and incentivizing ethics and compliance. The firm’s commitment to an anti-corruption program should be reflected in its human resource practices. It should be clear that compliance with the program is mandatory and that no employee will suffer demotion, penalty or other adverse consequences for sticking to the program, even if it may result in losing business.
  11. Detecting and reporting violations. The anti-corruption program should provide a safe space, and encourage employees and others to raise concerns and report suspicious circumstances.
  12. Addressing violations. Your firm should consider appropriate disciplinary procedures to address, among other things, violations of laws against corruption and bribery, and the company’s ethics and compliance program.
  13. Periodic reviews and evaluations of the anti-corruption program. Install periodic reviews to assess if improvements to your program are needed.

What’s next?

The ESG-topics covered in this series have some common aspects. First, they could all be seen as posing a risk to your company’s efforts for profitability (or even your license to operate). Second, it could be argued that they are not a core element of your firm’s mission but are ‘hygiene’ factors that do not immediately lead to higher profitability per se, but could hurt profitability if not properly managed. Third, external communication on these topics goes beyond communicating to such direct stakeholders as shareholders, customers and regulators. These three common aspects lead me to propose that ESG-topics should be viewed and managed as an integral topic from both an organizational structure as a business process point-of-view.

In my final post on the EU directive and related ESG-topics, I will, thus, revisit the advice given in previous blog posts, and try to synthesize these in a unifying approach towards managing ESG-topics relevant for your organization.

What every manager should know about (3/5): New Governance

As your organization is getting ready for the implementation of EU guideline 2014/95/EU on the disclosure of non-financial information, I hand you a series of blog posts on non-financial topics that business managers might be less familiar with. My aim for this series of posts is twofold: First, to give you insight into concepts that are integral to non-financial frameworks on reporting, such as the Global Reporting Initiative (GRI) framework. Second, to show why and how you should integrate these specific non-financial disclosures into your overall business and risk management strategy.

The first blog in this series discussed climate change; the second post discussed human rights.

For the third installment in this series on non-financial information, I will focus on governance. Not the governance business managers might already be familiar with; but a new governance arising from a world where a diverse multitude of stakeholders influence the decision-making process within the firm.

I will discuss what new governance is, why new governance is a good way to manage your ESG-risks, and how you should go about implementing a way of working that takes into account new governance.

Corporate Governance

Governance is the process of governing. Governing, in turn, is defined by the Oxford English Dictionary as conducting (i.e. directing or managing) the policy and affairs of a state, organization, or people. Corporate governance, therefore, can be defined as managing the policies and affairs of a corporation.

Business managers will be familiar with corporate governance being described along the lines of the following (and many more) concepts: accountability procedures for board and management team; policies and accountability to shareholders and other stakeholders; transparency; ethical behavior; audit procedures. All these concepts and procedures of corporate governance have been well established: see for example the G20/OECD Principles of Corporate Governance. (Although I have to add that discussions on governance issues such as executive pay, and occurrences of accounting scandals will probably never end, as this article and this article (respectively) in The Economist show; I guess no amount of governance will ever change human nature…)

Since business managers (and their internal and external auditors) already have a very clear understanding of what corporate governance entails, it would not add anything to their knowledge by only restating the principles of corporate governance as defined by (e.g.) the OECD. Instead, I will focus on a broader definition of governance. As you will see, this broader definition will help you understand how governance is a more extensive issue than just corporate governance, and how it is linked to those other ESG-risks: environmental risk and social risk.

Beyond Corporate Governance: New Governance

Setting rules, regulations and policies to govern the organization internally is not sufficient to manage a business organization in the twenty-first century. A number of developments in the last decades have pushed governance from hierarchical structures (such as those followed by most corporates and all national governments) towards new forms of governance.

The first of these developments is the ‘explosion of advocacy groups during the last third of the twentieth century’ as Mark Bevir calls it in Governance, A very Short Introduction. Without a doubt, the increasing range and variety of stakeholders are getting an ever stronger say in policy development, whether it be government policy or corporate policy. A second development is that the rise of globalization has called for global governance to manage international flows of good, money and financial products or investment. Increasing globalization necessitates governance of non-economic issues such as security, food safety standards, climate change, and other issues affecting global commons that transcend national boundaries (e.g. clean air and water, protecting marine life).

The old form of hierarchical governance (via national or international institutions) is increasingly replaced by multi-stakeholder governance models. According to Bevir, the features that these new models have in common are:

  • they combine established administrative arrangements with features of markets and networks;
  • they are multi-jurisdictional and often transnational;
  • they involve an increasing range and plurality of stakeholders;
  • governing arrangements, different levels of governance, and multiple stakeholders are often linked together in networks.

Business firms should be aware of new governance because they increasingly run into non-economic issues that transcend national boundaries. In many cases, they will find that the issue at hand is governed by new governance, instead of by old-fashioned hierarchical governance (i.e. national rules and regulations).

Corporate Governance vs. New (or Network) Governance

Although governance in business organizations is already in place in the form of corporate hierarchical governance, business managers need to be aware of new governance in the form of network governance. There are roughly three types of governance according to Bevir:

Most of the typologies focus on three ideal types: hierarchy, market, and network. Each of the ideal types relies on a particular form of governance to coordinate actions. Hierarchies rely on authority and centralized control. Markets rely on process and dispersed competition. Networks rely on trust across webs of associations. (…) Box 1 provides an overview of the resulting types.

As for corporate governance, organizations are – by their very nature – steeped in hierarchical thinking. In addition, the market variety of governance should not hold too many secrets for business organizations either. Network governance, however, is a different matter. Because of developments described earlier – dramatic increase in advocacy groups, and increasing multi-stakeholder governance for transnational issues –, organizations are faced with mounting pressure to start using network governance as an additional governance model in organizational processes.

Implementing Network Governance

Implementation of network governance within a business organization – to manage issues that transcend the sole responsibility of the company – might feel unconventional for business managers for two reasons. First, companies are built on hierarchical foundations and compete in markets, but the principles of network governance – based on trust – will feel new and alien in a business environment. Second, corporate governance is still very much focused on shareholders (as opposed to stakeholders) as Bevir argues:

A key principle of corporate governance is thus the rights of shareholders. The main issue of corporate governance is how to ensure that the rights of the shareholders are properly safeguarded.

Network governance introduces the concept of interdependency between multiple stakeholders, which comes with a number of sets of conflicting modi operandi: trust vs. authority, interdependent vs. dependent, diplomacy vs. rules and commands, and reciprocity vs. subordination. (Again, see box 1.) It is, thus, not an exaggeration that the ways of network governance are a-typical for how most business managers are used to conduct their business.*

Taking into consideration that i) network governance is a-typical for any business organization, ii) the need for implementing network governance is increasing, and iii) not being able to handle new governance poses an (ESG-) risk in itself, I propose that organizations start implementing new governance on a case by case basis, in order for the organization to get used to the processes of network governance.

In my previous blog post in this series, I introduced an 8-step approach on how to implement a human rights policy in your organization. Here, I repeat that approach in a slightly different format to highlight the elements that I think will help you understand where network governance comes into play.

An approach to start working on an issue that needs involvement of many stakeholders should always start with a broader ESG-risk analysis to determine where your firm’s priorities should be. After that – and this is the first step of implementing network governance in your organization – engage stakeholders. Engage widely with stakeholders and formalize the dialogue. The engagement should lead to a decision on a compliance strategy: a code of conduct or certification scheme(s) that has the support of your stakeholders. (The next four steps in the 8-step approach are mainly geared towards supplier selection in such a way that you can deliver on your results, so I will not discuss these here.)

After you have results from your activities and operations, report and communicate your efforts and results according to your compliance strategy or integrate the results in your ESG-report. Reach out to all stakeholders involved and get their feedback. The last step is setting up a quarterly review board. Make sure it is composed of in-house and NGO experts, external academics, and local stakeholders such as unions and local communities.

In short, to put you on track for implementing network governance in your organization, you should: engage stakeholders, report to stakeholders and get their feedback, and finally discuss your results in a quarterly review board. Putting so much emphasize on stakeholder processes (and regular transparent public reporting) might feel unconventional in a business environment, but it is the only way to adapt the firm’s processes to face non-economic transnational issues.

As I already argued in my blog post The Business Case for Non-Financial Reporting, disclosing non-financial information can lead to insights on how to update your business strategy or improve stakeholder relations. In addition, by implementing the new governance model, your firm will report on ESG-topics in such a way that your stakeholders will endorse your efforts. Implementing network governance thus becomes a powerful mechanism to reduce your overall ESG-risk and manage your firm’s reputation.

(* On a more philosophical note: network governance might also feel a-typical or unconventional because of the reign of the two main theories in international relations. Realists seem to accept that international issues are power-issues not all too different from Thucydides’ history of the power struggle between ancient Athens and Sparta. (Reading the classics really never is a waste of time.) Liberals hope to solve international issues through international institutions and law. Network governance (in this case called global governance), in contrast, seeks a solution that is not found in realist or liberal views; it tries to solve international issues through informal norms and self-monitoring. This could also be called the multi-stakeholder view, I suppose. For a short introduction on these views, again refer to the excellent little book by Bevir on governance.)

Holiday Reading to Blow Your Mind (and expand your perspective)

If reading up on philosophy can make you a more creative and effective manager, why not start by reading some non-business books that focus on contemporary philosophy?

Harvard Business Review argues that philosophy, through an increased ability for self-reflection, makes you a better leader. Reading philosophy:

(…) can promote business success by helping leaders to identify their values and strategic goals, synthesize information to attain those goals, and implement strong action plans.

Bloomberg writes about how philosophy can make you a better manager because it helps you to develop empathy (i.e. put yourself in someone else’s shoes). There is a warning though:

[Philosophy] doesn’t lead to easy answers, but it does help lead to the right questions. And that’s the true value of philosophy in business life. It can lead (…) to valuable self-reflection. But perhaps more importantly, it can help us think more clearly about the practical issues we face every day.

The Economist writes that real thought-leadership can only be achieved through reading ‘a few great thinkers’:

Inward-bound courses would do wonders for “thought leadership”. There are good reasons why the business world is so preoccupied by that notion at the moment: the only way to prevent your products from being commoditised or your markets from being disrupted is to think further ahead than your competitors. But companies that pose as thought leaders are often “thought laggards”: risk analysts who recycle yesterday’s newspapers, and management consultants who champion yesterday’s successes just as they are about to go out of business. The only way to become a real thought leader is to ignore all this noise and listen to a few great thinkers. You will learn far more about leadership from reading Thucydides’ hymn to Pericles than you will from a thousand leadership experts. You will learn far more about doing business in China from reading Confucius than by listening to “culture consultants”. Peter Drucker remained top dog among management gurus for 50 years not because he attended more conferences but because he marinated his mind in great books: for example, he wrote about business alliances with reference to marriage alliances in Jane Austen.

As much as I would love to dig deep into Thucydides here, I’ll keep it contemporary for now. Therefore, for this year’s holiday reading list, I selected some contemporary philosophy books by authors in the sphere of the humanities (a psychiatrist, an economist, a historian, and a moral philosopher among others).

It struck me that every single one of these authors has a different take on the state of our world and culture. Some argue that we (humans) are going into the right direction and there is a lot of progress in different fields. Others argue just the opposite. I find this quite intriguing. In the picture above, I’ve tried to put the books from this year’s holiday reading list on a scale from ‘pessimistic’ to ‘optimistic’. In discussions, some have suggested that the ‘pessimists’ should really be labelled ‘realists’; and those realists actually show much more insight in what it means to be human. I tend to agree. On top of that, people also suggested that one scale might be an oversimplification of where the authors stand: that it should be possible to introduce a second (and even a third axis). They probably have a point there too. However, I decided to stick with the scale for now. Both as a provocation to you, the reader, and a reminder to myself that I still have to come up with a better understanding than the ‘pessimist – optimist’ (or ‘no progress – progress’) dichotomy.

My recommendations for this holiday are (roughly in the order I read them, so ‘optimists’ and ‘pessimists’ in no particular order):

War, What Is It Good For. Ian Morris. This Professor of Classics at Stanford University argues that war has actually made society more productive and safer. It’s a sweeping view of world history from pre-historic times to the present. He introduces beautiful concepts such as the lucky latitudes, stationary bandits, and caging. Add to that the role of fortifications, cities, chariots, bronze, and gunpowder in shaping our civilizations (and the mere geographical (!) position of Germany that would lead to its tragic role in two world wars), and you have a book that will change your view on the role that warfare has had in the history of the world. In a review for this book, a Professor of Biological Anthropology at Harvard writes: “This book is equally horrific and inspiring, detailed and sweeping, light-hearted and deadly serious. For those who think war has been a universal disaster it will change the way they think about the course of history.”

Why Grow Up? Susan Neiman. Susan Neiman, a Harvard educated moral philosopher, held positions at Yale and Princeton, and is now director of the Einstein Forum in Berlin. This short book struck me because of the simplicity of its idea: in our lives we should always strive to bridge the gap between what is and what could be. Being a grown up is all about trying to bridge that gap through your endeavors. Whilst knowing that you can never really bridge the gap, and, very important, at the same time being comfortable with the idea that you will never reach your destination. In the process of reading this short book (perfect length for the holidays!), you will get acquainted with what Rousseau, Kant and Hume had to say about growing up (and how Neiman disagrees with them). She stresses the virtues of travelling, reading fiction, and living and working in other cultures than the one you grew up in. Two snippets (of many) that I especially liked: “We are kept dazzled by a wealth of small decisions”, and “Kant thought the Stoic advice was made for gods, not humans.”

The Silence of Animalson Progress and Other Modern Myths. John Gray. This former Professor of Politics at Oxford, Harvard and Yale doesn’t beat around the bush when he writes about the concept of progress: “Among the many benefits of faith in progress the most important may be that it prevents too much self-knowledge.” In a chapter called Humanism and Flying Saucers, he argues (if the chapter title itself wasn’t self-explanatory): “If belief in human rationality was a scientific theory it would long since have been abandoned”, and “Cognitive dissonance is the normal human condition”. Gray was actually the reason why I put ‘pessimist’ as the label on the left of the scale in the picture above (and you might start to get an inkling why…). Gray uses fiction (cf. Neiman and Heijne) by Orwell, Dostoevsky, and Conrad to show what the actual human condition is like. It’s fitting that Heijne (see below) uses roughly the same authors to come to a comparable gloomy sketch of the status of the world. It’s a beautifully written short book, full of insights that’ll make you question your world view. Although I rate him as a ‘pessimist’, I had to laugh out loud often because of his dark yet witty prose. If there’s one book you should read right now, it is The Silence of Animals.

Our Culture, What’s Left of It. Theodore Dalrymple. I only recently read this 2005 collection of articles after remembering some quotes I read in an old NRC Handelsblad article on Dalrymple. If the hypothesis holds that it is true that understanding other people’s arguments will make you a better decision-maker, I thought I would try to read a more conservative thinker like Dalrymple. He was shaped by working with urban poor all over the world as a prison psychiatrist. This has led to unique insights in the workings of ‘life at the bottom’ (as he calls it in a different book). Something that struck me as particularly insightful (and echoing the work of moral philosopher Jonathan Haidt and Nassim Taleb’s thinking) was: “But critics of social institutions and traditions (…) should always be aware that civilization needs conservation at least as much as it needs change. No man is so brilliant that he can work everything out for himself, so that the wisdom of ages [Taleb calls this heuristics; see my comments on Taleb’s book Antifragile] has nothing useful to tell him.” This is a kaleidoscopic collection of articles on Shakespeare, art, lust, and the transgression of moral standards. The Times Literary Supplement stated: “An urgent, important, almost an essential book (…) elegantly written, conscientiously argues, provocative, and fiercely committed.”

Antifragile – How to Live in a World We Don’t Understand. Nassim Taleb. A must read. I keep coming back to this book. But it’s hard to describe why. A former derivatives trader and risk analyst, Nassim Taleb made himself into some sort of a philosopher-statistician-writer who has held positions at the London and Oxford Business Schools. You could characterize him by being a skeptic; skeptic towards the scientific method (and very much a proponent of heuristics, or rules-of-thumb; also see my remark under Gray’s book):

(…) the best way to mitigate interventionism is to ration the supply of information, as naturalistically as possible. This is hard to accept in the age of the internet. It has been very hard for me to explain that the more data you get, the less you know what’s going on, and the more iatrogenics [harm caused by the healer] you will cause. People are still under the illusion that science means more data.

 He rants against just about anything in modernity:

We are moving into a phase of modernity marked by the lobbyist, the very, very limited liability corporation, the MBA, sucker problems, secularization (or rather reinvention of new sacred values like flags to replace altars), the tax man, fear of the boss, spending the weekend in interesting places and the workweek in a putatively less interesting one, the separation of work and leisure (though the two would look identical to someone from a wiser era), the retirement plan, argumentative intellectuals who would disagree with this definition of modernity, literal thinking, inductive inference [Taleb is very skeptical towards predicting future outcomes by extrapolating the past], philosophy of science, smooth surfaces, and egocentric architects. Violence is transferred from individuals to states. So is financial indiscipline. At the center of all this is the denial of antifragility.

I will not explain what he means with antifragility here; you should find out for yourself by reading this wonderful book. You might be irritated by his ability to put just about everything in a different light in a polemic way. But that’s exactly why you will gain new insights and be able to look at more things from a different angle.

Onbehagen (Discontent). Bas Heijne. A Dutch essay. A sharp analysis on why populism is rising and why that is inevitable. Heijne, a Dutch essayist who studied English language and literature and writes an influential column in NRC Handelsblad, questions if the worldview that he grew up with (i.e. progress) is still valid. With the help of fiction (again, remarkably, Dostoevsky and Conrad) he comes to the conclusion that we should not overestimate human rationality. He writes (book available in Dutch only as far as I know):

Wanneer het humanisme te zeker van zichzelf wordt, wordt het onherroepelijk naïef – en ook hypocriet. De mens laat zich niet rationeel beheersen. Hoed je voor de overmoed van de rede, het idee dat de wereld zich een kant op laat sturen, dat beschaving een blijvende garantie is tegen menselijke agressie en vernietingsdrang. Beschaving en verlichting roepen het onheil over zichzelf af zodra ze blind worden voor tegenkrachten – van buitenaf maar ook van binnenuit.

World beyond Your Head. Matthew Crawford. On my “to read” list for this holiday. From what I read about this book in Heijne’s essay (see above), Crawford goes on a philosophical journey to unravel why our contemporary society is at odds with human nature. The short supply of attention these days is not the result of technology (which helped shape social media and anecdotal news feeds). It is rooted in the philosophical worldview on the self, on the individual. The Guardian writes: “Like the Enlightenment philosophers he rebukes, Crawford makes deductions that stretch commonsense logic to its maximum extent and may have readers performing intellectual somersaults over his reasoning. For those who persevere, the experience should be rich and rewarding.”

Progress. Johan Norberg. This book by Johan Norberg, an economic historian, made this list because of an article in The Economist earlier this year. On top of that, it showed up as one of the ‘books of the year’ in the same newspaper. Also, it seems that this is an upbeat book that sits all the way on the right hand side of my makeshift scale from ‘pessimism’ to ‘optimism’. If you want to learn about the arguments of both the deniers of, and believers in, progress, Norberg’s book seems to be the book to learn about the argument of the ‘optimists’. The Economist writes:

Mr Norberg agrees with Steven Pinker, a psychologist, that humankind is also experiencing a “moral Flynn Effect” [the Flynn effect is a gradual rise in average IQ-scores since the 1930s]. As people grow more adept to abstract thought, they find it easier to imagine themselves in other people’s shoes. And there is plenty of evidence that society has grown more tolerant. As recently as 1964, even the American Civil Liberties Union agreed that homosexuals should be barred from government jobs.

To summarize: whether you are an ‘optimist’ or a ‘pessimist’, you should read up on the arguments of both sides presented in this year’s holiday reading list. These books will present different sides of the argument and will surely help you be a more creative decision-maker. Happy holidays, and happy reading!

P.S. For those of you who worry I abandoned my project “What Every Manager Should Know About…” in relation to the EU-guideline on the disclosure on non-financial information, fear not: I will be back with post #3 in that series – on governance and corruption – in January.

What every manager should know about (2/5): Human Rights

0-mazars-infographice-eiu-survey-march-2015_oe_full

As your organization is getting ready for the implementation of EU guideline 2014/95/EU on the disclosure of non-financial information, I hand you a series of blog posts on non-financial topics that business managers might be less familiar with. My aim for this series of posts is twofold. First, to give you insight into concepts that are integral to non-financial frameworks on reporting, such as the Global Reporting Initiative (GRI) framework. Second, to show why and how you should integrate these specific non-financial disclosures into your overall business and risk management strategy.

The first blog in this series discussed climate change. You can read it by following this link.

The second blog of the series will discuss the aspects of human rights you should be familiar with as a business manager. I will discuss what human rights are, what the key drivers for respecting human rights are and, finally, how you can build a supply chain that respects human rights.

Defining Human Rights

What should the relationship between business and human rights be? The United Nations (UN) defines the role of business as respecting human rights; as opposed to states, that must protect human rights. Paragraph 12 of the UN Guiding Principles on Business and Human Rights (UNGP) states:

The responsibility of business enterprises to respect human rights refers to internationally recognized human rights – understood, at a minimum, as those expressed in the International Bill of Human Rights and the principles concerning fundamental rights set out in the International Labour Organization’s Declaration on Fundamental Principles and Rights at Work.

Both the International Bill of Human Rights and the International Labour Organization (ILO) are part of the broader human rights movement that arguably started with the Enlightenment. In the table below, the Bill of Human Rights and the ILO are put into historical perspective. I highlight the texts which are referred to in this post (i.e. Bill of Human Rights, ILO, and UNGP) in blue:

table-complete

As we can see from this non-exhaustive timeline, human rights are ever evolving and expanding. In the words of Andrew Clapham in Human Rights: A very Short Introduction:

The human rights catalogue will continue to expand as new challenges emerge and new constituencies find it helpful to frame their claims as issues of human rights.

To list all articles in both frameworks (International Bill of Human Rights and in the ILO’s Declaration on Fundamental Principles and Rights at Work) will not be very helpful for managers to develop a first understanding of business and human rights.  Instead, I use clusters of human rights introduced by The Economist Intelligent Unit (EIU) in a report on the ‘challenges for business in respecting human rights’ (ranked in the order in which companies scored them as relevant to their activities):

clusters-of-rights

Not all rights are the same explains Clapham. We distinguish between:

  • Absolute rights: genocide, crimes against humanity, slavery, and torture are international crimes which are prohibited at all times.
  • Rights limited through legal restrictions designed to protect a defined legitimate objective: rights to liberty, fair trial, freedom of expression, belief, assembly, association, and property; any restriction on these rights has to be justified as proportionate to the aims pursued by the restrictions.
  • Rights that have built-in limitations: free speech and privacy.
  • Social, economic and cultural rights (sometimes called ‘aspirations’ instead of rights): food, education, health, housing and work.

Now that we have an understanding of the historical background of human rights, relevant clusters of human rights for business, and awareness that rights can have limits; we turn to the business drivers of respect human rights that go beyond mere compliance.

Drivers for Implementing Human Rights Policies

Besides compliance (a primary driver), there are a number of reasons why your company should have proper human rights policies in place. These include the protection of the company brand and reputation. Reputational risk is especially high if a firm has complicated supply chains. A 2015 article in the Journal of Business Ethics explains:

Social issues become relevant in supply chains because of the involvement of multiple suppliers who directly affect the reputation of the buying firm. Additionally, an enlightened stakeholder (both internal and external) holding the firm accountable for social issues in supply chains forces the firm to take responsible supply chain actions.

Two examples that are known throughout the business and human rights community are the Rana Plaza disaster and the Rohingya case in Thai fisheries.

In the Rana Plaza disaster in 2013, over a 1,000 garment workers died in the collapse of a factory building in Bangladesh. The EIU report rightfully links it to a failure of respecting human rights:

Spectacular failures of human rights protection still claim headlines. To cite just one of several recent examples, the tragic collapse of the Rana Plaza commercial building in April 2013 led to renewed questions about the quality of companies’ oversight of their suppliers’ human rights practices as well as the role of government in protecting such rights.

How events like these can hurt your companies’ reputation was shown by the bad news coverage Primark, a low cost British garment label, received when it was linked to the disaster (see for example the article Disaster at Rana Plaza in The Economist).

Another example that shocked the world in 2015, was the enslavement of Rohingya (an ethnic people from Myanmar) aboard Thai fishing boats. The Guardian reports:

Rohingya migrants trafficked through deadly jungle camps have been sold to Thai fishing vessels as slaves to produce seafood sold across the world, the Guardian has established.

The seafood was traced to individual leading supermarkets worldwide that had to take immediate action to manage their reputation.

External and internal stakeholder pressure is often mentioned as another driver to implement human rights policies. NGO’s, local communities, investors, and employees can all pressure the corporation into doing more on human rights topics. Risk management might be a fourth driver for implementing human rights policies and procedures. Risks to manage are, apart from the reputational risk already mentioned, risks that stem from disruptions in the supply chain because of issues with human rights (e.g. strikes, bad quality of products, or drops in productivity, etc.). A final driver, which is sometimes overlooked when it comes to human rights policies, is performance improvement. Workers that are well taken care of tend to perform better, which will, in turn, lead to higher output or higher quality of products in your supply chain.

With these five sets of drivers (i.e. compliance, protecting the company reputation, external and internal stakeholder pressure, risk management, and performance improvement) there is surely a business case for implementing human rights policies in your supply chain. We will now discuss how to do just that.

Implementing Human Rights Policy in Your Supply Chain

From all the ESG-topics that firms try to grasp, human rights might prove to be the most difficult one. The head of government relations at Anglo American, a mining corporation, says (in the EIU report):

the notion of human rights abuses is an alien and scary one among technical functions who are more used to ‘impacts’ and structured, technical processes to address them, as opposed to legal ones.

John Ruggie (who drafted the UN Guiding Principles), also in the EIU report, agrees:

It takes time. It takes training. Things have to be translated into operations-speak if they are going to be effectively internalised by people on the ground.

Concluding that implementing human rights policies is not easy, one of the key strategies in implementing those policies is to team-up: involve NGO’s and maybe academia and regulators. In the words of a study published in the Notre Dame Journal of Law, Ethics and Policy:

Human rights are ever evolving so there is a need for open dialogue with government, social groups, NGOs and other stakeholders.

Taking all this into considerations, I propose an eight step approach to implementing human rights policies in your supply chain. This approach borrows insights from the Canadian Network for Business Sustainability, William Bradford’s comprehensive article Beyond Good and Evil: The Commensurability Of Corporate Profits and Human Rights, and Yawar and Seuring’s literature review Management of Social Issues in Supply Chains.

Step 1: Analyze and prioritize. First, perform a risk analysis and determine where your priorities need to be. An example from the EIU report:

Coca Cola conducted a human rights risk analysis of its entire value chain, which identified seven priority risks, ranging from employment and health and safety issues, through to land rights, compliance with transparency and due diligence requirements.

Bradford advises along the same lines:

Corporations should independently perform a rigorous “social audit” to ascertain the current status of their human rights protective practices, the threats to human rights within their spheres of operation, and the internal procedures available to respond to change and rapidly emergent threats.

Step 2: Engage stakeholders. Engage widely with stakeholders and formalize the dialogue. The engagement should lead to a decision on a compliance strategy: a code of conduct or certification scheme that has the support of your stakeholders. Prioritize. Depending on the size of your operations, it might very well be impossible to implement ‘everything everywhere’. On engaging stakeholders, Bradford argues:

With the inputs from NGOs, corporations will be able to further refine their practices and enhance their capacities for compliance while reducing the risks of litigation and injury to reputation.

Step 3: Select suppliers. Select suppliers that are willing to work on respecting human rights. An implementation of virtually anything in your firm can never be just about ‘ticking the box’. Select suppliers that understand what you are trying to achieve and that will work with you in a longer term relationship.

Step 4: Develop KPIs. Develop KPIs together with suppliers and other stakeholders. Again, use the knowledge of your stakeholders. But do not forget to design processes and systems that can actually deliver on your KPIs.

Step 5: Evaluate. Evaluate your suppliers on a regular basis. Since you are implementing something that is also challenging for your firm, you should follow-up frequently to see if expectations are being met and evaluate progress.

Step 6: Enhance performance. Use supplier development strategies to enhance performance. Implement collaboration and training programs at the supplier, invest in assets, or offer technical and financial assistance. Informal evaluations and audits could encourage suppliers to take initiative.

Step 7: Report. Communicate your efforts and results according to the compliance strategy you chose in step 2 or integrate the results in your current ESG-report. Reach out to all stakeholders involved in step 2 and get their feedback.

Step 8:  Review. Set-up a quarterly review board. Make sure it is composed of in-house professionals and external academic, NGO expertise, and worker unions. Review performance evidence quarterly to identify patterns and explore possible solutions. Such formal review sessions might prove invaluable to organizations according to Bradford:

Over the last decade, formal and ongoing dialogues have developed wherein corporations, NGOs, government officials, academics, labour representatives, and community leaders meet to discuss issues of common concern, including monitoring of, and compliance with, CCCs [Corporate Codes of Conduct] governing the protection of human rights. Such dialogues afford corporations valuable and low cost information as to the social expectations of important stakeholders in a setting that enables the ongoing (re)negotiation of the details of broadly-based norms and principles that constitute civil partnerships. In exchange, NGOs acquire additional social status, wealth, prestige, and access. Through dialogues, corporations can calibrate their practices, learn how best to uphold their agreements, and retain the material advantages of identification by NGOs as socially responsible.

As I already argued in my blog post The Business Case for Non-Financial Reporting, disclosing non-financial information can lead to insights on how to update your business strategy or improve stakeholder relations. The discussion on implementing human rights policy – as part of the discussion on disclosure of non-financial information – has shown again that implementing sound ESG-strategies can boost your risk management, manage your reputation towards stakeholders, and enhance performance in your supply chain.

What every manager should know about (1/5): Climate Change

before-the-flood

As your organization is getting ready for the implementation of EU guideline 2014/95/EU on the disclosure of non-financial information, I hand you a series of blog posts on non-financial topics that business managers might be less familiar with. My aim for this series of posts is twofold. First, to give you insight into concepts that are integral to non-financial frameworks on reporting, such as the Global Reporting Initiative (GRI) framework. Second, to show why and how you should integrate these specific non-financial disclosures into your overall risk management strategy.

The first blog in this series will discuss what climate change is and what climate change has to do with managing business risk. If you are in need of a broader perspective on climate change I recommend Leonardo DiCaprio’s clear and informative film Before the Flood.

Defining Climate Change

Climate Change, according to the Concise Oxford English Dictionary is:

The change in global climate patterns apparent from the mid to late 20th century onwards, attributed largely to the increased levels of atmospheric carbon dioxide produced by the use of fossil fuels.

In his insightful book Climate Change, A Very Short Introduction, Mark Maslin writes:

Over the last 150 years, significant changes in climate have been recorded, which are markedly different from the last at least 2,000 years. These changes include a 0.85°C increase in average global temperatures, sea-level rise of over 20 cm, significant shifts in the seasonality and intensities of precipitation, changing weather patterns, and the significant retreat of Arctic sea ice and nearly all continental glaciers. (…) The IPCC [Intergovernmental Panel on Climate Change] 2013 report states that the evidence for climate change is unequivocal and there is very high confidence that this warming is due to human emissions of GHGs [i.e. greenhouse gases, such as CO2].

To be able to visualize why it’s so hard to combat climate change caused by CO2, consider this illuminating analogy from Climate Shock, by Gernot Wagner and Martin Weitzman:

Think of the atmosphere as a giant bathtub. There’s a faucet – emissions from human activity – and a drain – the planet’s ability to absorb that pollution. For most of human’s civilization and hundreds of thousands of years before, the inflow and the outflow were in relative balance. Then humans started burning coal and turned on the faucet far beyond what the drain could handle. (…) Inflow and outflow need to be in balance, and that won’t happen (…) unless the inflow goes down by a lot.

Recently, we have learned (see a recent Guardian article) that the amount of CO2 in the atmosphere reached 400 parts per million (ppm); that’s 40% higher than pre-industrial levels (280 ppm). In Climate Shock we read why this is a serious problem:

Last time concentrations of carbon dioxide were as high as they are today, at 400 parts per million (ppm), the geological clock read “Pliocene”. That was over three million years ago, when natural variations, not cars and factories, were responsible for the extra carbon in the air. Global average temperatures were around 1-2.5°C (…) warmer than today, sea levels were up to 20 meters (…) higher, and camels lived in Canada.

The conclusion that we must draw from this is not that climate change is new. Rather, for the first time in the earth’s history, climate change is manmade and happens at a rate which would make it impossible for us to re-actively adapt our infrastructure accordingly. Think for example of shifting entire agricultural regions, or moving complete cities from their present-day ocean front locations.

For an illustrated (and witty) example of how extraordinary the current spike in average temperature really is, see A Timeline of Earth’s Average Temperature. Below, only the very last brief time period – with a sharp increase in average temperature – is shown; the full infographic shows much slower changing average temperatures in the last 20,000 years.

temperature

Skepticism towards climate change is like denying smoking causes cancer

Perhaps most of the general public would not see climate change as an urgent problem, as Wagner and Weitzman point out in Climate Shock.  Although the science behind climate change is solid and has been accepted by the scientific community on the weight of evidence of the research, there seems to be an amazing amount of skepticism around the subject in non-science circles. In trying to explain this phenomenon, Maslin writes:

…the media’s ethical commitment to balanced reporting may unwittingly provide unwarranted attention to critical views, even if they are marginal and outside the realm of what is normally considered ‘good’ science. (…) Add to this the greater ease of communication, from conventional media, such as newspapers, radio, and television, to more informal blogs, tweets, etc. Normal private debate among scientists and experts can easily be shifted into the public arena and anyone, what ever their level of expertise, can voice an opinion and feel it is as valid as that of experts who have dedicated their whole lives to studying areas of science. Overall, this contributes to a public impression that the science of climate change is ‘contested’, despite what many would argue is an overwhelmingly scientific case that climate change is occurring and human activity is a main driver of this change.’

Or, maybe skepticism has to do with cognitive dissonance (i.e. a state of inconsistent thought, beliefs, or attitudes), write Wagner and Weitzman:

Whenever science points to the very real potential of these types of catastrophic outcomes, cognitive dissonance kicks in. Facts might be facts, the reasoning goes, but throwing too many of them at you at once will all but guarantee that you will dismiss them out of hand. It just feels like it can’t be true.

Leonardo DiCaprio in Before the Flood echoes this:

We keep being inundated with catastrophic news about the environment every single day, and the problem seems to get worse and worse. Try to have a conversation with anyone about climate change, and people just tune out.

The key point here is that the efforts to understand climate change are a scientific effort. Maslin rightfully states that ‘science is no belief system’. As Armand Marie Leroi points out in his book, this has been true ever since Aristotle invented science:

‘A scientist is someone who seeks, by systematic investigation, to understand experienced reality.’

Being skeptical towards climate change is therefore the same is being skeptical towards the process of scientific discovery itself. It is, Maslin states, to ‘deny that smoking causes cancer, or that HIV causes AIDS’.

Climate Change and business risk management

Integral risk management for your organization should include climate change risks. As the authors of Climate Shock put it: ‘First and foremost, climate change is a risk management problem’.  A risk analysis of climate change would lead to defining business risks that stem from both the direct consequences of climate change (like more severe weather events), and risks that stem from external stakeholders’ actions to curb climate change that, in turn, have an effect on the company’s operations or profitability (e.g. tighter regulations for GHG emissions). Without making any claims of exhaustiveness, as a minimum, your organization’s risk assessment should include the following risks in a risk assessment:

risk-matrix

Asset and infrastructure risk. We already see an increase in extreme weather events that could hurt a firm’s assets and supply chains. In Climate Change, A Very Short Introduction, numerous relevant examples are given:

[I]n recent years massive storms and subsequent floods have hit China, Italy, England, Korea, Bangladesh, Venezuela, and Mozambique. In England in 2000, 2007, and 2013/13, floods and storms classified as ‘once-in-200-years events’ have occurred within 13 years and frequently within a single year. Moreover, in Britain the winter of 2013/14 was the wettest six months since records began in the 18th century, while August 2008 was the wettest on record.

Organizations could use climate forecasting models to show which assets and infrastructure are more at risk because of climate change. A next step would be to develop scenarios that would lessen the impacts on your assets and supply chains (e.g. moving operations to areas less affected by extreme weather events).

Yield and price risk. When climate change starts to affect crop yields, it will also affect purchasing prices. The IPCC (Intergovernmental Panel on Climate Change) brings together key climate research conducted all over the world and provides a consensus of this research. The IPCC, 2014 report found:

Based on many studies covering a wide range of regions and crops, negative impacts of climate change on crop yields have been more common than positive impacts. [S]everal periods of rapid food and cereal price increases following climate extremes in key producing regions indicate a sensitivity of current markets to climate extremes (…).

Your organization should know which commodities are most at risk from the impacts of climate change. This should be a starting point for developing scenarios to mitigate yield and price risks.

Government regulations. Now that the Paris Agreement has come into force, we can see governments stepping up their work to implement policies that will make sure global average temperatures well below 2°C. Barack Obama in The Economist:

[S]ustainable economic growth requires addressing climate change. Over the past five years, the notion of a trade-off between increasing growth and reducing emissions has been put to rest. America has cut energy-sector emissions by 6%, even as our economy has grown by 11%. Progress in America also helped catalyse the historic Paris climate agreement, which presents the best opportunity to save the planet for future generations.

Any policy changes that try to curb climate change will impact business-as-usual. As a mitigation strategy, organizations should try to understand possible policy options and work out the effects on operations and profitability.

Reputation risk. Awareness of climate change in general is on the rise. Whenever the public is of the opinion that the firm’s activities are harmful (this obviously extends beyond climate change), there’s a probability that profitability is at risk. For example, the big palm oil trader IOI was accused of illegal logging recently  ̶  contributing directly to climate change because of loss of rain forest that stores CO2  ̶  , experienced extreme negative publicity (see this article in the Financial Times), and saw share prices and revenues tumbling. As a first step in creating mitigation scenarios, firms should make an effort in understanding external stakeholder’s views and wishes towards the firm’s climate change actions. As the IOI example shows, reputation risk does not only revolve around emissions but also around having supply chains that contribute towards climate change by deforestation (e.g. beef, soy, palm oil, and wood fiber). Your organization should therefore not only know which operations are most at risk from the impacts of climate change (direct risks), but should also know which commodities contribute the most towards climate change (reputation and regulatory risk).

As I already argued in my blog post The Business Case for Non-Financial Reporting, disclosing non-financial information can lead to insights on how to update your business strategy or improve stakeholder relations. Reporting on climate change gives you the opportunity to update your risk management framework. By breaking climate risks down into direct and external stakeholder risks, and putting in place mitigation scenarios, your organization will be well prepared for an age where climate change is at the top of the agenda.

3 Reasons to Use Science-Based Measures in Your Sustainability Report

planetary_boundaries_2015

In the Guardian, the case is made that current reporting practices on sustainability are a great waste of time. According to researchers, nobody actually reads sustainability reports. One of the main reasons being, that reports are impenetrable: they’re just too thick to get through.  The authors identified a number of issues with current sustainability reporting practices which could be the cause for this.

The main culprit: most companies do not have a good process in place to determine materiality. The outcomes of a materiality assessment determine which aspects are to be included in your sustainability report.

One thing researchers missed, which could address both their worry that ‘sustainability reporting has stalled’ and help further discussions on the materiality issue, is the use of science-based metrics in sustainability reporting. I see a number of frameworks arising that all seem to stem from Johan Rockströms’ famous article in Nature, called ‘A safe operating space for humanity’. The premise is beautifully simple:

To meet the challenge of maintaining the Holocene state, we propose a framework based on ‘planetary boundaries’. These boundaries define the safe operating space for humanity with respect to the Earth system and are associated with the planet’s biophysical subsystems or processes. (…) Many subsystems of Earth react in a nonlinear, often abrupt, way, and are particularly sensitive around threshold levels of certain key variables. If these thresholds are crossed, then important subsystems (…) could shift into a new state, often with deleterious or potentially even disastrous consequences for humans.

In short:  we need boundaries – sufficiently underpinned by science – for Earth’s relevant subsystems and processes to continue using the Earth for our resource needs. Boundaries do have to be properly translated for use in existing models (such as the Global Reporting Initiative’s G4 Guidelines). Also, the boundaries must correspond with a firm’s size – as yardsticks against which to measure a companies’ sustainability effort.  This gives us the ability to benchmark a company’s progress against the reality in which it operates. A number of science-based frameworks are already adopted by some of the world’s leading companies on sustainability, e.g. Science Based Targets (Coca-Cola, Dell and Carrefour among many others), One Planet Thinking (Eneco) and Context Based Sustainability (Ben & Jerry’s).

I give you three reasons why your business should include science-based measures and boundaries in its non-financial or sustainability report.

1.     Make your report more relevant by showing your relative impact

The Guardian argues that most sustainability reports do not really invite us to continue reading. I tend to agree. Just pick-up a random sustainability report and you’ll be sure to get lost in tables, charts, figures, and the ubiquitous pictures of smiling, happy people. You immediately wonder how you should put together all these stats and figures to reach a conclusion on the companies’ sustainability efforts. Or, what I often ask myself: why do the things this company does towards sustainability matter at all? What is their impact if you would compare this to the size and scale of their value chain? By including science-based measures and boundaries, you show what your firm is achieving against objective yardsticks. In turn, it’ll make your sustainability report more relevant and credible to your stakeholders and investors.

2.     Show that your business is not ‘greenwashing’

Sustainability reporting is still often seen as a greenwashing operation. Although a claim of greenwashing is actually almost always too severe an accusation considering the definition of that word – ‘misleading information disseminated by an organization so as to present an environmentally responsible public image’ – I hear the term a lot when talking about the sustainability efforts of organizations.

I believe that the term greenwashing is used by the general public, because it is difficult for companies to understand which elements to focus on in their sustainability reporting. This leaves space for stakeholders to wonder about all of the sustainability elements companies chose not to include.

In the article ‘Raising the Bar on Corporate Sustainability Reporting to Meet Ecological Challenges Globally’, the United Nations Environmental Program raises similar doubts about the effectiveness of sustainability reports:

(…) the quality of these reports is insufficient to represent the full impacts of a company’s use of resources and materials on the environment and on communities.

And:

“Corporate sustainability reporting needs to be rapidly elevated from focusing on incremental, isolated improvements to corporate environmental impacts,” said Arab Hoballah, Chief of UNEP’s Sustainable Cities and Lifestyles Branch. “It should instead serve to catalyze business operations along value chains to achieve the kind of transformative change necessary to accomplish the Sustainable Development Goals and objectives by 2030. This is precisely what is needed to encourage countries and companies to act effectively at their respective levels.”

Moving towards more contextual-based reporting – i.e. taking into consideration both boundaries and the impact that is expected from your organization in respect to its size and span of your value chain – will surely make your organization less susceptible to charges of greenwashing and will make your positive impacts (or the steps you take to mitigate negative impacts) clearer to your stakeholders.

3.     Safeguard your business against the Slippery Slope argument

Activist NGOs surely serve a purpose in raising important topics. However, their solutions might go a bit far at times. The way activist NGOs attack businesses often reminds me of something Theodore Dalrymple wrote (on an entirely different topic but the words resonate):

I was still of the callow – and fundamentally lazy – youthful opinion that nothing in the world could change until everything changed.

Hardin, in his magnificent Filters Against Folly, called this the Slippery Slope argument:

The punch line goes by many names, among which are the [The Camel’s Nose,] Thin Edge of the Wedge, and the Slippery Slope. The idea is always the same: we cannot budge a millimeter from our present position without sliding all the way to Hell. (…), the fear of the Nose/Wedge/Slope is rooted in thinking that is wholly literate and adamantly antinumerate.

Hardin goes on to call this the demand for absolute (or extreme) purity:

The greed of some enterprisers in seeking profits through pollution is matched by a different sort of greed of some environmentalists in demanding absolute purity regardless of cost.

And:

When costs are paid out of a common pot, extreme purity in one dimension can be achieved only by impoverishment or contamination of others. Trying for too much we achieve less. Rational limits must be set to every ideal of purity.

Thus, Hardin states that everything that we do will lead to some unwanted consequences. Our actions need to be analyzed with the right terminology (‘literacy’), but, on top of that, we will also need the right measures (called ‘numeracy’; for more on these very useful terms, also see my blog The Business Case for Non-Financial Reporting).

Numeracy doesn’t just mean quantifying things; it means making the numbers relative to certain boundaries that give the numbers meaning. Using science-based measures to show the performance of your business towards certain boundaries or limits makes for a compelling argument to counter any Slippery Slope argument. In a way, what you are doing is making both ‘purity’ and ‘pollution’ more relative. Now, it can be measured and actions can be discussed and taken more objectively.

By way of conclusion: moving closer to a world we want

I have given you three reasons why you should consider moving towards science-based measures and boundaries in your non-financial reporting. As I already argued in a previous blog post, see Beyond Shareholder vs. Stakeholder Value, a firm’s main purpose is to provide maximal value to the economic system, but it should do so by adjusting to changing stakeholder demands. I believe moving to science-based measures and boundaries is the next step in these stakeholder demands and could take non-financial reporting to the next level, benefiting both companies (through the three reasons I gave you) and society as a whole (by introducing planetary boundaries).

Including science-based metrics will not solve everything, but let us see it as the next step and acknowledge that we cannot solve all issues at once. To paraphrase Theodore Dalrymple, moving forward, let us be:

realistic without being cynical, and let us be idealists without sounding like utopians.

On the Need for Redundancy in Project Plans

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As a preface to this blog entry, forget about the strict definition of redundancy found in the Oxford English dictionary that tells you redundancy means ‘no longer needed or useful’. As will become clear – I hope -, redundancy is needed to have an option to maneuver when things happen that you could not possibly have predicted. In other words, redundancy gives you optionality. See redundancy not as superfluous but as an insurance. Or, as an investment even.

Projects fail to meet deadlines and budgets all the time. While rereading random passages in Nassim Taleb’s stimulating and provocative books The Black Swan and Antifragile, it struck me that I always try to build a little redundancy in project plans because ‘you never know what will happen’. Almost never taking time to consider the rationale behind my sub-conscious whispering ‘you never know what will happen’.

Taleb shares some nice insights on the reasons why redundancy (in general) is useful. I hope reading this blog entry will make you look at redundancy – and the world – from a somewhat different angle. (In a way, it is what this blog is all about: discussing concepts and tools that change the way you look at the world. Remember Proust? ‘My destination is no longer a place, rather a new way of seeing.’)

I will discuss two of Taleb’s concepts that will make it easier for you to include some well contemplated redundancy in your future projects. Including redundancy will definitely increase the success rate of your projects. But, you need to be able to explain why you included it in your budget. Here’s how to do that.

Concept 1: the world is more random than you think

Taleb constantly challenges you on how you look at the world. One of the main themes in his books is that the world is more random than we think, and that we are often fooled by this randomness. In Antifragile he argues:

Black Swans (…) are large-scale unpredictable and irregular events of massive consequence – unpredicted by a certain observer (…). I have made the claim that most of history comes from Black Swan events, while we worry about fine-tuning our understanding of the ordinary, and hence develop models, theories, or representations that cannot possibly track them or measure the possibility of these shocks.

Black Swans hijack our brains, making us feel we “sort of” or “almost” predicted them, because they are retrospectively explainable. (…) Life is more, a lot more, labyrinthine than shown in our memory – our minds are in the business of turning history into something smooth and linear, which makes us underestimate randomness.

In The Black Swan, Taleb claims that large scale events cannot be predicted (and are in effect random to the observer):

I discovered (…) that no researcher has tested whether large deviations in economics can be predicted from past large deviations – whether large deviations have predecessors, that is. (…) My results were that regular events can predict regular events, but that extreme events, perhaps because they are more acute when people are unprepared, are almost never predicted from narrow reliance on the past. The fact that this notion is not obvious to people is shocking to me. It is particularly shocking that people do what are called “stress tests” by taking the worst possible past deviation as an anchor event to project the worst possible future deviation, not thinking that they would have failed to account for that past deviation had they used the same method on the day before the occurrence of that past anchor event.

In Antifragile, he goes as far to call this a mental defect:

I have called this mental defect the Lucretius problem, after the Latin poetic philosopher who wrote that the fool believes that the tallest mountain in the world will be equal to the tallest one he has observed. (Note: Read the wonderful poem on science and philosophy by Lucretius called On the Nature of Things. In the 2007 Penguin edition, the translation of the passage Taleb is referring to actually reads as follows: “And any stream will seem to be, to one who’s never seen a larger, the greatest of rivers (…). Indeed, anything we see, we shall imagine, is the largest specimen of its kind if it’s the largest we’ve laid eyes on.”)

So, taking into account that randomness is a fact of life and we cannot predict big events, there needs to be some redundancy to counter for this. The next time you sit down and think through the things that can hurt your project plan, think ‘randomness’ and ‘Lucretius problem’.

Concept 2: the world is more random than we lead ourselves to believe

A second reason why you need redundancy – there might be more reasons, but my aim here is to introduce two new ways of looking at the world offered by Taleb – is the narrative fallacy. Planning is nothing more and nothing less than a narrative – a story – you create around your project based on your previous experiences with projects. You want this story (the budget and the planning) to unravel according to plan. You take with you all the things – the good and the not so good – that happened in previous projects, create a narrative why this happened, and include that knowledge in your current plan. I wrote about narratives and stories before in my blog entry Successful Businesses and the Halo Effect. It’s almost as if rereading Rosenzweig’s comments on stories in the Halo Effect when Taleb writes:

We like stories, we like to summarize, and we like to simplify, i.e., to reduce the dimension of matters. The first of the problems of human nature that we examine in this section (…) is what I call the narrative fallacy. (…) The fallacy is associated with our vulnerability to overinterpretation and our predilection for compact stories over raw truths. It severely distorts our mental representation of the world; it is particularly acute when it comes to the rare event.

And:

If narrativity causes us to see past events as more predictable, more expected, and less random than they actually were, then we should be able to make it work for us as therapy against some of the stings of randomness.

Needless to say, Taleb argues that we are ill prepared for randomness and will always be fooled by our tendency to attach an explaining narrative to events in the past. The narrative, however, will never prepare you for events in the future.

Redundancy as buffer against unforeseen events

The combined effects of randomness of the environment, the Lucretius problem, and the narrative fallacy create a background where you can easily underestimate the impact of unforeseen events in your project (or business plan, or – even – life itself). Build in some redundancy and use the concepts discussed here to rationalize your hunch that tells you: ‘you never know what will happen’. It’ll make your project plans more robust and realistic, and it’ll give you options. A final word from Antifragile:

Redundancy is ambiguous because it seems like a waste if nothing unusual happens. Except that something unusual happens – usually.

Summer Reading

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All my posts so far have introduced books that I think are well worth reading during your summer break. (See the full list of books referred to in previous posts at the end of this entry.) Why read? Nassim Taleb in Antifragile:

. . .  the worst thing one can do to feel one knows things a bit deeper is to try to go into them a bit deeper. The sea gets deeper as you go further into it, according to a Venetian proverb. Curiosity is antifragile, like an addiction, and is magnified by attempts to satisfy it – books have a secret mission and ability to multiply, as everyone who has wall-to-wall bookshelves knows well.

So, what I am trying to do is dig a little deeper and sometimes also further back in time to understand how some ideas first came into being. As Charlie Munger put it:

The more basic knowledge you have . . . the less new knowledge you have to get.

My additional recommendations for this summer do not all go back to the source, but are rather books about very old books. I hope you will enjoy them as much as I did.

The Mighty Dead – Why Homer Matters, by Adam Nicholson. I reread both the Iliad and the Odyssey recently and found reading the poems rather hard work to be honest. Then I stumbled across this 2014 book. I started reading to understand Homer better. But the book amazes as an archaeological Indiana Jones’ journey through Europe and Eurasia. The Daily Telegraph wrote: ‘. . . a compelling case for viewing Homer as a cluster of the qualities that still underlie our civilisation. He is horror. He is honour. He is home. He is us.’

The Lagoon – How Aristotle Invented Science, by Armand Marie Leroi. Not many people would want to dig through all that Aristotle wrote on biology and natural philosophy. Instead, you might really enjoy this book when you travel to Greece. Or anywhere else where they serve great seafood really. As the Observer put it: ‘This big, sumptuous book made me hungry. Intellectually, to learn about the classical world’s take on what we now call science. But it made me viscerally and literally hungry: for grilled fish, oysters, figs and meze, and to sit on the shores of the Aegean idling at barnacles and cuttlefish copulating in the spume. Not bad for a science book.’

The Great Sea – A Human History of the Mediterranean. (I seem it bit biased towards the Mediterranean this summer.) To counter the stories about just one or a few — although great — men or books, I will attempt to read this sweeping history of the Mediterranean. I hope to find another great travel book combined with lots of new insights on how our current world came into being. The Sunday Times writes: ‘His book is full of intrepid explorers, anxious pilgrims, enterprising merchants, ambitious politicians and terrified refugees . . . such a treasure trove.’

The books introduced in my posts so far, are all well worth taking on your summer holiday as well:

Enjoy your summer.

How to Beat Morality Bias in Decision Making

June 2016 was one of those months where groups took center stage over individuals. As Euro 2016 got underway, people no longer supported Man United or Man City, Lazio or Roma, Barça or Real. Instead, they support another group, their country. Then, June 23rd witnessed a clash of supporters and opponents of a Brexit. The lead-up to the referendum made me think: it seems nearly impossible to be persuaded by rational arguments of the other side. Why are we so groupish in our thinking? And, if you consider yourself to be part of a group, will you agree with all or most of the group’s standpoints and base your decisions on those? An Economist article reported that even ‘economists tend to fall into rival camps defined by distinct beliefs’.

In his landmark contribution to humanity’s understanding of itself (according to The New York Times), moral psychologist Jonathan Haidt has some interesting thoughts on why we are so groupish in the first place. Haidt (in his book The Righteous Mind) proposes that natural selection in humans not only took place on the individual level but also on group level:

Most of human nature was shaped by natural selection operating at the level of the individual. Most, but not all. We have a few group-related adaptations too (. . .). We humans have a dual nature – we are selfish primates who long to be a part of something larger and nobler than ourselves.

When everyone in a group began to share a common understanding of how things were supposed to be done, and then felt a flash of negativity when any individual violated those expectations, the first moral matrix was born.

Natural selection favored increasing levels of (. . .) “group-mindedness”—the ability to learn and conform to social norms, feel and share group-related emotions, and, ultimately, to create and obey social institutions, including religion.

This is a huge insight. Once you are caught in group thinking it becomes really hard to see the other side of the story. The story of people in other groups with other moral matrices:

Moral matrices bind people together and blind them to the coherence, or even existence, of other matrices. This makes it very difficult for people to consider the possibility that there might really be more than one form of moral truth, or more than one valid framework for judging people or running a society.

One of the phrases Haidt uses throughout the book is therefore: ‘Morality Binds and Blinds.’

“Yes, but …” I hear you protesting just reading this. Because we are rational human beings and our rational nature will overcome our biases. We are surely always trying to get to absolute truth? Haidt’s research leads him to disagree with the rationalists:

We do moral reasoning not to reconstruct the actual reasons why we ourselves came to a judgment; we reason to find the best possible reasons why somebody else ought to join us in our judgment.

You’ll misunderstand moral reasoning if you think about it as something people do by themselves in order to figure out the truth.

What, then, is the function of moral reasoning? Does it seem to have been shaped, tuned, and crafted (by natural selection) to help us find the truth, so that we can know the right way to behave and condemn those who behave wrongly? If you believe that, then you are a rationalist, like Plato, [and] Socrates (. . .). Or does moral reasoning seem to have been shaped, tuned, and crafted to help us pursue socially strategic goals, such as guarding our reputations and convincing other people to support us, or our team, in disputes? If you believe that, then you are a Glauconian. [Glaucon, Plato’s brother, famously claims that people are only virtuous because of fear of a bad reputation. His argument can be found in Plato’s Republic.]

Haidt makes a very convincing case that our thinking is mainly an after the fact activity to justify our quick intuitive moral judgment. And moral judgments are based on moral matrices of the group you are a member of.

My point here is not to counter the idea that we at least try to make rational decisions. But it is worthwhile to keep Haidt’s warning in mind (‘Morality Binds and Blinds’) the next time you enter a project, program or decision making process in which several groups with different backgrounds take part. Ask yourself if your thinking is really an objective weighing of pros and cons, or your thoughts fall prey to a morality bias.

A good counter measure to prevent yourself from falling into the trap of a morality bias – and maybe other biases too – is a rule the investor and Berkshire Hathaway Vice Chairman Charlie Munger uses:

I have what I call an iron prescription that helps me keep sane when I naturally drift toward preferring one ideology over another. And that is I say “I’m not entitled to have an opinion on this subject unless I can state the arguments against my position better than the people do who are supporting it. I think that only when I reach that stage am I qualified to speak.” Now you can say that’s too much of an iron discipline..it’s not too much of an iron discipline. It’s not even that hard to do.