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.)