What is the best way to integrate sustainability into the corporate governance framework? Boards of directors have chosen two distinct paths: the functional way, which focuses on corporate governance of sustainability, and the foundational approach, which leads to sustainable corporate governance. This article assesses the merits and limitations of both approaches and calls for a transition to sustainable governance. This requires board members to engage regularly with stakeholders and to continuously debate the underlying assumptions to further develop the governance framework as required.
Introduction
In the business world, there is a tendency to respond to each new challenge by developing seemingly new strategies and, as a result, new governance approaches. While the ability to anticipate and respond quickly to new trends is usually seen as a strength, it is not always the most effective approach. There is always a risk of living in the illusion of being able to influence a phenomenon rather than focusing on managing its impact.
The same is true for sustainability. Very often the focus is on proposing new ways to manage issues that are considered sustainable, be it diversity, climate change, or human rights, rather than challenging the underlying assumptions of governance. Even the terminology used, such as ESG (‘environmental, social and governance’), often implies ambiguity. While companies are busy setting up their governance systems to define, enact and measure environmental and social activities, investors ask for indices to assess them.
How to bring clarity to this debate? There are two distinct perspectives for how companies approach sustainability: The functional perspective, i.e. corporate governance of sustainability, and the foundational perspective, i.e. sustainable corporate governance.
Corporate Governance of Sustainability – The Functional Perspective
As companies recognize the increasing relevance of the role of business in society and the environment, they are beginning to functionalize sustainability by establishing sustainability functions, appointing Chief Sustainability Officers, or more generally adopting corporate governance of sustainability. This approach appears to offer a quick fix: Senior management signals to stakeholders that an issue has been addressed.
Boards that choose this perspective typically begin by discussing measurements, measures, and metrics, driven by external expectations and a desire to present what has been achieved to the outside world. While the mission statement may be slightly adjusted to signal commitment, these changes are often semantic in nature and rarely based on a fundamental change in motivation.
As a result, sustainability-related activities are limited in focus and tend to remain stand-alone. Dedicated teams ensure that they are carried out as planned. At the same time, decision makers consider them done. Given the responsive nature of the action, the organization places great emphasis on communication, risking a cosmetic veneer.
Sustainable Corporate Governance – The Foundational Perspective
Developing sustainable corporate governance is quite different from establishing a sustainability function. This implies an integrated view to ensure that everyone in the company is committed and aligned to sustainable value creation, defined as economic value appropriation that generates net positive value for current and future generations of stakeholders, i.e., employees, consumers, suppliers, investors, regulators, and society at large. This requires a sustainable approach to corporate governance, which can be defined as overall systems and structures that enable sustainable value creation.
The path to achieving this begins with addressing the motivation or, in other words, the purpose of the organization. Once the motivation is clarified, the company can adapt the mission statement. Only then does the organization begin to define a roadmap and agree on metrics and measures, and finally measure the impact achieved.
As a result, the activities are likely to be comprehensive and fully integrated into organizational behavior. The measures are usually substantive and consistent with the image presented. Therefore, they are more likely to be viewed as credible by the stakeholders.
The Perspectives in Perspective
While both perspectives have merit, it is important to understand the different goals, development paths, and implications as outlined below.
| Corporate Governance of Sustainability | Sustainable Corporate Governance |
Nature | Functional | Foundational |
Approach | Reactive | Proactive |
Development Path | Measurements, measures, metrics, mission, and motivation | Motivation, mission, metrics, measures, and measurements |
Outcome | Focused and standalone | Comprehensive and integrated |
Impact | Cosmetic | Substantive |
Both perspectives can be, and are, adopted by companies. However, there are risks associated with both approaches that should not be underestimated.
The biggest challenge to overcome is the perception gap: The functional approach can easily lead to greenwashing accusations that are counterproductive to the purpose of responding to changing expectations. In this case, it is advisable not to oversell, but to say what you do, i.e., to comply with regulations and societal expectations, and not to go any further. Second, the company must decide to what extent it wants to actively participate in influencing societal norms and narratives, e.g., through lobbying or communications.
Companies that choose a foundational approach face a different set of communication challenges, as they need to convince the various stakeholders that they pursue a different approach than their peers who choose a functional approach. This cannot be done through communication alone but requires the active involvement and engagement of all relevant stakeholders, i.e., owners, employees, regulators, business partners, and society in general. This engagement must not only be comprehensive, but also related to the process. Stakeholders must be involved from the beginning, i.e., from aligning to a common motivation, to the end, i.e., measuring performance.
This requires the five impact levels to be considered as follows:
Motivation: Sustainable management can only work if those responsible and commissioned adopt the mindset of sustainable value creation. At the same time, they must recognize that there are different mindsets and motivations and that it is ultimately up to stakeholders to evaluate a company's behavior. However, the company must align its governance to be consistent with its interpretation of expectations and mindsets.
Mission: Sustainability is not just a matter of motivation; it must also be reflected in a clear mission that sets a distinct direction within the company and among its business partners. Even more important, however, is that the owners define a corporate purpose that ensures sustainable value creation. This mission statement not only has legal significance, but also sends a strong signal to stakeholders.
Metrics: The commitment to sustainable value creation must be treated like any other endeavor: It should be translated into tangible goals that can be measured to monitor progress, but also to communicate them to all stakeholders. Defining metrics is of particular relevance, as sustainable value creation is the most important metric.
Measures: Like any clear mission, it must be translated into clear measures, both in terms of business direction and governance. This means, for example, designing the structures to accommodate the voices of different stakeholders, and setting up the system to support collaboration and measure these changes. At the same time, the composition of the board should represent the defined purpose, as should the way the owners, board, and management work together. Most importantly, sustainable governance requires a culture that provides space for debates and dialogue about sustainable value creation.
Measurements: Finally, metrics must be applied to ensure transparency and provide feedback to all stakeholders on the extent to which the organization has met or exceeded expectations. Both should be measured: sustainable value creation, but also progress toward sustainable governance.
Making Sustainable Governance Sustainable
Overcoming these challenges is key to turning an organization focused on corporate governance of sustainability into an organization committed to sustainable corporate governance. However, this is only the first step. Sustainable corporate governance is not a destination, but a journey; it is a dynamic process, not a static concept. It requires the board to constantly realign both its goals and its governance. This means that the board must maintain an ongoing dialogue with its key stakeholders and align itself internally to deliver on the promise of sustainable value creation.
In this regard, fully integrating the issues into its leadership culture is imminent. A commitment to constantly questioning the goal and being open to stakeholder input are prerequisites. This requires that the debates and resulting decisions along the five M’s thrive in a governance culture that is effective from an institutional perspective and considers the impact. This calls for considering three governance lenses in board discussions and decisions:
The cognitive governance lens: The cognitive lens illuminates how decisions are made and what conditions and contexts may influence outcomes. In particular, it addresses cognitive biases and their effects. Thus, it considers the cognitive limitations of board members as decision makers.
The political governance lens: The political lens acknowledges that individual decision makers have vested interests that may influence discussions and decisions. These interests may also lead to the formation of alliances among individual members to achieve certain outcomes.
The ethical governance lens: Finally, the ethical lens illuminates the fact that different decision makers have their own values and ethical viewpoints, which can be influenced by various factors. These values affect how decision makers evaluate a situation and ultimately reach a conclusion.
What do the three lenses mean for sustainable corporate governance?
Sustainability through the cognitive governance lens: Board debates about sustainability are vulnerable to several biases. As sustainability is widely discussed in public and strong opinions are expressed, groupthink, i.e., board members' fear of challenging the perceived consensus opinion, can impede open debate. Bias toward the status quo, such as overestimating sunk costs, can be another barrier to achieving optimal outcomes. This bias is of particular importance when it comes to enabling change. The best way to overcome these biases is to openly acknowledge and work together to eliminate them.
Sustainability through the political governance lens: Since the sustainability debate is, at its core, about valuing and balancing different interests, the debate is political in nature. The challenge for board members is to understand the political nature of the discussion, separate personal from organizational interests, and identify potential conflicts of interest. This requires not only full transparency, but also full tolerance of different interests and a shared understanding about how to deal with potential conflicts. Acknowledging the existence of such conflicts helps manage expectations.
Sustainability through the ethical governance lens: Evaluating different approaches to sustainability is always based on personal values and ethical attitudes. A thorough understanding and open articulation of these values is key to understanding why assessments of different sustainability approaches may differ. If a decision-making body does not address the differing values of its members, it risks failing to reach an agreement in the long run. Therefore, open articulation of personal values is vital for success.
To ensure that sustainable corporate governance remains sustainable, organizations must ensure that the governance culture allows and even encourages constant questioning of the status quo. This requires understanding and applying the various governance lenses to achieve the desired outcome in a sustainable manner.
Conclusions
When boards actively discuss and decide how to address sustainability, there is always a risk that they will immediately take action to demonstrate their commitment to sustainability and avoid being seen as out of step with the times. While the functional approach can lead to quick wins and help the company learn more about the issues, the potential cosmetic outcome can backfire if relevant stakeholders begin to question the substance of the actions and their alignment with the commitments.
Companies that intend to move beyond the functional approach are not only well advised to follow a clear process and sequence, starting with aligning on motivation, agreeing on the mission, defining the metrics, designing the measures, and finally measuring the impact, but also to place special emphasis on establishing a strong governance culture that ensures governance remains dynamic and evolves as the shared understanding of sustainability changes. Thus, the journey from corporate governance of sustainability to sustainable corporate governance is, ultimately, all about nurturing a strong governance culture.
This article was published as a chapter in the book Governance of Sustainability in September 2023.