There are different areas that are quite correctly drawing attention of European Union policy makers, particularly re-assessing factors that will need to be addressed regarding social elements of the corporate governance matrix after the Covid-19 crisis. This is being given importance to ensure the preparation of a stimulus plan that will be needed for countries with varied backgrounds. It is also being understood that it will require participation of both the public as well as the private sector.
According to the principles of existing company law and the common denominators, it is also agreed that the rules and practices that a Board of Directors will need to follow to ensure transparency, fairness and accountability in a company's relationship with its stakeholders can be "an effective tool for making finance and the economy more sustainable"
Consequently, socio-economists of the European Commission have decided to focus their planned revision firstly on the Non-Financial Reporting Directive (NFRD) and secondly on the Shareholder Rights Directive II (SRDII), which aims to encourage long-term shareholder engagement. Both these elements require large companies to disclose information about how their activities impact the environment and human rights, how they treat their employees, the degree of diversity in the boardroom, and their policies on transparency. NFRD has gained special attention as it is recognised by European States as a component of the European Green Deal, an essential step in the efforts to align EU action with the 2015 Paris Agreement.
To this one needs to add the Environmental, Social and Governance (ESG) factors which are related to giving companies the flexibility to disclose their information. Analysts in this context underline the importance of a strong ESG performance for higher value creation and ensuring long-term success. This has particularly resulted from the fact that investors, employees and consumers are becoming increasingly aware of and sensitive to how companies behave, the values they uphold, and the potential impact they have or might have in the world.
In fact, this socio-economic paradigm will need to be very carefully scrutinised by the whole world from now on till the end of the year. It is not just Europe but Asia, North America, Africa and the Latin America that will need to tread with caution. They will need to remember that all companies are highly dependent on environmental resources, human capital and good governance.
In addition to this, they will have to seriously ascertain how they will attempt to overcome persisting ecological and social challenges related to companies' activities, such as increased pressure on local water sources, environmental degradation, rising carbon emissions, and child and forced labour. This also applies in the case of Bangladesh.
Lastly, while setting forth future measures, all concerned investors will have to be sensitive about how companies behave, the values they uphold, and the impact they have in the world.
It needs to be mentioned here that there have already been some interesting findings by the EU-funded programme Sustainable Market Actors for Responsible Trade (SMART), a project led by Professor Beate Sjåfjell that studied the contribution of finance and businesses to sustainability. It has been noted that interestingly, at times, corporate governance codes have been equating corporate interests with the interests of shareholders and that as a consequence, the transition to a more sustainable society is being hampered.
In this regard, one needs to recall that earlier in the recent past, the Davos Manifesto of the World Economic Forum (WEF) called on businesses to serve the interests of all of society rather than simply focusing on shareholders. This will obviously attract particular attention with regard to all future investment efforts that will be conjoined with recovery efforts. It needs to be realised that all investors, both public and private have to understand that they will have to invest in environmental measures and pay better wages to their employees.
This axiom will apply not only in the case of the European Union but also in particular to those entrepreneurs associated with our garments industry and the leather sector. Firms will need to understand that the only focus must not be mainly on making money for the shareholders.
It would be pertinent to refer here to an important initiative that is also being considered by the relevant authorities in the EU. In principle, they are in all probability going to introduce a ban on dividend payments, bonuses and share buybacks in the recently updated state aid rules. These new rules will apply to businesses receiving public support during the current crisis, as long as the Covid-19 recapitalisation measures have not been redeemed. This would be a welcome first move to stop public money from benefitting private shareholders and executives at a time when many workers and small and medium enterprises are facing financial uncertainty.
Another significant factor has also drawn special attention during this crisis. Economic strategists are thinking that the current economic meltdown might also pose an opportunity to revise the Shareholder Rights Directive 2 (SRD) II. This is being considered because the EU has recognised that the 2008 global financial crisis revealed that managers and investors tend to focus on "excessive short-term risk-taking" and that shareholders "in many cases" supported these practices. To fix this, it is now being felt that the SRDII needs to encourage investors to adopt a more long-term focus in their investment strategies and to consider social and environmental issues, as well as to encourage more transparency and accountability about executive pay.
This exhaustive EU study based on analysis of nearly a thousand companies has shown that as long as companies can not determine what and how they report, the potential of the sustainable finance agenda might be difficult to achieve. That is why opinions have been expressed in Brussels that in the revision of the NFRD, the Commission should introduce an independently developed, legally binding, standardised, and detailed set of reporting requirements for businesses to assess the impact their operations, and their supply and subcontracting chains have on the climate and society. It is generally agreed that without this measure the potential of the sustainable finance agenda will be impossible to achieve and, therefore, the chances of a green, sustainable, Paris aligned recovery will be reduced.
It would be worthwhile to point to what happens in Denmark. There, national public limited companies and limited companies employing 35 employees or more can have employee representation in the board of directors. As such, employees have a say in the remuneration policy.
The European Union for the first time is under pressure to accept that Executive remuneration can be a powerful tool to drive a company's ESG agenda. According to Article 9a of SRDII, remuneration policy "shall explain how the pay and employment conditions of employees of the company were taken into account when establishing the remuneration policy". However, since not all countries require employees to be represented on boards, this does not take place.
In fact, this element is missing in South Asia as well as in most parts of the world. This is persuading many social and economic activists to take remedial measures. They are reiterating that future legislative reforms should introduce an obligation to disclose the compensation ratio between a CEO-to-average and a median employee. This would help ensure corporate transparency, and increase the accountability of the directors, a goal enshrined in SRDII.
On its part, the European Commission should encourage more member states to explore a salary cap for directors' fees and bonuses in state-owned enterprises, as Belgium does. Member states should also organise a consultation with social partners, business representatives, government representatives and scholars at the national level and monitor how directors' remuneration in non-state-owned enterprises is included in their corporate governance codes.
The ongoing Covid-19 pandemic has demonstrated the decisive necessity to strengthen the sustainability and resilience of our societies and fundamentally change how our economies will need to be run in the post-Covid era. Combined and shared efforts in this regard will assist in the creation of better and reformed corporate governance throughout the world. This in turn will assist in sustainable development.
Muhammad Zamir, a former Ambassador, is an analyst specialised in foreign affairs, right to information and good governance.
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