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CORPORATE GOVERNANCE
SUSTAINABILITY BRIEFING PAPER 4
IN PARTNERSHIP WITH
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CORPORATE GOVERNANCE
Embedding sustainable development
within corporate governance requires
companies to identify and understand
their environmental and social impact and
responsibilities and to act accordingly. The
process involves using the knowledge and
experience of the leadership and others in
the business to establish:
responsibilities of whom and in
relation to which issues?
accountabilities to whom are those
with responsibilities accountable and
how?
checks and balances what
systems of supervision, control and
communication flows are required?
There is a clear link between governance
and financial, ethical and sustainability
issues that traditional accounting, reporting
and audit do not effectively capture.
Governance must draw not just on financial
but also on social and environmental
accounting, reporting and audit to
understand the full scope of a firms
activities and performance and to establish
an integrated approach to sustainability.
Corporate governance is the means
by which companies are directed,
administered and controlled. It influences
how the objectives of the company are
set and achieved, how risk is monitored
and assessed, and how performance is
optimised. Good corporate governance
enables companies to create value
(through entrepreneurialism, innovation,
development and exploration) and provides
accountability and control systems
commensurate with the risks involved.
Corporate governance is a key element
in improving organisational performance
and sustainability as well as enhancing
stakeholder confidence.
A company that is well governed is one that is accountable and
transparent to its shareholders and other stakeholders, such as
employees, creditors, customers and society at large.
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The 2008/09 financial crisis can, to
an extent, be attributed to failures and
weaknesses in corporate governance.
When corporate governance mechanisms
were put to a rigorous test, they failed;
they did not protect against excessive
risk taking and irresponsible behaviour.
Getting governance wrong is not a small
matter that can be dismissed lightly. These
failures have contributed to recession, the
collapse of large businesses, widespread
redundancies, consumer mistrust, and a
fundamental recasting of the relationship
between the state and financial institutions.
So what were the governance-related
reasons for the current turmoil? First,
it was clear that dysfunctional boards
did not fully understand the risks and
impact associated with the strategies and
activities they approved. Neither did they
understand these activities and risks in
relation to sustainability. Furthermore,
in many cases, boards did not provide
adequate monitoring of implementation,
accounting, reporting and audit. The lack
of appropriately qualified non-executive
directors also contributed to the problem,
as the broad range of skills and knowledge
required to fully understand the complex
financial and non-financial factors that
influence organisational performance were
not available.
Dysfunctional boards are symptomatic
of the irresponsible ownership that has
contributed to the financial crisis; powerful
shareholders did not play an active enough
role in improving governance. As a result,
new ownership and governance models
are being considered or in some cases,
such as RBS and Lloyds TSB, being forced
upon companies. The Cooperative Bank
has emerged relatively unscathed from the
current financial crisis, causing Jonathon
Porritt, chairman of the UKs Sustainable
Development Commission, to suggest that,
at the very least, the relative resilience of
this business model should prompt both
Treasury and the sectors regulators to
think again about alternative ownership
and governance structures in the financial
services sector. The investor community
has also failed in its wider role. It failed
to engage actively enough or push hard
enough for meaningful reform, and certainly
did not identify and reward examples of
success sufficiently. Now that investors
have been reminded how crucial adequate
governance is and what failure can mean,
they need to use their weight to influence
change.
Remuneration systems that have
encouraged short-term thinking and
unsustainable risk taking at the expense
of longer term sustainability are also
symptomatic of failed governance.
Bonuses awarded for short-term annual
performance, with limited consideration of
the impact on longer term performance,
encouraged employees to act in ways that
undermined the efficient and sustainable
functioning of markets. Ineffective
governance allowed large mismatches
between risk assessment, incentives
and internal controls. It is clear that risk
assessment procedures have not worked;
they have not always looked at the right
things, or assessed them in the right way.
Taken together, these issues contributed
to the recent large scale business failures.
Corporate governance failings were
certainly not the only cause but they were
a significant contributor to the current
financial crisis and recession. It has
become clear that corporate governance
models need changing. Enhanced
governance practices should be seen as
integral to an overall solution aimed at
restoring confidence to markets, developing
a sustainability approach to business and
protecting us from future crises.
Corporate governance and the current nancial crisis
where did it all go wrong?
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CORPORATE GOVERNANCE
AND SUSTAINABILITY
Corporate governance is on the radar
screens of corporations, regulators and
stakeholders as never before. With the
business media dominated by corporate
activities such as the sub-prime mortgage
lending crisis, carbon trading schemes
and the collapse of many high profile
organisations including Lehman Brothers
and Enron, the role of companies in
society is under ever-greater scrutiny.
Global companies are subject to increasing
demands from activists, employees and
investors to behave in a sustainable
manner, taking into account important
social, environmental and ethical issues.
The trajectories of corporate governance
and sustainability are meeting head-
on and new demands are being placed
on companies and their leadership.
Regulation (such as the King II report)
and the materiality of sustainability issues
are forcing organisations to integrate
such concerns more fully into governance
structures. While certain sustainability
concerns are core to success, they do not
always lend themselves to discussion and
debate within governance frameworks
that focus on financial indicators and
controls. For example, the financial lens of
the audit committee may not fully focus
on some of the important non-financial
issues associated with sustainability.
In recognition of these limitations new
approaches to governance are evolving.

The increasing importance of sustainability
issues is now recognised by many
companies, but for such issues to
truly become integrated into strategy,
operations and performance, they need
to be embedded in governance systems.
The key to successfully embedding
sustainability in governance is getting the
right issues into the mix and getting the
right voices heard. These need to be given
due consideration and not treated as a
mere side issue. This requires aligning
the strategic direction of the organisation
with strategic environmental and social
goals and ensuring governance oversight
mechanisms understand and play their role
in maintaining that focus.
Mainstream governance conversations
have traditionally focused on legal and risk
issues, finances, management structures,
individual competencies, leadership and
independence. Yet todays governance
issues, related to sustainability, all operate
beyond mere legal requirements and focus
on process innovations that engage key
knowledge-brokers through softer forms
of governance that take account of values
and principles. Sustainability is gradually
reshaping the way organisations approach
corporate governance.
The trajectories of corporate governance and sustainability
are meeting head-on and new demands are being placed on
companies and their leadership.

Corporate governance
is concerned with holding the
balance between economic and
social goals and between
individual and communal goals.
The governance framework
is there to encourage the efcient
use of resources and equally to
require accountability
for the stewardship of those
resources. The aim is to align as
nearly as possible the interests
of individuals, corporations
and society
Sir Adrian Cadbury, Corporate Governance Overview,
1999 World Bank Report

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King II
King II is the abbreviated name for the King Report on
Corporate Governance for South Africa published 2002.
It followed a 1994 report commonly known as King
I. Companies listed on South Africas JSE Securities
Exchange have to comply with King II.
It is a set of principles. It does not determine a detailed
course of action. It states that the board is responsible
for the process of risk management and that it must
decide the companys appetite and tolerance for risk. The
board must ensure that an assessment of the processes
and outcomes of key risks is undertaken annually.
And, importantly, risk management information should
be disclosed annually. It sets out the following seven
characteristics of good corporate governance:
discipline (a commitment to adhere to proper
behaviour)
transparency (ease with which an outsider can
analyse a company)
independence (use of mechanisms to prevent conflicts
of interest)
accountability (decision-makers must be accountable
for decisions)
responsibility (for behaviour allowing for corrective
action and for mismanagement)
fairness (systems must be balanced)
social responsibility (awareness and response to
social issues).
THE ROLE OF BOARDS
The board needs to realistically evaluate the
nature and signicance of the sustainability
issues facing the company, as well as where
sustainability needs to be considered in relation
to issues such as succession planning and
performance evaluation.
Boards are a crucial component of governance structures and, as
with other governance mechanisms, need to embrace sustainable
development. There is a need to ensure that boards have the ability
to lead with integrity and possess the right skills to make difficult
decisions and manage risk.
The voices of wider stakeholders clearly need to be included in the
governance process. Employee representatives have participated
in boards for a number of years; perhaps the most well known
cases are in Germany and Japan. But, clearly there is a need to
look beyond employee representatives alone and to carefully select
non-executive directors with sustainability-related expertise in areas
such as the environment, health and safety, consumer relations or
human resources, as well as those from non-business backgrounds
who can bring valuable perspectives into the boardroom. These
skills and perspectives can enable companies to evaluate key
strategic sustainability issues more comprehensively and monitor
their performance more effectively. Non-executive directors need
the right blend of skills, experience and personal qualities to enable
them to advise, monitor and challenge effectively. Organisations
need to be encouraged to cast the net widely in seeking such
people and to develop a deeper understanding of what skills are
required. The board needs to realistically evaluate the nature and
significance of the sustainability issues facing the company, as well
as where sustainability needs to be considered in relation to issues
such as succession planning and performance evaluation.
Expert stakeholder advisory panels can also help bridge the gap
between an organisations wider stakeholder engagement and its
governance, by bringing experts together with senior management.
Companies are increasingly using expert panels to advise how to
respond to emerging social and environmental issues in a way that
is strategically aligned to the organisations business model. The
existence of a committee responsible to the board allows specific
issues to be explored in more depth than is possible at board
level, while ultimate responsibility remains with the board as a
whole. Where these panels exist it is crucial that they are credibly
integrated into the traditional governance structures.
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Panels and CSR Governance
at British Telecom
BT has had a CSR leadership
panel for several years. The
purpose of the panel is to
encourage innovation and
leadership on sustainability and
corporate responsibility. The
panel consists of external and
independent thought leaders in the
fields relevant to both sustainable
development and BTs strategy
and operations. It meets four times
a year and has a remit which
includes advising on key areas of
performance and strategy.
The panels primary contact is
with the BT CSR team but links
into the BT board and presents
to them at least once a year
when the BT board discusses
corporate social responsibility
strategy, performance and risks.
The panel keeps the board
informed of emerging issues and
changing stakeholder expectations
that may affect its duties. In
addition the panel provides an
annual independent comment on
BTs social and environmental
performance within the non-
financial report.
Remuneration and incentives, while not
often thought of as a sustainability concern,
would benefit from being viewed through a
sustainability lens. Remuneration needs to
be considered in terms of pay equity and
pay differentials as well as in relation to the
way in which it influences unacceptable
risk taking. Short-term performance-related
pay is seen by many as central to many
of the problems, particularly within the
banking system, that caused the global
financial crisis.
REMUNERATION AND INCENTIVES
There is growing pressure to redesign corporate regulation
and governance to emphasise the importance of long-term
sustainability in relation to remuneration practices.
There is growing pressure to redesign
corporate regulation and governance to
emphasise the importance of long-term
sustainability in relation to remuneration
practices. Central to this is the need to
dismantle incentives which have led to
short-termism and an undermining of
corporate ethics. Incentives clearly need
to encourage sustainable behaviour.
They need to be based on longer term
performance characteristics and encourage
decision making that will advance the
sustainability of organisations, incorporating
both financial and non-financial metrics.
Including sustainability issues in the
creation of new remuneration and incentive
structures will give a greater focus to these
issues at both a strategic and day-to-day
level.
While clearly a more fundamental review
of remuneration practices is needed, there
is evidence of an existing trend towards
longer term incentives. A report by PWC
in 2007 found that there has been a
continued emergence of bespoke long-
term incentive plans designed for specific
business circumstances. The same report
also suggests that two thirds of companies
surveyed had adopted a balance scorecard
linking non-financial performance to
rewards, and across the FTSE, just 20%
of companies relied solely on financial
metrics to judge executive remuneration.
Increasingly executive bonuses will
depend on non-financial performance,
with customer satisfaction, employee
engagement and health and safety ranking
as the most commonly considered issues.

It would be useful to
have further clarication
of sustainability-related
responsibilities from the board
level through to the executive
committee, including whether
and how remuneration includes
incentives based on
sustainability performance
Alcoa Stakeholder Panel, 2008

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The Brazilian Novo
Mercado
The Brazilian Novo Mercado is a
premium stock market listing for
shares issued by companies that
have voluntarily adopted corporate
governance practices and
transparency requirements beyond
those requested by law. Created
by the Sao Paulo Stock Exchange
Bovespa in 2001, it is based on
the premise that stock valuation
and liquidity are positively affected
and assured by shareholders
rights and the quality of company
information. The primary market
restricted entry to those that met
stringent standards including:
the issuance of only voting
shares
a minimum of 25% of shares
not controlled by majority
shareholders
12 month terms for board
members
provision of statements in
accordance with US GAAP
and IAS GAAP
settlement of shareholder
conflicts by arbitration.
THE ROLE OF INVESTORS
Questioning the suitability of non-executive directors in
understanding the materiality of non-nancial issues is crucial.
Institutional investors and fund managers
have a responsibility to generate long-term
value on behalf of their shareholders, the
individual savers, investors and pensioners
for whom they are ultimately working. They
should insist that the companies they invest
in put sufficient resource into developing
governance mechanisms that deliver long
term value. Shareholders should take
governance into account as part of their
investment decision-making.
Institutional investors and other
shareholders need to understand what
questions they should be asking boards.
For example, does the board have the
knowledge and competencies necessary to
understand the sustainability implications
of the current market and does the board
composition reflect the direction of the
future strategy? Questioning the suitability
of non-executive directors in understanding
the materiality of non-financial issues
is crucial. Ultimately investors need to
ask if the board and individual members
are delivering. Part of this is establishing
whether governance meets international
standards. The case below indicates the
reaction of investors when the answers are
not as they wish.
Corporate Governance and Investors:
Marks & Spencer
Marks & Spencer sparked a furious reaction from big
institutional investors in 2008 after announcing that it was
combining the roles of chairman and chief executive to
keep Sir Stuart Rose at the business until 2011. Investors
reacted strongly to the decision and, although they have
since been reassured to a certain degree, the incident
highlights the ability of investors to influence and stresses
the importance of governance to this community.
The Co-operatives responsible investment manager at
the time stated The structure clearly departs from best
practice. We are also disappointed by the lack of prior
consultation with shareholders. The head of equities
for Legal & General, one of the largest shareholders,
emphasised the importance of accountable governance:
As set out in the Combined Code we believe strongly
in the separation of the roles of chairman and chief
executive, believing this allows a much needed balance
in the boardroom and prevents the potentially damaging
concentration of power.
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OTHER GOVERNANCE MODELS
The quality of governance is important not only for individual
companies but also for collaborative initiatives, partnerships and
wider economic systems.
Collaborative governance
Collaborative initiatives and various types
of partnerships (including public-private
partnerships) are seen by many as a way
to successfully address many sustainability
challenges. However, these collaborative
initiatives and partnerships do not always
deliver their objectives. Underlying many
of the challenges are governance systems
that fail to deliver accountable decision
making. Partnership performance depends
on effective governance. Partnerships are
supposed to create new ways for citizens,
stakeholders and interested parties to
engage in the delivery of sustainable
outcomes. To ensure the governance of
partnerships is effective there is a need
to create incentives for good partnership
governance, to ensure partnership
governance systems gain the trust of core
stakeholders and to build the knowledge
and capacity of partnerships and their
stakeholders to govern effectively.
New global governance
Current economic circumstances raise
serious questions as to the adequacy
or perhaps even relevance of many
preconceived notions of good corporate
governance, especially those emanating
from international best practice rooted
broadly in Anglo-Saxon approaches that
have proved lacking. There is a growing
feeling that now is the right time to forge
a cooperative approach to the crisis,
and to build a stronger, more inclusive
international financial and economic
governance architecture that will also
address other global challenges such as
energy and climate change, security and
terrorism, and poverty and health issues.
European Commission President Barroso
has indicated that major reform is needed
on the current financial supervision and
regulation model at international level and
that it should be built on the principles of
transparency, responsibility, cross-border
supervision and global governance.
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THE ROLE OF ACCOUNTANTS
The work of accountants is clearly crucial
to effective governance, especially in
relation to its traditional focus on financial
performance and accounting integrity. The
fundamental role of the accountant is to
provide transparency in reporting, financial
or otherwise, to shareholders and the
broader stakeholder groups who have an
interest in the performance of the business.
To undertake this role accountants must
ensure they are familiar with the general
management, risk management, operational
and reputational aspects of the business to
provide context to the figures presented in
the financial statements. In order to provide
independent opinion on a companys
financial statements, ie their annual
report, accountants must have access to
information on all company activities which
could be material to its financial position.
Accountants working in a business are
involved in several of the governance
mechanisms, which may include
nominations committees (identifying
appropriate candidates/non-executive
directors) for the board, remuneration
committees and risk and compliance
committees as well as the audit committee.
The Sarbanes-Oxley Act 2002 defines
the audit committee as a committee
(or equivalent body) established by and
amongst the board of directors of an
issuer for the purpose of overseeing
the accounting and financial reporting
processes of the issuer and audits of the
financial statements of the issuer.
Audit committee members are faced with
increased expectations from many groups,
including shareholders, shareholder and
governance activists, regulators, the media,
and fellow board members.
The other area where accountants
working in business currently support
good corporate governance is in de-
coding regulation for the company
and supporting internal integration and
adherence. Accountants bring their
regulatory knowledge and industry standard
experience to their clients to drive through
best practice. Additionally they interpret
the listing requirements relevant to their
business and legal structure.
Accountants bring a professional rigour
in demanding transparency; in order to
maintain professional integrity, accountants
must follow standards and procedures
that will highlight concerns. They must
make sure their risk discussions with
management are healthy and productive
and help the company and the board to
prepare for change.
Accountants are also in the best position
to provide an independent challenge to
practices they observe within a business.
It is within their professional conduct to
have this role and dispute practice which
is not in the interests of the long-term
sustainability of the company and its
stakeholders.
Aligning their thorough approach to
preparing financial statements with wider
governance reviews enables accountants
to provide a full comment on a companys
annual and long term performance.
Ultimately this will provide the company,
its stakeholders and society with a truer
and more robust reflection of the business
performance and its potential impact on
wider social, environmental and ethical
concerns.
The fundamental role of the accountant is to provide
transparency in reporting, nancial or otherwise, to shareholders
and the broader stakeholder groups who have an interest in the
performance of the business.
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REFERENCES
IFAC
FEE
IASB
FASB
IAASB
FSA
AccountAbility
World Bank
Independent Audit
Institute of Internal Auditors
Institute of Business Ethics
Network for Sustainable Financial Markets
Alternative Investment Management Association
Conference Board Europe
International Corporate Governance Network www.icgn.org
European Corporate Governance Institute
Global Association of Risk Professionals
International Centre for Financial Regulation
IOSCO
OECD
Financial Reporting Council
European Corporate Governance Forum
Ethical Corporation
Corporate Governance
The Corporate Governance Network
Author ACCA, AccountAbility and KPMG
Publisher ACCA UK
Date July 2009

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