Introduction
Nowadays, the issues of corporate governance and the Environmental, Social, and Governance (ESG) criteria are the subjects of debate. Corporate governance and ESG are some of the most critical indicators that determine not only the level of economic development of a country. They also have a significant impact on social and investment climates. The purpose of this essay is to consider corporate governance and the ESG metrics as two significant concepts from the perspective of business practices.
Corporate Governance Definition
What shareholders would like directors to do is to work to ensure that their objectives are met. However, directors have their purposes, and they may differ from what shareholders want. Corporate governance seeks to make directors behave in such a way so as to ensure shareholders’ objectives are met (Garcia-Torea, Fernandez-Feijoo & de la Cuesta, 2016). Corporate governance is a method by which a “firm is directed and controlled” (Chen, 2019, para. 1). It means that corporate governance implies the separation of ownership and control. It is a system of activities to regulate relations between business members, such as a board of directors, shareholders, a top management team, and others.
Corporate Governance from the Historical Perspective
The emergence and development of corporate governance reflect the patterns of evolution of the global economy. According to Morley (2016), from the Middle Ages till the first part of the 20th century, corporate governance was expressed through “the common law trust” (p. 2146). The trust form allowed businesses to obtain some general benefits of the corporate type of governance, for example, limited liability (Morley, 2016). Thus, business trust was the first step to the development of the corporate governance form.
Corporate governance was a response to new requirements for the forms and principles of organising business turnover. The need for corporate governance arose with the emergence of large corporations in the second part 19th – first part 20th centuries (Veldman & Willmott, 2017). It was a time when the process of separation between ownership and management of this property began to take place (Kazemian & Sanusi, 2015). The owners started to expand the scope of their activities, and they had to transfer executive functions to others (Cheffins, 2016). As soon as this happened, a conflict of interest between shareholders and managers became apparent. Therefore, there was a need to develop a new way of doing business.
Development of Corporate Governance
The idea of managers being accountable to shareholders and the terminology of corporate governance emerged in the 1970s, in the US (Ullah, Hashim, Khan & Safi, 2017). A significant phase of the development of corporate governance was the adoption of the Cadbury Report, Financial Aspects of Corporate Governance, in 1992, in the UK (Veldman & Willmott, 2016). According to Veldman and Willmott (2016), the Cadbury Code is “a blueprint of ‘best practice’” not only in the EU but also all around the world (p. 582). The Cadbury Code has become a model for many countries, such as Germany, France, Russia and Japan, and influenced the development of corporate governance in developing countries (Nordberg, 2017). From the international perspective, it became the departure point for the use of the code regime as a way of dealing with corporate governance problems.
Benefits of Corporate Governance
Effectively managed companies can make a significant contribution to the national economy and the development of society as a whole. There are numerous benefits of good corporate governance and a well-organised management system, for instance, low-cost capital, and better access to external financial resources (International Finance Corporation, 2015). Investors perceive well-managed companies as “friendly” and credible and being able to provide shareholders with an acceptable level of return on investment. Moreover, companies can reduce the cost of external financing that allows them to enable efficiency gains in general.
Corporate governance is an effective system or strategy with the help of which the board of directors, shareholders and the top management team can interact with each other to make the company sustainable in the long run. The existence of a transparent system of accountability reduces the risk of divergence of interests between managers and shareholders and minimises the risk of fraud by company officials (Ocansey, 2017). Furthermore, according to Sarah (2017), an effective business management system gains the confidence of customers and investors.
Forms of Corporate Governance
Corporate governance, as a regulatory sort of environment, can take one of the two forms. The first one is called a rules-based approach and implies the need to formalise the relationship between participants through legal frameworks. If one does not comply with the legal requirements of some formal act, then there are legal consequences. The second form of corporate governance evolved from a principle-based approach. It is usually required to be implemented on a comply-or-explain basis, which makes it possible to avoid the “the inflexible hard law “one size fits all” framework” (Rose, 2016, p. 204). With this approach, one lays out appropriate practice principles, which can be applied flexibly in a different term and circumstances.
ESG Metrics
Environmental, Social, and Governance (ESG) is a framework for analysing companies and assessing how well they compare to their competitors in terms of performance against three metrics: environmental, social and governance issues. According to Xie, Nozawa, Yagi, Fujii and Managi (2019), “ESG disclosure is aimed at gaining social legitimacy for environmental or social impacts caused by the firm’s operation” (p. 290). The environmental factor shows how the company relates to the environment. The social element is about the relations between shareholders and employees, suppliers, customers and the local community. As stated by Lawal, May and Stahl (2017), the financial performance of a company significantly depends on its social policy. The governance metric covers such factors as enterprise management, remuneration, internal control, shareholder rights and others.
Nowadays, many companies around the world face some sort of social or environmental pressure. Companies are expected to care about the environment and their local communities (Baldini, Dal Maso, Liberatore, Mazzi, & Terzani, 2018). They need to have a positive social impact to contribute to work towards inclusive and sustainable growth besides being financially profitable and successful. That is why the number of investors applying the ESG criteria is increasing every day.
Benefits of ESG
Many companies see ESG activities as profitable business opportunities. They start bringing these considerations into the core of their organisational structures, strategies and business models. To be responsible to the environment and the broader society is a strategic choice. Moreover, there are numerous benefits of ESG. It is important to note that environmental indicators can help to predict the economic collapse of a nation (Capelle-Blancard, Crifo, Diaye, Scholtens, & Oueghlissi, 2016). From the perspective of a social metric, “high social responsibility at work may lead to higher returns” (Björkman & Erlandsson, 2019, p. 9). Companies paying attention to their shareholders have more stable and long-term shareholder relationships. It means that lower informational asymmetry results in a lower risk of agency cost (Dunne & McBrayer, 2019). Integrating ESG considerations into the investment processes has the potential to lead to better long-term financial outcomes.
Corporate Governance and the ESG Criteria System
ESG is considered to be about management, which is intrinsically linked to the corporate governance concept. When it comes to corporate social responsibility (CSR), one needs to see what kind of impact the company makes with it. What distinguishes responsible companies is that they understand that they are managing a corporation for a set of stakeholders. The ESG framework allows businesses to establish relationships with local communities and organisations. It enables to extend the scope of companies’ activities and attract more consumers and other participants for business development. Moreover, the ESG issues help companies enter new markets and create innovative products and services (Cini & Ricci, 2018).
There is a way to apply the ESG metrics in practice within the company. According to Hörnmark (2015), in connection with the changes in the environmental and social fields, a firm must change its strategy and internal organisational environment to maximise its profit and be attractive for investors. For example, “environmental investments or social responsibility activities” can be introduced (Fatemi, Glaum, & Kaiser, 2017, p. 46). Moreover, it can be done through various incentives for both executives and employees on financial and non-financial metrics.
Conclusion
The challenge for companies today is to adapt to the environment which requires cleaner, smarter and healthier products and services. Today, industries no longer see pollution as free, labour as a cost factor and scope and strategy as dominant aspects. A business must adapt to new political and social conditions and take into consideration what impact they have on people and the planet. The corporate governance strategies and the ESG criteria are modern approaches to enhancing the development of a democratic and prosperous business environment.
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