The changing landscape for corporate governance and responsibility.
What does it mean in the early 21st century for a company to perform well? In particular, how does a company’s performance in terms of its corporate social responsibility (CSR) relate to sustainable success for any business in society? Finally, what is the connection between CSR (and the social licence to operate, triple bottom line, corporate citizenship, and related notions), corporate performance, and broader corporate governance standard-setting? In short, a company’s performance and corporate governance today includes, in part, fulfilling its social licence to operate.
Such deep questions of corporate performance and governance are thrown into sharp relief by the controversy surrounding the ASX Corporate Governance Council’s proposed 4th edition of its corporate governance principles and recommendations for listed companies. The proposed 4th edition reinforces the need for listed companies to act in lawful, ethical, and socially responsible ways. Most of the controversy focuses upon amplifying the social licence to operate for business, its consistency with the present state of the law, and its coherence within the existing framework of principle-based regulation.
The current debate about explicitly embedding a company’s social licence to operate in Australian corporate governance standards sits within a broader landscape of shifts in thought leadership and regulation on corporate governance and performance. For example, we are in the midst of changes in approach by commercial regulators and banks in the wake of the revelations and Interim Report of the Hayne Royal Commission. At least some of what the Hayne Commission has exposed as bad performance is attributable to failures of corporate governance oversight by banks and regulators alike, along with failures by banks in meeting basic standards of morality and legality, allowing individual self-interest and greed to get out of control.
The social dimension for companies of both ESG-sensitive investment analysis and shareholder dialogue about a company’s social and environmental footprints means that dealing with its social licence to operate is a necessity and not simply a voluntary option for any listed company.
Meanwhile, markets worldwide are grappling with the rise of environmental, social, and governance (ESG) factors in responsible investment decision-making. ESG thinking is entering the mainstream and becoming part of the DNA of integrated reporting, investment analysis, and corporate governance.
In early 2018, for example, Blackrock CEO Larry Fink used his influential annual letter for the global investment community to demand that companies take their social licence to operate seriously. He also called for ‘a new model of shareholder engagement’ that properly integrates ‘environmental, social and governance matters’ in investment. The social dimension for companies of both ESG-sensitive investment analysis and shareholder dialogue about a company’s social and environmental footprints means that dealing with its social licence to operate is a necessity and not simply a voluntary option for any listed company.
For some time, ‘soft’ law and regulation has been influencing ‘hard’ law and regulation, including on matters of corporate law and governance. More broadly, on a global level the mass social movements and industry developments pressuring business successfully over time on labour practices, environmental pollution, and social impact now drive business in directions favouring human rights, responsible investment, and sustainable development, including climate action.
So, the points of entry for discussion about a company’s social licence to operate extend beyond what some of the public submissions to the ASX CGC canvass about the 4th edition. Where you land in this current debate depends upon where you stand on some deeper underlying issues, as follows.
On any view of corporate governance, corporate performance is a crucial element, along with other elements such as corporate conformance (compliance), accountability, and leadership. The traditional view of corporate law and corporate governance envisages them as confined solely or mainly to managing the triangular relationship between a company, its board, and its shareholders – what might be termed the ‘owner-manager nexus’ (or ‘internal constituencies’) view of corporate law and governance. For decades, corporate law subjects at law schools have diverged hardly at all from that underlying conception, at least in terms of the coverage of topics and their correlation to sections of the Corporations Act, although things are changing.
An alternative view arguably is gaining traction within and beyond the business community in Australia and overseas – what might be termed the ‘managing valuable relationships’ (or ‘integrated constituencies’) view of corporate governance. If a company’s major asset is its reputation with both shareholders and other stakeholders - peers, regulators, employees, customers, creditors, investors, markets, and the communities where it does business - then a large determinant of its sustainable success is how well it manages all of its internal and external relationships of value to that company.
Most academic theories of corporations – everything from shareholder primacy to stakeholder pluralism and beyond – grapple in one way or another with what lies along that analytical spectrum. This theoretical debate is not an esoteric one, because the view that anyone has about the ASX CGC’s proposal to incorporate more explicitly the social licence to operate in corporate governance standards probably reflects to one degree or another underlying views along that spectrum about the overall point of corporate governance and regulation.
ASX CGC 4th Edition – What It Says
Proposed Principle 3 now says: ‘A listed entity should instil and continually reinforce a culture across the organisation of acting lawfully, ethically and in a socially responsible manner’. Its commentary adds new guidance and illustrations on meeting a company’s social licence to operate, especially in dealing with its relationships with both shareholders and other stakeholders.
While Proposed Principle 7 (ie ‘recognise and manage risk’) remains the same as in the last edition, Proposed Recommendation 7.4 now says: ‘A listed entity should disclose whether it has any material exposure to environmental or social risks and, if it does, how it manages or intends to manage those risks’. Its commentary explicitly incorporates a cross-reference to a company’s social licence to operate under Proposed Principle 3, saying that such a licence ‘can be lost or seriously damaged if the entity conducts its business in a way that is not environmentally or socially responsible’, with appropriate disclosure to the market to inform investors’ assessment of the risks of investment. Carbon risk and climate change risk management are also explicitly covered in the commentary.
For the last few reporting seasons, ASX-listed companies have faced corporate governance requirements on a ‘comply or explain’ basis to identify and report on managing material risks to their business, based upon ‘social sustainability’ and ‘environmental sustainability’ as well as ‘economic sustainability’. Admittedly, those existing requirements are framed in terms of managing and reporting risks under Principle 7, as distinct from requirements to act ethically, lawfully, and otherwise responsibly under Principle 3. Nevertheless, whatever misgivings are felt in some parts of the commercial community about how well the ASC CGC standards do their job and what they contain, it remains a fact that a generally defined notion of ‘social sustainability risks’ has been part of corporate governance standards since the last edition, without attracting the amount of controversy generated by the 4th edition.
ASX CGC Edition – Assessing the Reactions
The suggested inclusion of a social licence to operate in the next edition of the ASX CGC standards has received a mixed reception in the public submissions about it. In the opinion of the Law Council of Australia’s Business Law Section, the notion of a social licence to operate ‘is too vague and uncertain to serve as the touchstone for an important piece of regulatory policy’, especially given the nature of the ASX CGC standards as ‘soft law’ serving ‘a regulatory function’.
The AICD’s publicly stated position is that the draft should not extend beyond the current state of the law, especially on ‘the legal and fiduciary obligations of directors’. Its concern is that ‘concepts proposed to be introduced such as “social licence to operate” and acting in a “socially responsible manner” (see Principle 3) are subjective and will add unnecessary complexity and uncertainty’.
This is not the forum in which to affirm or debate the veracity of those and other submissions, some of which are to similar effect. However, the following points might be made about the relationship between the 4th edition and the current state of corporate law and governance.
The law prescribes, prohibits, and permits corporate actions of many kinds, and there is nothing inherently wrong in providing regulatory or industry guidance to companies on what the law permits them to do in meeting society’s expectations of well-governed companies, consistently with the prescribed legal obligations of companies and their governing boards. Similarly, nobody seriously doubts that well-performing companies should act in accordance with accepted business ethics and to safeguard their corporate reputations, but those responsibilities are neither easily defined nor explicitly mandated by law in discrete terms, although failures in meeting such expectations can have other legal consequences.
Some people might also be surprised about the extent to which corporate law and governance is already sensitised to CSR and ESG considerations. For example, a widely publicised Australian legal opinion (available on the Centre for Policy Development’s website) confirms that company directors breach their directors’ duties if they mismanage the physical, transitional, and regulatory risks of climate change for their respective businesses. In that sense, company directors do not legally have the luxury of being deniers of climate change. Given the similar formulation of directors’ duties in state and federal laws governing the public sector and in other countries, this important legal opinion has implications for public sector boards and foreign companies too.
Institutional investors and other shareholders can use standard corporate governance mechanisms such as annual general meetings to put proposals and interrogate boards about a company’s ESG track record on climate change, human rights, and its social and environmental footprints. Where a financial product has an investment component, the Corporations Act requires that the associated investment product disclosure statement must disclose ‘the extent to which labour standards or environmental, social or ethical considerations are taken into account’ in associated investment decisions.
When the UK codified its directors’ duties and enshrined the concept of ‘enlightened shareholder value’ in the Companies Act, which mandates that directors must consider a range of stakeholder interests, many in the legal and business communities there feared (unreasonably, as it turns out) dilution of shareholder primacy as the basis for a director’s twin primary duties of care and loyalty. Even without such legislative prescription, Australian law readily permits company directors to consider shareholder interests along with other stakeholder interests in deciding what is genuinely in the best interests of their company.
However, what remains important is the extent to which those other interests bear upon the interests of the company and its shareholders over the long run. Shareholder-centricity no longer justifies (if it ever did) a blinkered focus upon share prices and dividends in the short term as the sole or best benchmark of corporate performance. The Hayne Commission’s Interim report bells the cat on that particular fallacy in criticising ‘greed – the pursuit of short-term profit at the expense of basic standards of honesty’.
No reasonable view of shareholder value supports risky business behaviour in defiance of common decency and the law, or justifies shareholder wealth-maximisation at all costs and particularly at the expense of the fabric and survival of society. Even the famous disciple of shareholder value, Milton Friedman, conceded that it had boundaries, grounded in the rule of law, business ethics, and healthy competition.
Nothing in the corporate governance literature about shareholder primacy supports or excuses the unethical and unlawful banking conduct exposed by the Hayne Royal Commission. Indeed, those engaging in such conduct were acting contrary to what on any view would be in the interests of banking shareholders.
Similarly, no reasonable view of business success over the long run ignores business relationships with stakeholders beyond shareholders alone. Nothing in the current corporate law and commentary suggests that non-shareholder interests have trumping capacity over shareholding interests in their own right. Nor does anything in the 4th edition justifiably lead to that conclusion.
Accordingly, acceptance of a company’s social licence to operate is not inherently contrary to the prevailing legal and business orthodoxy of shareholder value. Yet much public and media debate about Australian corporate law and governance generally and the 4th edition in particular remains stuck in a sterile win-lose contrast between a company’s pursuit of shareholder value and its social licence to operate.
At the same time, it is reasonable – up to a point - for the business community and its commercial advisers to flag a concern about how material in the 4th edition might be used in future by courts when interpreting or amplifying obligations under corporate law. Concerns about the potential expansion of corporate law and regulation by reference to industry standards to create afresh a free-standing, open-ended, and enforceable obligation upon companies to behave in what someone else stipulates as a socially responsible manner must be tempered against a necessary reality-check of the likelihood and magnitude of that risk.
Moreover, such concerns cannot justifiably detract from all of the ways in which companies pursue the requirements of their intertwined political, economic, legal, and social licences to operate from the communities in which they do business. Unfortunately, there is more heat than light coming from the recent public and media discussion of those issues, including the criticisms of the 4th edition from some senior business leaders.
Still, the relationship between corporate ‘soft’ and ‘hard’ law is evolving, with undeniable implications for the regulated content and scope of corporate responsibility and governance. Nobody can reasonably deny that industry standards and other ‘soft’ corporate laws inform interpretation and amplification through judicial adjudication of ‘hard’ corporate law. The AWA v Daniels decision on auditors’ liability more than 25 years ago put everyone on notice that relevant internal and industry standards might affect the ultimate question of professional liability under the law.
As recently as November 2018, with specific reference to the 4th edition and the debate about CSR, the current Chief Justice of the NSW Supreme Court offered the opinion that while ‘(i)t remains to be seen whether the draft changes will be accepted’, what is clear is that ‘it seems increasingly likely that either what have traditionally been soft law principles will be translated into hard law obligations under a principles-based approach, or that existing soft law obligations, which still serve important regulatory functions, will expand in scope’. Clearly, in the light of such comments, the 4th edition matters to the content and scope of legal advice about corporate governance requirements and their relationship to corporate law and regulation.
A company’s performance, overall governance, and social licence to operate are all inter-connected. The scope and limits of any of those things as prescribed, prohibited, or permitted by law are important matters to clarify in relevant regulatory contexts and business practices. However, those exercises must now be conducted with an understanding that a company’s socio-ethical performance and accountability for its relationship with all of its stakeholders is just as suitable a matter for corporate law and governance as its financial performance and accountability.
To that extent, it is unsurprising to see corporate governance standard-setting that includes ESG considerations, along with related requirements about companies ‘acting lawfully, ethically, and in a socially responsible manner’, as the 4th edition suggests. If the 4th edition is ultimately revised by early 2019 to sharpen its focus upon the reputational and risk-related aspects of how a company’s social responsibility relates to its corporate performance and other aspects of corporate governance, such additional clarity and granularity would be a welcome continuous improvement.
If, however, anything presently in the 4th edition about the social licence to operate is diluted in substance or delinked from the economic, legal, and other licences to operate as part of contemporary corporate governance, that would be a backward step, especially when Australia’s stance is viewed against the rest of the world. It would represent an over-reaction to criticism of the 4th edition as well as a lapse in institutional responsibility for corporate governance standard-setting. The ASX CGC should hold its nerve.
Professor Bryan Horrigan is the Dean of the Faculty of Law at Monash University. He has academic and professional expertise in public and corporate law and governance. He is the author of Corporate Social Responsibility in the 21st Century, published internationally by Edward Elgar Publications (UK).
This article is an opinion piece commissioned by the Governance Leadership Centre. The opinions expressed do not necessarily represent the views of the Australian Institute of Company Directors, nor its members, directors or employees.
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