Gerencia Ambiental Internacional, S. A.

Corporate Governance and Environmental Performance

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What does corporate governance have to do with environmental performance? The answer is: everything. And this relationship is becoming increasingly important as more and more institutional and individual investors focus on "intangibles" such as environmental, social, and ethical issues to evaluate the overall performance of corporations. The flip side, however, is equally important: high quality governance-and particularly a commitment to accountability and transparency-is critical to accurate and timely reporting and disclosure of environmental, social and other intangible liabilities, obligations, and risks.

Corporate governance is generally understood to mean the relationship between shareholders, directors and management and the systems which guide and control those relationships (e.g., bylaws, policies, rule of law). This has traditionally included such issues as executive evaluation and compensation, board composition, auditing practices and investor relations. However, in the last 10 years, the concept of corporate governance has been increasingly interpreted to include a much broader range of (non-financial) economic, ethical, social and environmental issues encompassing a greatly expanded group of stakeholders such as suppliers, customers, local communities, and the public at large.

Environmental, social, and even ethical issues are now commonly considered to be core governance issues with tremendous potential impact on financial liabilities and corporate reputation. Corporate managers are expected to identify and manage these risks just as they would any other, and it is now conventional wisdom that corporate policies, procedures, and strategies must reflect this reality.

Many factors account for this change in attitude, but ultimately it boils down to investor demand. Investors want not only good returns, but also strong environmental, social and even ethical performance because: 1) they know that these attributes are associated with short- and long-term financial performance and/or 2) they see additional value beyond short-term profits in these attributes.

The latter school of thought is known as Socially Responsible Investing (SRI) but it is becoming increasingly mainstream with many large institutional investors and brokerage firms using some type of SRI product or employing some type of SRI "filter" (e.g., no investments in arms or tobacco products). There now exist a number of sustainability indexes including the Domini 400 Social Index (DSI), the Dow Jones family of indicators (DJSI) and the most recent FTSE4Good Index, all of which serve as performance benchmarks just like their conventional counterparts such as the Dow Jones Industrial Average (DJIA) and S&P500.

The total value of SRI investments is somewhere between US$1-2 trillion and SRI is good business: the Domini 400 Social Index (DSI) has consistently outperformed the Dow and S&P500 since its inception in 1990, and the rating services Lipper and Morningstar Inc. gave four or five-star ratings to 42% of the SRI funds they track as compared to only 32.5% for conventional mutual funds. Also, interestingly, no SRI funds have been implicated in the recent spate of mutual funds scandals in the United States.

Enron, WorldCom and many other corporate scandals and lawsuits over the last five years have demonstrated that accurate reporting of conventional financial information can be difficult enough (and clearly the level of accuracy is intimately tied to the quality of corporate governance), so how, then, do individual and institutional investors evaluate the environmental and social performance of corporations? For publicly held companies in the United States, Canada, South Africa and several European countries, there are specific legal requirements that govern environmental and to a lesser extent social disclosures. The other source of information for investors is the traditional annual report or more specialized Environment, Health and Safety (EHS), Corporate Social Responsibility (CSR) or Sustainability reports.

All of these reporting instruments increasingly follow voluntary, third party guidelines for "sustainability" or "triple bottom line" reporting, the most widespread of which is the Global Reporting Initiative (GRI). Companies which subscribe to these schemes agree to report on the environmental, economic and social impacts of their activities, products and services following specific guidelines and standards. GRI, to give only one example, now boasts a list of 400 organizations employing their guidelines, including some of the world's largest and best-known corporations such as 3M, BP, Chevron Texaco Corp., Chiquita Brands, Citigroup, DuPont, GM, Henkel KGAa, Hewlett Packard, IBM, International Paper, Johnson and Johnson, Lafarge, McDonald's Corporation, Procter & Gamble, Royal Phillips Electronics, TDK, Volkswagen AG and others. These reports are far from perfect but there are many initiatives underway to improve corporate disclosure and reporting and these efforts are clearly part of a broader trend to equip investors with better information to assess intangible liabilities and risks and select companies that offer the best prospects for long-term value.

In summary, environmental issues are now a core issue for corporate governance, and good corporate governance, in turn, is essential for evaluating the environmental, social and ethical performance of corporations. It is fair to ask, though, whether this trend is really relevant to developing countries where there are no legal disclosure requirements and where many, if not most, companies are privately held.

As it turns out, many of these same drivers are also at work in different types of companies in emerging markets and the relationship between corporate governance and environmental performance is equally important, though sometimes for different reasons. A recent report entitled Developing Value: the business case for sustainability in emerging markets , examines the business rationale for improving corporate governance and environmental, social and economic performance (Sustainability/IFC/Ethos Institute, London, 2002). Case studies from several countries in Latin America demonstrate that companies in the region realize concrete benefits such as cost reductions, greater worker loyalty, improved access to capital, and development of new products and services by incorporating these issues into their normal business plans and activities. In this era of increasing trade and globalization, there is another compelling reason for companies to take these issues seriously: those who do not run the very real risk of being left behind as more and more consumers (including investors) scrutinize the products they consume and demand compliance with certain basic, minimum environmental and social standards.

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Originally published in Spanish as 'Gobernación Corporativa y el Desempeño Ambiental' in Cuaderno Empresarial, No. 7, 'Desarrollo y Cultura Empresarial Guatemalteca,' Instituto para la Promoción de la Responsabilidad Social (IPRES), Guatemala, April 2004

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