The best practice in corporate social responsibility is the best practice in corporate governance

Paloma del Val, Executive Director of the Editorial Board and General Secretary of BBVAMF

P10201052 Paloma del Val

Corporate governance, from the stakeholders’ viewpoint, requires companies to listen to their environment and make commitments to respond to socio-economic changes and to the expectations demanded by society

The other day, an interview with a well-known executive of a hotel chain caught my eye in the Latin-American press.  When asked which corporate social responsibility standards were applied in his company, he firmly replied: “Pursuance of good corporate governance”.

One might think that this professional knew his business but could not distinguish between corporate responsibility and corporate governance. However, I will argue that his statement, far from displaying confused thinking, makes enormous sense coming from someone with proven success in managing a large company.

The interview triggering these thoughts is intended to demarcate the roles of good corporate governance and corporate social responsibility in companies and in other kinds of organisations subject to lesser regulation (public administration entities, non-profits, etc).

In its origins, corporate governance was shaped through standards and codes, and its recommendations dealt solely with the functions of the governing bodies of companies, information models and reporting lines, and supervision mechanisms limited to the protection of shareholders.

This changed when the crisis ensuing from the Enron scam in 2001 led corporate governance to focus more on the quality of audits. Then, from 2008, the crisis triggered by Lehman Brothers’ collapse led to a review of the veracity of agency ratings. Since then, we have witnessed an outpouring of codes, guidelines and standards promoted by all kinds of institutions. This proliferation continues in the industrialised economies and it spreads like an oil spill to developing countries.

Thus, corporate governance has evolved from being a means to ensure due protection of shareholders to become a way of protecting stakeholders in general. Today’s good governance is concerned with ethics, transparency, long-term sustainability and social commitment.

The rules of governance have given way to an architecture of relationships connecting all actors with any stake in how companies operate: markets, funders, regulators, employees, suppliers, customers, environmentalists, local communities, etc.

Good governance is configured by three layers of relationships, stretching from the outside into the inside of organisations. The three levels are equally important, interact with one another, and complement and influence each other. They are: first, external regulation and markets; second, the highest supervisory body (board of directors, board of trustees and similar); and finally, the corporate governance infrastructure within the institution.

Markets and external regulation influence organisations’ model of governance to protect direct or indirect stakeholders. In principle, markets reward organisations able to offer quality products and services meeting customers’ demands and punish those failing to do so. And increasingly, customers and other players with a stake in the markets, in addition to such product and service attributes, value social or environmental dimensions, such as fair trade or organic products.

In this level of external regulation there is also the public administration, where the government issues norms and regulatory standards for industries, sectors and different categories of organisation. Regulators and supervisors work to ensure that markets are stable and efficient and to protect consumer rights. Legislation is enacted to ensure legality and fairness in institutional decisions. Meanwhile, capital markets and rating agencies require and create transparency and stimulate competition. This is also the level at which external auditors validate the performance indicators being reported to the outside world.

The second layer of corporate governance concerns organisations’ highest supervisory bodies. These must safeguard companies’ strategic direction and their model for linking the different functional units within a structure and their impact will depend on the nature of the decisions adopted.

The set of all the functional units most directly affected by the resolutions passed by the senior supervisory body come together to form the third level of governance, which we can call the infrastructure of corporate governance. The main function of this infrastructure is to operate inside the organisation, to mitigate the risks generated by their activities, by establishing efficient procedures, mobilizing resources, and generating reputation from its financial and non-financial performance, through the control of operating, legal, technological, social, environmental and other risks.

Corporate governance, from the stakeholders’ viewpoint, requires companies to listen to their environment and make commitments to respond to socio-economic changes and to the expectations demanded by society. For this to happen, the highest supervisory bodies and the governance infrastructure must, above all, invest in activities generating trust and create distinguishing capacities, by building up the reputation and designing optimal relationships with their stakeholder groups.

It has been estimated that from 1970 to year-end 2010, tangible assets only account for 20% of enterprises’ total value. The remaining 80% comes from intangible assets. This transformation in the fundamentals of value explains why corporate governance must focus on non-financial issues. Good governance should preserve 100% of an organisation’s worth. And that 80% of intangible assets is where good practices can be found: respect for workers, (training, gender diversity, integration of the differently abled, health and welfare), respect for the environment (efficient use of resources, reduction of waste, pollution mitigation), respect for ethical management (fighting fraud and corruption), respect for customers (transparency, clarity of information), etc.

The European Union Green Paper made the first attempt to define corporate social responsibility (CSR), making it clear that social responsibility does not simply mean full compliance with legal obligations. It encouraged companies to take their responsibilities further, investing in human capital, in their surroundings and in establishing relations with their stakeholders.

Corporate social responsibility was also defined as companies voluntarily coming up with solutions to social and environmental concerns, and voluntarily establishing ethical relationships with their customers and suppliers.

More recent regulatory developments, institutional recommendations, markets and, in general, those operating in the external layer of corporate governance have promoted the inclusion of much of the content of social responsibility into habitual management processes. Some have incorporated responsibility policies merely because they were mandatory, but others have voluntarily accepted that they make sense in order to generate reputational gains and the highest possible intangible worth.

A third factor that has encouraged the integration of social responsibility models into organisations’ strategy has been how hard it is to find indicators and metrics to measure the actual impact of social responsibility policies. Many companies have thus considered that the most efficient way of capturing the value generated by CSR activities is simply to incorporate them into habitual management policies.

The growth in business regulation, media pressure on companies to commit to the societies in which they operate and increasing demands from markets and investors have generated a new status quo, where the sources of non-financial impact become blurred. Is it corporate governance or corporate social responsibility? It is no longer clear.

The absorption of CSR content into good governance is a work in progress and we can expect it to continue. On 29th September, the European Council passed the Directive on Non-Financial Reporting. This is clearly one such consequence as the process continues to expand.

The directive will require organisations to report on the policies they have regarding their impact on the environment, their measures to ensure respect for human rights, their procedures to fight corruption and malpractice, their human resources management models (gender diversity, equal opportunities, working conditions), among others. From now on, these and other such policies must be described in the companies’ annual financial reports or in a specific report on corporate social responsibility. The directive also requires them to publicly disclose what tools and indicators must be used to monitor their evolution in these areas.

Regulators, governments, markets and public opinion are fully aware that financial earnings are insufficient grounds on which to make investment decisions. On their own, they are not enough to boost brand recognition, to attract talent or to encourage confidence in the company’s long-term value creation. The scope of duties for the highest supervisory bodies within institutions is becoming ever greater. Boards are expected to direct their organisations in their function of key drivers of transformation of society over time. They must enable their enterprises to take on an ever more essential role in tackling current economic, social and environmental challenges, while ensuring the regeneration of inclusive and balanced economic development.

With these ideas in mind, the BBVA Microfinance Foundation has recently adopted a modern governance model that is shared by all the financial institutions in which we hold an interest. Our new Corporate Governance Code establishes a single model of management and relations for all. The aim is to deepen our commitment to generating an inclusive social impact that is sustainable over the long-term and to create value and reputation.

As a foundation, we and those working with us must meet the most exacting standards of good governance, exclusively guided by a commitment to society and to our founding principles. For non-profit entities, financial earnings do not need to be our top priority, which is why we must recognise the special importance of the social impact of our business and our generation of intangible value. Such goals are only possible under business models that have fully incorporated the best standards of corporate social responsibility into the heart of their corporate governance.

As the CEO of the hotel chain said in his interview, the best corporate social responsibility standard is the best corporate governance.