How boards with ethics can make business better

Employee representation on company boards is just one way companies can behave better, writes John Spiers of EQ Investors. And there is plenty more they can do too.

Corporate scandals and economic meltdowns are not just a 21st century phenomenon. In fact, nearly 300 years ago, unscrupulous players, political cronies and laissez-faire government combined to create the first stock market crash. 

The South Sea Company was founded in 1711 as a public-private partnership and given exclusive trading rights for slaves and other goods in Spanish America, in return for taking up a large share of the unfunded British national debt. The value of this monopoly, however, was closely tied to the outcome of the War of Spanish Succession (1701-1714).

While the Treaty of Utrecht effectively ended the war in 1713, it curtailed the scope of trade opportunities for the South Sea Company by confirming Spain’s sovereignty over its new world colonies.

In an effort to stir up popular interest in the stock, the directors circulated false claims of success and fanciful tales of South Sea riches. With no prospects of such a trade developing, the directors sold their stocks at the height of the boom.

Like all bad news, however, the knowledge of their actions spread, and the panic selling of worthless stock certificates ensued. From a high of £1050 in June 1720, the share price crashed to £150 by that September, wiping out individuals and companies all over the country.

Formal investigations exposed a web of deceit, corruption, and bribery that led to the prosecution of many of the major players in the crisis, including both company and government officials. 

Fast forward four centuries to a spate of depressing incidents in the financial sector, such as the LIBOR and Forex rate fixing scandals, GlaxoSmithKline’s bribing of officials to boost sales, not to mention the almost unbelievable deviousness of VW in flouting diesel emissions rules for 11m vehicles – a €14.7bn settlement was reached with the US Justice Department in October. 

Just last month, Tesco came to an agreement with the Serious Fraud Office to pay a £129m penalty to avoid prosecution for a 2014 accounting scandal, while also setting up an £85m compensation scheme for investors who bought shares in the weeks after the flawed numbers were published.

It’s not overstating things to say we are in the midst of a plague of criminal corporate malfeasance. 

But it would be wrong to place the blame for this entirely on the shoulders of corporate executives. The system has evolved primarily under pressure from large shareholders and especially from private equity groups. 

How can we change this? I am not advocating a return to the 1970s where many executive teams were sadly lacking in ambition. Back then the differential between success and mediocrity was too narrow. Today it’s too wide. 

The way to better business

In her maiden speech last July, Theresa May promised a shake-up of boardroom ethics where employees will be guaranteed representation on company boards – a practice commonplace across Europe. With the upcoming general election, it was pleasing to see this included in the Conservative manifesto. 

As a long-term advocate of employee ownership, I have seen first-hand the strategic and ethical rewards of adopting a model which aligns the interests of employees with that of the business. 

Research from the Charted Management Institute (CMI) revealed that managers in employee-owned companies are more ethical in their decision making, meaning they are more likely to take into account the interests of their colleagues, customers and communities.

Whilst recognising the vast benefits and accountability bought about by external ownership, I would encourage management teams to utilise the power of their employees to bring about wider changes.

If employee ownership is to become widespread, work is needed to reduce tax and legal complexities and offer businesses the support required to allow employee ownership to enter the mainstream of the British economy. 

It is not enough for companies to think of ethics and culture as a compliance exercise. Processes and controls alone will not lead to the embedding of the right values and culture. That requires vigilance by the board. 

Board members undoubtedly have a fundamental role to play in effective governance; after all, legally the buck stops with them and they are responsible for everything that happens within the company.

The ultimate solution would be for excellent standards of corporate governance to become directly linked to strong financial returns.

Relevant experience, a systematic approach to overseeing what the company does and a strong moral compass are all requirements for strong company directors.The ultimate solution would be for excellent standards of corporate governance to become directly linked to strong financial returns.

Impact investing is designed to generate measurable social and environmental influence alongside a financial return, and although it is early days in this increasingly popular investment style, there are a few encouraging straws in the wind. For example, the Impact Investing Benchmark developed by Cambridge Associates and the Global Impact Investing Network (GIIN) has been created to analyse the relative performance of impact investing. 

The burgeoning number of B Corporations – companies that are truly serious about social responsibility – is testimony to a growing feeling that change is needed and is on the way. Globally, the certification is considered the gold standard for sustainable businesses and social enterprises, and already has the backing of global brands including Ben & Jerry’s, Triodos Bank and Hootsuite.

We need to get to the stage that there are enough B Corps listed on stock exchanges that their performance can be compared with competitors that are not prepared to sign up to trying to do things ‘the right way’.

EQ Investors is proud to have become one of the first in the UK to take this necessary step towards a more ethical City and I’d encourage CEOs of all businesses to consider taking the certification.

By way of a start, they can assess their performance against dozens of best practices by using a free online impact assessment tool. Improving impact and meeting the highest standards of corporate purpose, accountability and transparency helps B Corps build the most important asset: trust.

The risk of continuing with the status quo is that the investor will relinquish all faith in the company as more and more scandals erupt, only to be swallowed into the subsequent tide of regulation. And do we want more reactive over-regulation and piecemeal implementation?

Regulation alone will not change this negative cultural shift that fills the media every day. It is time to change attitudes towards governance and sustainability. Businesses must instil a culture which encourages people at all levels to make the right decisions.

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