Study on directors’ duties and sustainable corporate governance: a summary

On 29 July 2020, the European Commission published its awaited “Study on directors’ duties and sustainable corporate governance”. The objective of this study is to assess the root causes of “short termism” in corporate governance (C.G.), and to identify possible EU level solutions. 

The study consisted of two main tasks:

1) the analysis of the state of play and potential problems, examining sustainable corporate governance practices and national regulatory frameworks in the EU, and

2) the identification of possible options, starting from the problems highlighted in Task 1, and analysing their potential impacts against the baseline scenario with no EU action. The methodology used for this study was a combination of desk research and field research (survey and interviews). 

According to the report, evidence shows that there is a trend for listed companies within the EU to focus on short-term benefits of shareholders rather than on the long-term interests of the company. To make this claim, the authors indicate that upward trend in shareholder pay-outs can be observed in the data, as well as a decrease of the ratio of CAPEX and R&D investment to revenues. Based on the analysis, Belgium is also presented as one of the most short-term oriented countries in the EU.  

The study identifies the following seven key problem drivers: 

2. Directors’ duties and company’s interest are interpreted narrowly and tend to favour the short-term maximisation of shareholder value; 
3. Growing pressures from investors with a short-term horizon contribute to increasing the boards’ focus on short-term financial returns at the expense of long-term value creation; 
4. Companies lack a strategic perspective over sustainability and current practices fail to effectively identify and manage relevant sustainability risks and impacts; 
5. Board remuneration structures incentivise the focus on short-term shareholder value rather than long-term value creation for the company; 
6. The current board composition does not fully support a shift towards sustainability; 
7. Current C.G. frameworks and practices do not sufficiently voice the long-term interests of stakeholders; 
8. Enforcement of the directors’ duty to act in the long-term interest of company is limited. 

The report claims that shareholder primacy and short-term pressures from the financial markets have negative environmental, social and economic consequences. Hence, the authors call for EU action. 

The report defines a general objective of fostering more sustainable C.G. and contributing to more accountability for companies' sustainable value creation. For achieving this goal, the authors suggest that EU action should pursue the three following specific objectives: 

• Strengthening the role of directors in pursuing their company's long-term interests. 

• Improving directors' accountability towards integrating sustainability into corporate decision-making 

• Promoting C.G. practices that contribute to company sustainability (e.g. in the areas of corporate reporting, board remuneration, board composition, stakeholder involvement).  

The study identifies a list of measures to be considered for a detailed assessment. Those measures are linked to the seven key problems drivers mentioned previously: 

2. Directors’ duties and company’s interest: measures to incentivise directors to properly balance the long-term interest of the company alongside the interests of shareholders, and to identify and mitigate sustainability risks and impacts; 
3. Pressures from investors: measures to incentivise longer shareholders periods, and to discourage listed companies to publish earnings guidance and returns of a quarterly basis; 
4. Lack of strategic perspective over sustainability: measures to incentives boards to integrate sustainability aspects into the business strategy, to identify and set sustainability targets, and to disclose appropriate information; 
5. Board remuneration: measures to regulate the executives’ ability to sell shares they receive as pay, and to include non-financial ESG metrics in executive pay scheme; 
6. Board composition: measures to ensure that sustainability-related expertise is systematically considered in the board nomination process of companies; 
7. Involvement of stakeholders: measures to ensure the involvement of both internal and external stakeholders in identifying, preventing and mitigating sustainability risks; 
8. Enforcement of directors’ duties: measures to strengthen enforcement of directors’ duty to act in the interest of the company; 

For each set of measures, different levels of regulatory interventions are considered:  

• Option A (non-legislative/soft) – Spread sustainable C.G. practices through awareness raising activities, communications and green papers; 

• Option B (non-legislative/soft) – Foster national regulatory initiatives aimed at orienting corporate governance approaches towards sustainability through recommendations; 

• Option C (legislative/hard) – Set minimum common rules to enhance the creation of long-term value while ensuring a level playing field through EU legislative interventions. 

Each policy option is then evaluated according to its potential impacts: impact on companies, economic impacts, social impacts, environmental impacts and impacts on fundamental rights. Each option is also being assessed in terms of effectiveness, efficiency, coherence and proportionality. The authors do not make any conclusion on the findings of this assessment, but some general trends can be noticed. Firstly, hard/legislative measures are always characterised by the highest positive social, environmental and human rights impacts (and hence, the highest effectiveness). Secondly, those same hard/legislative measures are often associated with negative impact for companies due to high compliance costs. Thirdly, the economic impacts of the measures are evaluated as positive for measures regarding director’s duties, strategic perspective on sustainability, board remuneration and enforcement of directors’ duties. On the other hand, the economic impacts are seen as negative for measures that relate to the pressures of investors, board composition and the involvement of stakeholders. 

This new study on directors’ duties identifies some key problem drivers of short-termism in listed companies and provides a structure for assessing policy options. In addition, it highlights the key role of directors towards long-term value creation and stresses the potential benefits of involving key stakeholders in decision-making processes.  

According to GUBERNA, the study also presents some shortcomings, namely:  

• First of all, there are certain shortcomings in the methodology and sample used. 

• The report takes a rather negative view of current business practices and neglects the sustainability efforts and initiatives undertaken by many companies. 

• In addition, it is assumed that only companies are responsible and/or have a role to play in tackling the most pressing problems of modern society. 

• The study takes a one-sided point of view as it only considers short-termism as the problem and long-termism as the solution. In some cases, short-termism can also be a necessity for firms in a fast-changing environment. GUBERNA advocates for a balance between short-term agility and long-term vision depending on the specific circumstances faced by companies. 

• Furthermore, the study assumes that if a company acts on the short-term, she does not take the interests of stakeholders into consideration. These are in fact two different concepts, where one of which does not exclude the other. 

• The ratio of dividend pay-outs to revenues is used as the main indicator for short-termism. The authors neglect other indicators, as the percentage of controlled companies (opposed to free float). Indeed, companies with one or more stable controlling shareholders, which are common in the Belgian market, are more likely to be managed with a long-term perspective. 

• With respect to policy options, the study focuses solely on classic regulatory policies. It omits self-regulation, in particular under the form of corporate governance codes. The latter are a widespread C.G. practice, whose effectiveness in promoting long-term value creation is generally accepted. It is important not to fall into regulatory excess, which would have negative consequences for companies and would encourage box-ticking. Companies also need a stable regulatory framework. 

The study was presented recently to the European Parliament by the competent European Commissioner, Didier Reynders. The European Parliament considers the topic of directors’ duties to be a top priority and is inclined to follow and even to reinforce the recommendations of the study. 

A broad consultation on director’s duties (and on due diligence) will be launched soon.