KEY CONCEPT

We live in a society that scrutinizes the environmental activities of the corporate world. How can companies address society’s concerns and improve levels of environmental performance, while maintaining market share and financial returns? The answer could lie in their corporate governance structure.

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IDEA SUMMARY

Recent years have seen company stakeholders demand better environmental performance, particularly by businesses in polluting industries. Whether it is consumer pressure for green products, media pressure for a green approach or government pressure to stick to green regulations, leaders must take action. The degree to which they respond – or not – appears to hinge on the corporate governance mechanisms that are in place.

When it comes to environmental measures, stakeholders’ and management’s preferences are likely to diverge. Stakeholders show a greater willingness to ‘go green’ than management, because not only do they not have to implement environmental strategies, they are also less likely to be concerned about the effect of such strategies on financial margins.

For management, however, devising an environmental strategy requires a lot of effort, redesigning the company’s internal processes and developing green practices to minimize pollution levels. The possible impact of a new environmental strategy on the bottom line will also cause concern if executives are under pressure to improve margins.

This divergence of interest can be resolved to some extent, however, by corporate governance mechanisms that increase management’s willingness to satisfy stakeholders’ environmental demands. Several important instruments can impact on management’s environmental behaviour, thus helping to determine a company’s environmental performance levels. These include:

• The market for corporate control (for example, the stock market): if a company underperforms environmentally, negative stakeholder reaction can affect its market value. By yielding to demands for greener practices, management can avoid this outcome. In other words, more exposure to the market for corporate control means management has to be more willing to satisfy environmental concerns.
• Legal and regulatory system: environmental legislation has coerced companies towards better environmental performance, not least to avoid potentially costly litigation and fines. A greater exposure to the legal system increases management’s dependency on stakeholders, which in turn strengthens stakeholders’ ability to enforce their environmental claims.
• Board of directors: when it comes to resolving the issue of divergent environmental interests, success depends on whether the voice of stakeholders is strongly represented on the board. If that is the case, it increases stakeholders’ ability to enforce their environmental preferences.
• Managerial incentives: whether it is stock options or other equity-based incentives, offering executives such inducements can help align their interests with stakeholders, and so increase their motivation to satisfy environmental demands. In other words, if management’s incentives are strongly tied to a stock market that can be affected by stakeholder activism, they are more likely to listen to stakeholders and their environmental concerns.

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BUSINESS APPLICATION

Corporate governance and environmental management can go hand in hand, with evidence suggesting that ‘well-governed’ firms also seem to be good environmental performers.

When considering what corporate governance mechanisms to put in place, leaders need to be aware of the effect of such mechanisms on their organization’s strategy, in this case its environmental strategy.

Understand the links between your management teams and your company’s various – and often vocal - stakeholder groups. Using commonly employed corporate governance mechanisms such as those outlined above can affect environmental performance because they increase management’s sensitivity towards stakeholders’ environmental concerns.

In short, those companies that have a greater exposure to the market for corporate control, and to the legal and regulatory system, higher equity-based compensation, and more pro-stakeholder directors on their boards, show a better level of environmental performance.

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REFERENCES

Corporate Governance and the Environment: What Type of Governance Creates Greener Companies? Carl J. Kock, Juan Santaló & Luis Diestre. Journal of Management Studies (March 2011).

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