Response to the Proposed Corporate Sustainability Due Diligence Directive by Nordic and Baltic Company Law Scholars
The purpose of the EU Commission’s ‘Proposal for a Corporate Sustainability Due Diligence Directive’ (the ‘Proposal’) is to further the ‘Union’s transition to a climate-neutral and green economy in line with the European Green Deal and in delivering on the UN Sustainable Development Goals’. This purpose is of great importance, and the Commission’s initiative is commendable. However, as we discuss together with some 25 Nordic and Baltic corporate law and corporate governance scholars in our recent paper, ‘Response to the Proposal for a Directive on Corporate Sustainability Due Diligence’, there are several critical problems with the Proposal.
The Proposal can be divided into two quite different parts: one corporate governance and one on sustainability due diligence. Our paper addresses these parts separately.
The corporate governance part of the Proposal includes Art. 15 on climate plans and environmental remuneration, Art. 25 on director’s duties and Art. 26 on the responsibility of the due diligence actions required by companies. It has its roots in the European Commission’s 2020 ‘Study on Directors’ Duties and Sustainable Corporate Governance’, which triggered an extensive criticism not only from business, but from a nearly united research community (including Nordic scholars). That this part of the initiative was insupportable, both in its premises and empirical foundation, was subsequently confirmed when the Commission's own quality control organ, the Regulatory Scrutiny Board, overruled the initiative. The key criticism was that the grounds for the initiative presented in the ‘Study on Directors’ Duties and Sustainable Corporate Governance’ could not be substantiated by empirical evidence, and to those of us familiar with the research in the field, many if not all of the conclusions in the study either appeared to be very poorly substantiated or plainly wrong. It is therefore misleading, when the Proposal now states that the rejection of the Regulatory Scrutiny Board of the previous iteration only concerned the ‘quality of the impact assessment and not an assessment of the related legislative proposal’.
We discuss the corporate governance aspects in the Proposal in detail in section 2 of our paper and point towards several principal and technical issues. Here, remuneration based on environmental performance may serve as an example. Art. 15.3 states that companies shall take into account sustainability metrics in their plans for variable remuneration. While a noble idea, one of the central issues that stock market regulation needs to deal with to make equity financing attractive is the agency problem. A core part of corporate governance aimed at this problem is that shareholders, in the words of Fama and Jensen, are given the right ‘to hire, fire and set the compensation of top-level managers’. Variable remuneration is a key tool to align management and shareholder interests. Many of the most sustainability-focused investors, such as the Norwegian Oil Fund, take an eloquent approach on this: ‘the variable remuneration of directors’ should be transparent and simple by being based only on long term shareholdings, in order to ensure that management acts with the long-term and sustainable interests of the company in mind’.
The proposal on variable remuneration based on environmental performance fiddles with at least the compensation-part of the shareholder control rights and thus makes it harder for shareholders to oversee and control management, and it can be argued that Art. 25 on directors’ duties entrenches management by decreasing accountability towards shareholders. Vibrant equity markets do not only provide ordinary households with opportunities to diversify their long-term savings and supply companies with equity capital, they can also serve as an important contributor to solving the climate crisis. Since the Proposal risks weakening these functions and thus may contribute to the already declining use of stock markets as a way of financing in the EU (which is often explained as a result of over-regulation), it must be taken very seriously. In a time when the ability of the equity market to handle risk and to further innovation and sustainable growth might be what we need most of all, the stakes of introducing experimental and unfounded corporate governance standards are simply too high.
With regards to the due diligence parts of the Proposal, our criticism is limited to a corporate governance perspective and is far less fundamental. We primarily believe that: the grounds for harmonisation needs further consideration, not least taking into account the need to ensure competitiveness of European companies under the dramatically changed geopolitical circumstances that have come about since the introduction of the Proposal; Art. 22 on civil liability might in several ways be counter-productive to the goals of the Proposal; the effects on SMEs as well as for the financial companies covered by the Proposal warrants further analysis; the choice to focus the Proposal on individual companies instead of company groups needs to be reviewed; and a risk-based approach should be taken rather than an approach where companies are unable to focus their efforts on where they can be most effective. Overall, these issues need serious consideration and many of them can be worked out, but if they are not, then the Proposal could not only have an adverse impact on EU companies and possibly capital markets but might actually hinder EU companies from acting in the way that the Proposal aims for them to do. It is not evident that obligations that may make European companies withdraw from difficult foreign markets rather than to adapt and moderate their behaviour in these markets is the best way forward.
It is our firm belief that the Proposal should not be enacted in its present form. If it were to be, we believe that it could not only damage European businesses, but also run the risk of having an adverse effect on the transition to a climate-neutral economy. This is to a large extent a consequence of the Proposal’s provisions being excessive, unfounded, and disproportionate and, as such, in violation of the fundamental principles of subsidiarity and proportionality safeguarded by Art. 5 of the Treaty on the European Union.
Erik Lidman is Associate Professor at Stockholm University and the University of Gothenburg.
Jesper Lau Hansen is Professor at the Center for Market and Economic Law, University of Copenhagen.
This post is published as part of the OBLB series on ‘The Corporate Sustainability Due Diligence Directive Proposal’.
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