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A common argument against stakeholder governance is that it renders managers less accountable while doing little to improve the welfare of stakeholders. Lucian Bebchuk and Roberto Tallarita call this “The Illusory Promise of Stakeholder Governance.” But what if stakeholder governance actively empowered stakeholders? Rather than being merely just of and for the stakeholders, it could become governance by the stakeholders as well.
In a new article, I survey disclosure by S&P 100 companies to get a picture of how they engage their stakeholders and incorporate that engagement into corporate governance. I look primarily at disclosure in the companies’ sustainability or ESG reports, though I also look at a few practices disclosed in required proxy statements.
Of course, there are problems with relying on self-reporting. Since most of the disclosure is voluntary and hence lightly regulated, companies often cherry-pick and present overly rosy pictures of their ESG practices. A more subtle but bigger problem is that not all companies report common but mundane practices such as customer satisfaction surveys. Still, sustainability reports provide a readily available source of information that can tell us much about what companies are doing.
I look first at the variety of ways in which companies say they engage with their various stakeholders. I find that employees are the most engaged group, followed by customers, nonprofits, suppliers, and government regulators. That makes sense. Employees are critical to the success of a corporation, they have much valuable information about how a business is functioning, and they are particularly vulnerable to corporate actions. Customers are also vital to the success of a business, but they are more diffuse and less embedded within it.
The most common forms of engagement are the most basic, meetings and surveys. An interesting finding is that employee resource groups – networks of employees sharing features such as gender, race, sexual orientation, religion, and veteran status–are near-universally used. Higher levels of engagement such as partnerships and representative councils are used less frequently but regularly. The very highest level of engagement, in which stakeholders help make some corporate policies, occurs only through the remnants of unionization. Companies in some countries, like Germany, empower employees through work councils or employee representatives on corporate boards. That does not happen in America’s largest companies.
I also survey how companies incorporate stakeholders into internal governance. Most companies assign oversight of ESG matters to a specific board committee, usually the traditional nomination or governance committee, but in a significant number of companies a special committee for overseeing ESG. The most important stakeholder groups, employees and customers, are not generally represented on corporate boards, but directors from nonprofit organizations and academia and former government officials are common. At the executive level, chief sustainability officers and chief diversity officers have become widespread. Most companies also have one or more committees of officers dedicated to coordinating and supervising action on ESG matters. An increasing number of companies are experimenting with ways to tie executive compensation to ESG practices and performance. As with Bebchuk and Tallarita’s study of compensation tied to ESG at S&P 100 companies, I find disclosure of such compensation vague and spotty. Insofar as one can make inferences from the disclosure, it appears that, though widespread, compensation tied to ESG is often based on subjective, easily satisfied factors and affects a small fraction of total compensation.
But the current reality falls well short of the future possibilities of stakeholder engagement. I make a variety of suggestions for reform. I advocate only two mandatory new rules, both related to disclosure. First, I suggest that disclosure concerning stakeholder engagement itself could be codified, making cross-company comparison easier. Second, I suggest more extensive and detailed disclosure of how executive compensation is tied to ESG factors. Though I agree with Bebchuk and Tallarita’s analysis of current practice, I don’t think the answer is to discourage compensation based on ESG. Rather, let’s have better disclosure of that compensation, so that shareholder and stakeholder activists can better monitor and respond to what companies are doing.
As for substantive practices other than disclosure, current engagement mostly involves companies listening to what stakeholders have to say. It does not empower stakeholders to be more actively involved in corporate decisions. Yet the greatest potential benefits from stakeholder engagement would come from involving some stakeholders in decision making. The most effective candidates would be employees, who could be given more power through unionization, board representation, or works councils. Other stakeholders (especially customers) could be given more limited power through advisory stakeholder councils. Such advisory councils could be asked to propose board candidates to nominating committees. The committees would not be required to accept such nominees but could be required to explain why they chose not to accept proposed nominees.
Unlike my proposed disclosure reforms, I would not mandate any of these changes in stakeholder engagement practices. The costs and benefits remain uncertain, and the most suitable may well vary across companies. It is better to allow and encourage experimentation. Still, these reforms could be encouraged, rather than required, through various forms of regulatory relief to companies adopting stakeholder empowerment mechanisms. Companies adopting forms of employee involvement in corporate governance could be held to looser standards of employment regulation, for instance, as Matt Bodie and I have suggested. A similar loosening of environmental regulation could apply for companies adopting environmental stakeholder councils with the power to suggest board nominees. Various forms of stakeholder empowerment could be rewarded with tax advantages. Such guided experimentation would encourage companies to explore the many potential benefits of stakeholder empowerment.
This post was initially published on the Columbia Blue Sky blog.
Brett McDonnell holds the Dorsey & Whitney Chair at the University of Minnesota Law School.
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