Major construction site "Sustainable Corporate Governance"
2022-11-24 Interview with Dr. Patrick Velte, Professor of Business Administration, in particular Accounting, Auditing & Corporate Governance at Leuphana University Lüneburg: "The sustainability expertise on the board of directors and supervisory board urgently needs to be increased".
The summer of 2022 will go down in history. Heat, drought and resulting massive disruptions to supply chains hit the economy hard. Companies are increasingly incorporating these impacts into their business models. But they are going further thematically and also addressing aspects of equality and diversity. Parallel to this, a stronger standardisation of sustainable corporate governance is currently being discussed and regulated at German and European level. As expected, this is controversial. In addition to expanded reporting on environmental and social sustainability and diverse legal acts on sustainable corporate financing (sustainable finance), environmental and social aspects are to be given greater consideration in the context of corporate management and monitoring - including a view of the supply chains.
In an interview with the M&T editorial team of the Faculty of Management and Technology, Patrick Velte comments on the major topic of the day. The Professor of Accounting, Auditing & Corporate Governance at Leuphana University Lüneburg takes a broad view. He takes business management research as a starting point for the mandate for action in practice. The guiding question is: "How can companies simultaneously address the complex issues of diversity, equality, transparency and respect for human rights in supply chains with the tasks of coping with climate change and sustainable business and thereby achieve practicable results?" First and foremost, listed public companies in Germany are facing this challenge. Medium-sized companies that are far from the capital market are equally affected by supply chain regulation. They are looking for ways to align themselves with current and future sustainability obligations within the framework of corporate governance.
©Leuphana/Patrizia Jäger
- What did the previous sustainable corporate regulations in Germany provide for? For example, was there also sustainable board remuneration linked to these goals?
- As a result of a German law from 2019, listed stock corporations have had to align their variable executive board remuneration with a "sustainable and long-term development of the company" since the 2021 financial year. Since then, a mere consideration of long-term financial targets in the sense of the temporal dimension of sustainability is no longer sufficient. Rather, social and/or environmental goals must also be taken into account in a resilient and measurable way. At EU level, there are no comparable remuneration obligations for board members so far.
- Has gender diversity as an element of sustainable corporate objectives in the executive and supervisory boards of listed companies improved in recent years?
- In 2015, a law (FüPoG I) regulated gender diversity on boards of directors and supervisory boards. According to this, listed stock corporations with parity co-determination must consider a gender quota of at least 30 per cent on the supervisory board. If the company is either listed or subject to co-determination, target figures must be formulated for the gender proportion on the supervisory board, the executive board and the two management levels below the executive board (flexible gender quota). In 2021, another diversity law (FüPoG II) was passed. This provides for a minimum participation requirement of one woman for executive boards with more than three members of listed companies that are also co-determined on a parity basis. Targets of zero percent for the gender share on the executive board and supervisory board must be justified. Otherwise fines will be imposed. At the EU level, there has been a dispute for more than ten years over a draft directive to introduce a gender quota for listed companies. A renewed attempt by Ursula von der Leyen, the EU Commission President, finally led to success this year. In future, listed companies will have to meet either a quota of 40 per cent on the supervisory board or a quota of 33 per cent on the executive board and supervisory board as a whole. That gender diversity can lead to increased sustainability performance has been proven from a European level. In recent years, for example, many studies have been able to demonstrate a positive influence of gender diversity on the board of directors on corporate sustainability performance.
- Change of view: the vulnerable supply chains. Remembering the summer, the low river levels with consequences for inland navigation, then the nuclear reactors in France that are difficult to cool before our eyes - what do we have to prepare for? What sustainable risk management systems do companies need according to the legal situation?
- A so-called Supply Chain Due Diligence Act (LkSG) from 2021 is aimed at all companies based in Germany with more than 3,000 workers employed in Germany or posted abroad. This will apply from 1 January 2023, and one year later - on 1 January 2024 - the threshold will be lowered to 1,000 employees. The law focuses on corporate due diligence in relation to human rights and environmental obligations. The companies concerned must set up a supply chain-related risk management system for risks in the supply chain caused by the company. In response to the Wirecard scandal, the former German government had also regulated in 2021 that listed stock corporations must implement a risk management and internal control system.
- Would you - Mr. Velte - explain in more detail below some conceptual fields that are of importance for corporate practice from a research perspective?
- Yes, I am very happy to do that: Let me go into these topics: First - Non-Financial Statement; Second - Diversity Reporting; Third - Future Sustainable Corporate Governance Standardisation and Sustainability Duties of the Board; Fourth - Sustainability Expertise on the Board; Fifth - Sustainability Oriented Risk Management Systems; Sixth - Integrated Financial and ESG Reporting; Seventh - Sustainability Duties of the Supervisory Board and Eighth - Monitoring and Auditing Duties.
- Thank you - we are curious...
First - the non-financial statement:
Already since the 2017 financial year, certain public interest entities have to prepare a non-financial statement. This is a small subset of a sustainability report. Here, environmental, employee and social concerns, respect for human rights and the fight against corruption and bribery must be addressed. The supervisory board must also check the content of this declaration, while the auditor only has to formally check whether the declaration has been made.Second - Diversity reporting:
Since the 2017 financial year, listed public limited companies have also had to conduct diversity reporting as part of the corporate governance statement. Thus, companies must present their diversity concept (not only gender) with regard to the composition of the executive board and supervisory board, including the goals of the concept, the way it is implemented and the results achieved in the financial year. However, as an exit solution, companies can also justify why they do not have a diversity concept.Third - future Sustainable Corporate Governance standardisation and sustainability obligations of the board:
The board of directors in a public limited company must manage the company "under its own responsibility". The "corporate interest" can be interpreted in different ways. In the 1980s and 1990s, the shareholder value approach was very popular among listed companies. Since the financial crisis of 2007/08 at the latest, a stakeholder value approach has been propagated as an alternative, which involves an appropriate balance between shareholders (investors) and other stakeholder groups of the company (such as customers, suppliers). Ed Freeman, who initiated the stakeholder theory, has been an honorary doctor of Leuphana for many years. A "sustainable corporate purpose" in the sense of a public value orientation is also proposed. According to the aforementioned new version of the Code, listed stock corporations should in future give appropriate consideration to sustainability goals in the sense of stakeholders. This concerns their inclusion in corporate strategy, planning and in operational implementation. According to the current EU draft directive on sustainability-related due diligence, also mentioned above, the business model and strategy of certain companies should in future be oriented towards the climate protection goals of the Paris agreements.
Fourth - Sustainability expertise on the board:
Sustainability expertise on the board is not yet mandatory by law. Some companies have already established sustainability persons, sustainability committees or even Chief Sustainability Officers (CSOs) on the board on a voluntary basis. Current empirical research results show from an international perspective that sustainability committees and CSOs increase a company's sustainability performance. The former German government's Sustainable Finance Advisory Council had also recommended consideration of sustainability expertise as a criterion when appointing board members.Fifth - Sustainability-oriented risk management systems:
The Code provides for an expansion of operational control, risk management and compliance systems to include environmental and social aspects. Due to current events, climate risks in particular are to be monitored in an integrated manner in order to meet the goal of a climate-neutral economy. As a result of the German Supply Chain Act, there will also be a legal obligation to include the supply chain and related risks of human rights violations in internal corporate governance systems from 1 January 2023 and 2024 respectively. There will be no focus on climate risks. However, the EU Commission plans in a current draft directive that supply chain-related risk management should in future not only focus on human rights violations but also on climate protection.Sixth - Integrated financial and ESG reporting:
Unfortunately, from the EU's point of view, there are no plans to link ESG reporting by listed companies with traditional financial reporting in the sense of integrated reporting. The new EU sustainability reporting, which was recently adopted, does not resolve this two-track reporting. The central risks of greenwashing and information overload, which can be empirically proven in the European capital market, cannot be reduced by the directive on sustainability reporting. On the contrary, there is a risk of increased complexity in reporting ("complexity monster").Seventh - Sustainability duties of the supervisory board and sustainability expertise:
Apart from the financial and industry expertise, which was regulated by law and tightened after the Wirecard scandal in Germany, no sustainability expertise has been required on the supervisory board so far. Since the supervisory board has already had to explicitly review the content of the non-financial declaration of the management board since the 2017 fiscal year, this regulatory gap is to be criticised. The new version of the Code therefore provides for a recommendation that in future there should be adequate sustainability expertise on the supervisory board. Furthermore, the chair of the audit committee should not only be an independent financial expert, but also have sustainability expertise. Parallel to the establishment of an audit committee, which is necessary for PIEs after the Wirecard scandal, an institutionalisation in the form of a sustainability committee in the supervisory board also suggests itself. Against the background of the audit of financial and ESG reporting, however, environmental and social competence must also be present in the audit committee.And finally, eighth - monitoring and auditing obligations:
The integration of sustainability into internal corporate governance systems will significantly expand the supervisory board's monitoring radius. A corresponding sustainability-oriented monitoring will be necessary, which goes beyond the mere examination of the executive board's reporting. The supervisory board's auditing duties will be extended to the entire ESG reporting, analogous to the financial reporting. In order to specifically support the supervisory board in this regard, the auditor must also conduct a mandatory review of the content of all ESG reports. Otherwise, a central reliability gap will remain for the German and European capital markets.
- And finally: Where do you think the journey is heading?
- Looking ahead, I am certain that even though German lawmakers have already started to regulate sustainable corporate governance in recent years (e.g. introducing gender quotas, supply chain due diligence obligations), further reforms by the EU Commission on this topic will come in the coming months and in 2023. Empirical research on the impact of (sustainable) corporate governance on corporate sustainability has reached unmanageable proportions since the financial crisis of 2008/09. Therefore, we need to structure and process the results from research, via the instrument of knowledge transfer, for companies and legislators. Then they will also arrive in everyday business life and hopefully also in Berlin and Brussels.
- Thank you very much, Mr Velte, for the interview!
©Markus Lemmens/Josephine Puls
Professor Dr. Patrick Velte,
Professor of Business Administration, esp. Accounting, Auditing & Corporate Governance at Leuphana University Lüneburg, has focused his research and teaching on the following fields: Accounting, Auditing and Corporate Governance from a sustainable perspective. At Leuphana, especially in the Faculty of Management and Technology, a wide range of studies on this topic are carried out and taken into account in the sense of research-oriented teaching in the Bachelor's and Master's degree programmes as well as in doctoral studies (including the Master's programme in Management & Sustainable Accounting and Finance). Patrick Velte researches and teaches with his team on corporate reporting, auditing and corporate management and monitoring from a sustainability-oriented perspective (Environmental, Social & Governance). In the inter- and transdisciplinary management orientation of the professorship, there is a close interlocking between research, teaching and transfer in the aforementioned disciplines to link business administration and sustainability science. The professorship has incorporated the UN Sustainable Development Goals, in particular Goals 4 (Quality Education), 5 (Gender Equality) and 13 (Climate Action), into its research and teaching concept.
UPDATE
Patrick Velte is ranked in the top 2 per cent Scientist in 2022. See in more detail:
Ioannidis, John P.A. (2022), “September 2022 data-update for "Updated science-wide author databases of standardized citation indicators"”, Mendeley Data, V4, doi: 10.17632/btchxktzyw.4
To explain the ranking, the Elsevier source says:„…Scientists are classified into 22 scientific fields and 176 sub-fields. Field- and subfield-specific percentiles are also provided for all scientists with at least 5 papers. Career-long data are updated to end-of-2021 and single recent year data pertain to citations received during calendar year 2021. The selection is based on the top 100,000 scientists by c-score (with and without self-citations) or a percentile rank of 2% or above in the sub-field.”
https://elsevier.digitalcommonsdata.com/datasets/btchxktzyw/4