Five Questions about Corporate Governance – Special Interview with Geoffrey Mazullo, Principal, Emerging Markets ESG, and Adjunct Professor, School of American Law (SAL), Gdansk, Poland and Wroclaw, Poland – December 3, 2012

On the first Monday of each month Emerging Markets ESG publishes a special interview with an academic, expert or practitioner about a specific topic with relevance to environmental, social and/or governance (ESG) issues.

This month’s interview, the ninth interview in the special interview series, is about corporate governance and is with Geoffrey Mazullo, Principal, Emerging Markets ESG, and Adjunct Professor, School of American Law (SAL), Gdansk, Poland and Wroclaw, Poland.

Emerging Markets ESG is an independent advisory, consulting and research firm dedicated to the analysis, benchmarking, development and promotion of reporting on environmental, social and governance (ESG) indicators in emerging markets.  The mission of Emerging Markets ESG is to promote ESG reporting in emerging markets as an effective tool for boosting competitiveness and promoting sustainable growth.  The Emerging Markets ESG internet portal serves as an archive for innovative research, a depository for information about projects undertaken, a calendar of upcoming events and a network to brainstorm about ideas as well as exchange information.   Geoffrey Mazullo is Principal of Emerging Markets ESG and Adjunct Professor at the School of American Law (SAL) in Gdansk and in Wroclaw, Poland, where he teaches corporate governance.  Following studies of diplomacy, economics and political science in Washington, DC; Krakow, Poland; Berlin; and London; as well as completion of a bank traineeship in Frankfurt am Main, Mr. Mazullo worked as a corporate governance analyst, with Institutional Shareholder Services (ISS) and with Investor Responsibility Research Center (IRRC).  From 1995-2000, Mr. Mazullo worked on several donor-funded capital market development and corporate governance projects in Bosnia and Herzegovina, Bulgaria, Moldova and Russia. From 2001-2009 he directed the Partners for Financial Stability (PFS) Program, a regional financial sector development program in Eastern Europe, for which he designed and conducted two semi-annual surveys of listed companies in emerging markets: Investor Relations Online (2001-2009; 2011) and Reporting on Corporate Social Responsibility (2003-2009).  Since 2006 Mr. Mazullo is chair of the evaluation committee of the NASDAQ OMX Baltic Market Awards. Complementing his advisory, research and teaching activities in emerging markets, he publishes on the Emerging Markets ESG internet portal a weekly expert interview, “Five Questions about SRI” and a monthly special interview on a specific ESG topic of current interest and relevance to emerging markets.  Geoffrey Mazullo brings to Emerging Markets ESG comparative analysis skills, emerging markets expertise, foreign language capabilities and 20 years of international financial sector development experience.

Emerging Markets ESG:  Please define corporate governance.

Geoffrey MazulloCorporate governance is the mechanism by which interested parties (the board, management, shareholders and stakeholders) in a corporation interact with each other and promote their interests.  Corporate governance is a dynamic phenomenon, in two important ways:  First, the interaction among the parties is dynamic.  Second, the rights and responsibilities of each of the parties have a time component.  For example, members of the board are responsible for:   review of documents regarding the company’s previous financial period(s); analysis of the company’s present financial status; and brainstorming with management about the company’s strategy for the future.

Emerging Markets ESG:  Does corporate governance mean the same thing to everyone, everywhere?

Geoffrey MazulloAbsolutely not.  There are two fundamental approaches to governance.  The stakeholder model (found in many Asian and continental European countries) assigns rights and responsibilities to a broad group of constituencies, “stakeholders,” including:  banks, bondholders, employees, the government and local communities or society at large.  The shareholder model (found in all common law countries and in a diverse group of countries worldwide) maintains that ownership is key and therefore the shareholder is the primary focus of governance.

Even within these two approaches, there are fundamental differences.  In continental Europe, for example, one might describe the “German” model as the most pure or strict model, since it contains all elements of the model:  strict separation of the management function (in a management board composed of executives) and supervision (in a supervisory board composed of non-executives); co-determination of capital and labor, whereby employees elect a percentage of supervisory board members; and legal determination of the size of the supervisory board, to allow for the principle of co-determination to be applied in practice (in small corporations shareholders elect the entire supervisory board; whereas employees elect one-third of the supervisory board members in mid-size corporations and one-half of the supervisory board members in large corporations).

Variations of the stakeholder model exist across the continent.  Switzerland, which uses a one board (or Anglo-US) model, is a notable exception, as are several jurisdictions which allow a corporation to choose its governance structure – one board or two boards.

Also, the stakeholder model in Korea is different from the stakeholder model in Japan, due to the historical development of the model, the goals of financial-industrial policy and the ownership structure of financial industrial groups (chaebol or keiretsu) as well as individual publicly-traded corporations.

In the UK, a corporate governance code led to the separation of the roles of the chairman of the board of directors and the chief executive officer in publicly-traded corporations.  In the US, no code addresses this issue and today the two roles are still combined in approximately 40% of publicly-traded corporations, although the percentage is declining.

Emerging Markets ESG:  But isn’t the purpose of corporate governance to increase shareholder value? 

Geoffrey MazulloProponents of the Chicago School would argue yes, because the shareholder is the focus of the model, whereas proponents of the stakeholder model would argue no, because the shareholder is only one of many stakeholders to whom the corporation is accountable.

Equating corporate governance with maximizing shareholder value reduces the focus of corporate governance to creating “external” benefits for shareholders alone.  This is not the sole purpose of corporate governance.

The reduction of corporate governance to maximizing shareholder value is not only wrong in principle; in practice it has led to dramatic failures, such as the recent and ongoing global financial crisis.

Emerging Markets ESG:  If the purpose of corporate governance is not simply to increase or maximize shareholder value, what then is the purpose of corporate governance? 

Geoffrey MazulloEffective corporate governance, or good corporate governance, should help the corporation function more effectively over the long term, to the benefit of all stakeholders – by identifying, analyzing and managing risks; pursuing opportunities; mitigating negative impacts; and improving triple bottom line performance (planet, people and profit).

How is this done?

Good governance assigns clear rights and responsibilities among interested parties (the board, management, shareholders and stakeholders).  This should be an ongoing process by which the corporation continually identifies, analyzes and manages risks as well as continually improves and strengthens organizational management.

Thorough analysis, effective management and strategic planning of extra-financial (environmental, social and governance [ESG]) and financial indicators enable management and the board to better understand the company’s prior performance, continually monitor its current performance and improve future performance.

Good governance of extra-financial /ESG and financial indicators entails the proactive oversight of all internalities and externalities, with the aim of improving the company’s internal performance as well as its external impacts on and relationships with all stakeholders – clients, customers, investors, owners/shareholders, partners, regulators, suppliers and others.

Perhaps this sounds simplistic or theoretical.  However, there are ample examples of successful corporations which operate in this manner.  Conversely, observe how ongoing human rights problems at Foxconn impact Apple’s triple bottom line.

Emerging Markets ESG:  Which rewards does good corporate governance reap?  What is the nexus between corporate governance and SRI?

Geoffrey Mazullo:  Good governance entails policies, practices, procedures and systems that strengthen the corporation, reaping internal benefits:  clear governance policies, practices and procedures; improved oversight and supervision; sound organizational management; heightened risk awareness; management and mitigation; compliance with regulatory and self-regulatory requirements; appreciation and recognition of corporate citizenship; strong corporate reputation; and good triple-bottom line performance.  These internal benefits in turn create and reap external benefits, including:  better marketing of the corporation’s products and services; liquidity of the corporation’s bonds and shares; maintenance of corporate reputation; and improved access to capital.

Twenty years ago, when I began my career as a corporate governance analyst, one assumed that good governance brought the above-mentioned internal benefits to the corporation and internal/external benefits to shareholders and stakeholders.  However, there was little data, research or statistics providing proof.  Today, a growing number of research studies document the relationship between corporate governance and triple boom line performance.  Here I will only note two recent studies; the first study finds a positive relationship between corporate social responsibility (CSR) and access to capital (CSR and Access to Finance, Harvard Business School, July 2011) whereas the second study describes how corporate responsibility reporting enhances financial value (KPMG International Corporate Responsibility Reporting Survey 2011).

Of course, detractors will cite alternative research which finds no relationship between good governance and financial performance.

Detractors explain that socially responsible investment (SRI) relies on negative screening, thereby reduces the size of the potential portfolio and therefore decreases financial returns.

This is an outdated and simplistic view of SRI.  Similarly, the use of the term “non-financial” suggests to me an outdated view of risk management.  Today the financial industry embraces the term “extra-financial” and assigns the indicators to three categories – environmental, social and governance.  These indicators are analyzed and managed due to their direct and/or indirect impact on triple bottom line performance.