In 1994, The Toronto Stock Exchange (TSX) accepted a new set of guidelines for board governance as developed in the report, Where Were the Directors? Triggered by the mixed response from the Canadian corporate sector to the stresses of the 1990-91 recession, the guidelines were meant to urge boards of directors to align with growing expectations concerning the manner in which boards are constituted, and the relationships between boards and shareholders.

In the face of climate change, rising economic inequality, systemic racism and the COVID-19 pandemic, it is once again time for a new set of guidelines. While the 1994 guidelines — which concern best practices around board independence and oversight — continue to be relevant, they served the governance needs of the 1990s. Two-and-a-half decades later, we ask, Where is the leadership in a world in crisis?

The guidelines we have developed in response to this question are based on the principle that companies must account for the interests of all stakeholders — what we call 360º governance. They also reflect a similar sense that, as in 1994, Canada must upgrade its corporate standards or risk being left behind.

New era, new standards

The year 2020 forced a reckoning about the role of the corporation in society, and along with it, the responsibilities of senior leaders to the corporation’s myriad stakeholders. It is increasingly clear that corporations depend on a wide variety of stakeholders to function effectively: Customers, the planet, workers, communities and others offer the resources and markets required to grow businesses. And, while corporations contribute jobs, innovation and economic growth, they have also contributed to creating or exacerbating social problems like climate change, income inequality, gender inequality and the opioid crisis.

Too often, these social costs have been treated as ‘externalities’ outside of the scope of action for companies. At a time when a company’s primary responsibility has been to produce short-term returns to its shareholders, these issues have been dismissed as ‘the cost of doing business’. Yet, for an accumulating set of reasons, stakeholder concerns are now corporate concerns.

The COVID-19 pandemic — and resulting health and economic crisis — has only exacerbated schisms in society. But it has also given us a prime opportunity to build back better. Rather than getting back to normal, we need to envision an economy that works for everyone.

Following are three of the forces pressing companies to change and make a clear case for the necessity of new corporate governance guidelines.

Increasingly, companies must use the same strategies
to attract consumers as they use to attract employees.
 

Regulation and legislation

Given the severity of the many crises on our hands, governments at all levels are increasingly changing the rules of the game for Canadian companies. Recent examples include the Ontario Securities Commission (OSC) instituting ‘comply or explain’ regulations for women on boards and executive leadership in 2015, and this has been followed by federal legislation covering women and other underrepresented groups. In December 2020, the federal government announced additional carbon taxes. Proposed changes from its Expert Panel on Sustainable Finance and the Ontario Capital Markets Modernization Taskforce include corporate reporting that conforms to the Task Force on Climate-related Financial Disclosures (TCFD) guidelines.

Because many Canadian companies have international operations, they may also be subject to laws in other countries such as the UK’s Pay Transparency regulation. And, even if laws and regulations are not in place at the moment, they may soon be. The United Nations Principles for Responsible Investing (UNPRI) calls this “the inevitable policy response.” In their assessment, it is not a question of whether there will be greater government intervention on crucial issues for society, but when. Thus, executives and boards must anticipate and respond to increasing legal and regulatory constraints on their strategic decisions. 

The war for talent

The new generations of workers in blue-, pink- and white-collar jobs are more interested in working for companies they can believe in. And even though Millennials and Gen Z are leading the pack in terms of a desire for their employers to contribute to social or ethical causes, Gen X and Boomers are not far behind. According to a LinkedIn survey, the vast majority of respondents would consider taking a pay cut to work for an organization whose purpose and values align with their own. 

Human resource consulting firms report that firms with higher environmental, social and governance (ESG) scores, lower carbon emissions and a greater proportion of women on their boards of directors also have higher employee satisfaction and are more attractive to young talent. In short, ESG has become a competitive advantage in the war for talent.

Customer demand

Customers are also demanding that their suppliers respond to societal challenges. In the business-to-consumer (B2C) space, studies have shown that 64 per cent of consumers — Millennials and younger generations in particular — tend to buy products that have social benefits and are more trusting of and loyal to brands that are seen as socially responsible. And nearly half of consumers will walk away from a brand that does not align with their values.

As an example, in response to consumer awareness that food production accounts for nearly one-quarter of all greenhouse gasses, the World Resources Institute has created the Cool Food Pledge, which helps the food industry track its climate impact. The City of Toronto is the only Canadian signatory to date, but major U.S. food chains such as Panera Bread and Chipotle Mexican Grill are already labelling their meals accordingly in order to attract customers.

Increasingly, companies must use the same strategies to attract consumers as they use to attract employees. This is just as true in the business-to-business (B2B) space, where major buyers such as Walmart want suppliers to reduce emissions, adhere to worker health and safety standards, eliminate waste and cut toxins in their manufacturing processes.

The 360º governance guidelines

The following 13 guidelines are meant to help executives and boards address these challenges.

1)  Define corporate purpose

Every leadership team should identify, disclose and regularly review the purpose of the business. Put simply, why does the corporation exist? There are two aspects to purpose. The first is that the corporation was brought into existence to meet human wants or needs by producing a product or service to be used by its customers. By fulfilling this purpose, value is created. The second is that these efforts to produce value may impact the corporation’s stakeholders positively or negatively.

The support of stakeholders can only be expected if the corporation understands and addresses the impact of its efforts on them. The statement of purpose should be a living document rooted in the fundamental value proposition of the corporation. It should be specific enough to enable accountability and should be revisited with some regularity to ensure it still provides a powerful guiding light for the board and senior management.

2) Embrace the board's duty

Every board should be able to identify and articulate the best interests of the corporation in every decision it makes, and align these interests with the corporation’s purpose. When acting with a view to these best interests, the duty of loyalty will of necessity demand that boards consider the interests of stakeholders. This includes considering the long-term sustainability of the corporation’s business.

3) Clearly define your stakeholders

To understand the best interests of the corporation, the board must have knowledge of the stakeholders of the corporation. This may include people and organizations interested in or representing the following: climate and greenhouse gasses, communities in which the corporation operates, governments, customers, current and former employees and their representatives, pollution and environmental damage, supply-chain parties, holders of the corporation’s debt, shareholders and any other party or group connected to the corporation that contributes to the operation of its business or could be impacted by those operations.

4) Recognize indigenous peoples

The corporation should establish and implement a mechanism for fostering its relationship with Indigenous Peoples which recognizes the unique historical circumstances under which the relationship is created. Ideally, such a mechanism would be jointly developed to apply to the specific Indigenous Peoples affected by any prospective project. Cognizant of the fact that Indigenous Peoples are not mere stakeholders with interests but people with constitutional rights that are recognized and affirmed by section 35 of the Constitution Act, 1982, and recognizing that the UN Declaration on the Rights of Indigenous Peoples (UNDRIP) is applicable to the laws of Canada (and is already in BC law), boards must assure that these rights are recognized in any activities that may affect or impact their rights. Specifically, UNDRIP implementation in Canada may require that corporations obtain the “free, prior and informed consent” from impacted Indigenous Peoples. Corporations should report activities with and without free prior and informed consent to shareholders as a matter of risk disclosure.

5) Report on stakeholder impact

In order for the board and stakeholders to understand the corporation’s management of its stakeholders, the corporation should integrate reporting on stakeholder impact in its annual report. The report should reflect the status of and any changes to the corporation’s relationship with its stakeholders. To enable benchmarking and accountability and to track progress over time, boards may want to adopt an existing social accounting standard in their integrated reporting. Noting that there are currently several efforts ongoing to align existing standards, boards may also want to include reporting on issues that extend beyond these standard measures.

6)  Create a stakeholder committee

The board should identify those stakeholders that have a material impact on or could be impacted by the corporation’s business over the long term (as described in Guidelines 3 and 4) and should review the reporting and disclosure about each stakeholder group (as described in Guideline 5). It should assess the impact on the corporation’s stakeholders of all initiatives requiring board approval.

Every board should also have mechanisms in place for engaging directly with key groups of stakeholders. For many, these functions will best be carried out by a dedicated Stakeholder Committee that functions in a manner similar to the Audit Committee in its responsibility for overseeing the veracity of the reporting on stakeholder impact, but with greater strategic responsibilities for responding to stakeholder interests. Smaller firms might incorporate these responsibilities in another committee or in a lead director role.

7)  Address stakeholder conflicts

In making a decision, the board should be able to conclude that the corporation’s stakeholders have been fairly treated and that no stakeholder interests have been unfairly disregarded. To reach this conclusion, it may have to resolve competing interests amongst stakeholders, which should involve a process that fairly considers the interests of all involved.

8) Revisit compensation policies

The board should ensure that management compensation is aligned with achieving the purpose and long-term sustainability of the corporation. This can be accomplished by adopting metrics and targets (as identified in Guideline 5) in compensation plans that are aligned with the purpose of the corporation. The plans should provide that the achievement of these targets makes up a meaningful component of management’s bonus and other forms of compensation.

9) Embrace board refreshment

Every board should have a process to ensure board renewal, board diversity and the right mix of skills across the skills matrix. Recognizing that a director can cease to be independent after serving for a sustained period of time, the process should include term limits and should be complemented by regular performance assessments of all directors. In addition, the skills matrix used to assess current and desired board member competencies should be updated to include knowledge about key stakeholder issues (as identified in Guidelines 3 and 4).

10) Ensure board diversity

The demographics of a board should represent and reflect the communities in which the corporation operates. Specifically, as suggested by regulations governing most Canadian stock exchanges, boards should announce targets for representation of women and track progress towards achieving these targets. Consistent with recent federal legislation (Bill C-25), companies should also report on the representation of other underrepresented groups — at a minimum, the other protected groups under the Human Rights Code: Indigenous Peoples, persons with disabilities and members of visible minorities.

11) Institutionalize organizational diversity

Every corporation should have and disclose its policy relating to diversity in its leadership and overall workforce. This includes gender diversity as well as diversity along all dimensions protected by the Human Rights Code. The policy should provide specific targets and timelines for achieving them. Management should regularly report to the Board on its progress in meeting its targets, and this information should also be disclosed in the company’s annual report.

12) Disclose your climate change policy

Every corporation should have and disclose its policy for addressing climate change and climate-related risks and opportunities. Consistent with Task Force on Climate-related Financial Disclosures (TCFD) recommendations, boards should disclose their oversight of climate-related issues, including the processes by which their committees consider these issues when reviewing strategic choices. They should also account for progress made against goals and targets for addressing climate-related issues.

13) Embrace corporate activism

Corporations may, from time to time, be pressured to state their position on an issue with social or political implications. The corporation may also decide, of its own volition, to make such a statement. The CEO should lead this process to decide whether to make a statement and what its content should be. Before making that decision, the CEO should consult the board to obtain its input and approval on whether, when, and how to take a stand. The disclosure of the corporation’s position should be prepared with the same degree of care as any other company release. Because the nature of the issue may attract substantial attention, the corporation should have in place a process that enables the CEO and the board, if necessary, to respond to public inquiries.

The challenges facing corporations in the 21st century are myriad, and senior leaders and their boards must be prepared. With its deep and diverse pool of talent and its aspiration to be a global leader in creating an inclusive and sustainable economy, Canada is well-positioned to meet these challenges. We are optimistic that the principles described herein will contribute to the ongoing reform process.

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This article first appeared in the Fall 2021 issue of Rotman Management magazine. Published in January, May and September, each issue features thought-provoking insights and problem-solving tools from leading global researchers and management practitioners. Subscribe Today.