E.S.G. could paralyse boards

As the federal government and the regulators continue to implement the banking royal commission recommendations and companies seek to win back lost trust in a rapidly evolving regulatory environment, it seems we can barely go a day without reading about a so-called “social licence” for companies and their directors.

The narrative is now that shareholder primacy is dead and directors need to consider the interests of not just shareholders but also customers, employees, suppliers and broader community concerns such as climate change.

Many have called for the Corporations Act to be amended to reflect this so-called “marked shift” in corporate responsibility and the greater standards the public now expects from directors, adding to the regulatory maze of corporate compliance that directors already face.

This commentary was buoyed by the release of the US Business Roundtable’s revised Statement on the Purpose of a Corporation in August, when 181 of America’s most high-profile CEOs expressed a “a fundamental commitment to all our stakeholders”.

This has been labelled a “radical change” in traditional corporate mantra, reflecting an alleged global movement away from prioritising shareholders and profits. And the issue is due to be debated by the business and legal communities once again at a Supreme Court of NSW conference on “The Future of the Corporation” on Tuesday.

But behind this debate and the vague generalities of the now in vogue social licence concept lies a false assumption: that the interests of shareholders and other stakeholders are opposed.

Far from being in competition, in the current post-banking royal commission climate of public mistrust and heavy scrutiny of the actions of corporate officers, along with lower consumer confidence in a slowing economy with an uncertain future global outlook, the interests of shareholders and other stakeholders will very often be aligned.

If directors fail to actively consider non-shareholder interests, both in pursuing general CSR measures designed to enhance the company’s reputation as a trusted “corporate citizen” and in identifying and mitigating the direct costs to the company of various ESG market risks, the company’s profits will inevitably take a hit as investors, customers, employees and suppliers take their business elsewhere. As a result, directors will prejudice the interests of shareholders and breach their duty to act in the best interests of the company.

It is true that shareholder wealth and non-shareholder interests may diverge when directors genuinely take the view that a sufficient reputational boost has already been achieved, and ESG risks have been adequately reduced, to justify any further CSR and ESG expenditure.

Yet imposing more regulations on directors is not the answer in seeking to protect “vulnerable” stakeholders and pressing community concerns in those cases.

To change the law to expressly require directors to place all stakeholders on an equal footing in pursuit of some kind of social justice outcome would create enormous uncertainty and expose directors to a significant litigation risk from aggrieved interest groups every time they make a corporate decision. With the ongoing growth in shareholder activism and corporate class actions in Australia, that threat would be a very real one.

As a result, reformulating directors’ duties would have a paralytic effect on directors’ willingness to take risks and pursue innovative, value-creating activities on behalf of a company. That would reduce corporate profit and growth to the detriment of not only shareholders but also the very “other stakeholder” interests intended to be protected by legislative change.

While the end goal of protecting non-shareholder interests and advancing public policy concerns is perfectly legitimate, the most efficient means of achieving it is for the government to introduce specifically tailored, mandatory environmental, climate, labour and consumer laws, so that directors must ensure the company complies with those laws as a direct cost in its unique ESG risk profile. That would avoid the unintended negative consequences of over-regulating directors while ensuring public policy remains the responsibility of the government instead of being outsourced to directors of private enterprises ill-equipped to deal with it.

Scott Atkins is a partner, deputy chair and head of the risk advisory practice at Norton Rose Fulbright. Dr Kai Luck is a senior risk adviser in the risk advisory practice at the same firm.