Supporting Responsible European Business through Policy Change

I was recently asked about medium-term prospects for supporting responsible and purpose-driven business at the EU level. Below is an edited version of my response:

  • Implementation of the Non-Financial Reporting Directive – The EU Non-Financial Reporting Directive (Directive 2014/95/EU) must come into effect in member states by 2017 (see background here). The Commission will publish a consultation in early 2016 to seek stakeholder input before it issues its guidelines to member states at the end of the year. As of last week, DG FISMA says that it does not know when the consultation will be published but probably in January or February.
  • Clarification or expansion of the fiduciary duties of investors – DG ENVI commissioned a study on the fiduciary duties of institutional investors to consider ESG matters. The study disappointingly does not see a need for legal changes in relation to fiduciary duty, but instead calls for softer action such as guidance from national financial authorities (with support from the Commission) about the interpretation of these duties and their implementation. The study also calls for mandated disclosure by institutional investors on a comply or explain basis of any sustainable / responsible investment policies. At a minimum, the Commission could give stronger guidance to Member States about the content of the fiduciary duty.
  • Strengthening European social enterprise law –  The EU’s expert group on social enterprise, GECES, will issue a report with recommendations in mid-2016. The recently created European Social Enterprise Law Association (ESELA) has released an EU-wide mapping study with recommendations on social enterprise, which may provide some fodder for GECES’ report. (Full disclosure: our law firm Frank Bold is a member of ESELA but we were not involved in writing the report).
  • Adoption of the Diversity Directive – The Directive aiming to increase gender diversity on boards is in deadlock due to the European Council’s rejection in December of a compromise proposal. The Netherlands (which has taken over the presidency) voted against it and it is unlikely to proceed any time soon in its current form.
  • Developing a responsible Capital Markets Union - The current project to develop a Europe-wide Capital Markets Union has a number of implications for facilitating/impeding responsible and purpose-driven business. A number of stakeholders have written excellent position papers, including AvivaE3G, Eurosif, Finance Watch, Share Action, and last but hopefully not least, Frank Bold.

Any comments about my assessment are most welcome by email or Twitter.

Teaching Corporate Governance

This semester I will be teaching a course on corporate governance at the University of Kent’s Brussels School of International Studies as part of their Masters of Law programme.


Corporate governance, the procedures and processes according to which a business is directed and controlled, has become the subject of increasingly close scrutiny by both companies and regulators. Since the onset of the financial crisis in 2007/8, the debate about how companies should be run has intensified. Although individual malfeasance was clearly a factor in the crisis, there were also contributory structural issues, including a systemic bias towards short-term, speculative trading over long-term investment and misaligned incentives.

The course begins with an overview of corporate governance and its predominant theoretical models: shareholder primacy and stakeholder theory. It then addresses several core questions of corporate governance: the nature and purpose of the corporation; the function of the share; and the role of stakeholders. The course proceeds to examine corporate governance in the context of European integration; the role of corporations in society; and the current debates on the future of corporate governance. The course will focus on both the theoretical and policy implications of corporate governance, including efforts in Europe and elsewhere to reform governance and strengthen oversight in the wake of corporate scandals.

Here is a link to the syllabus: Corporate Governance Syllabus.

Any comments by email or Twitter (@paigemorrowlaw) are most welcome.

The Importance of Defining Corporate Purpose

Blog post at Triple Pundit

The future of sustainable development is being shaped by events such as the U.N. Forum on Business and Human Rights held earlier this month in Geneva, the Climate Change Conference in December, and the adoption of the Sustainable Development Goals in September. Considering that many corporations have greater turnover than the GDP of several countries and that 500 transnational corporations control roughly 80 percent of world trade, it is clear that we need business on board. The way these corporations are governed is essential for either positive or negative change of the system as a whole, depending on the chosen stewardship, which takes us to the central question: What is the purpose of the corporation? 

A corporation may decide to maximize profits and share price ­it is a permitted objective, but not one that is required by law. ​The purpose of a corporation is instead whatever its founders wish it to be, as long as it is legal. Thus, it might be to make innovative products, develop cutting edge technology, build a spaceship or create the next penicillin. The law has left a vacuum allowing companies to decide what their purpose should be. Unfortunately, the current model of corporate governance is based on the popular conception that the sole or primary purpose of the corporation is to maximize its value for shareholders.

The often myopic focus on share price is driven by a business culture that is based on this misunderstanding of the legal obligations of directors and a corporate governance system that empowers short­term oriented shareholders and facilitates the demands of capital markets. This approach has resulted in decision making within companies that focuses on quarterly earnings and creates perverse incentives that encourage problematic practices such as stock buybacks. This way of doing business is also implicated in a range of unintended social, human rights, and environmental consequences. It compels companies to externalize as many costs as they can get away with (e.g. companies’ carbon footprints and supply chains issues). It is also a driving force behind growing inequality (e.g. the pay gap between average workers and bonus­driven top management compensation, the race to the bottom in the cost of labour, and the reallocation of resources to shareholders).

Not surprisingly, the focus on maximizing shareholder value ultimately undermines the viability of companies in the long­term as they are not reinvesting their returns into R&D, human capital, addressing systemic risks and exploiting strategic opportunities. The maximizing shareholder value imperative drives spending of corporate resources and time of top management on strategies such as buying other companies, paying out dividends to shareholders and buying back shares.

Furthermore, according to an a​rticle published in the Harvard Business Review​ by William Lazonick, professor of economics at UMass Lowell, the focus on short­-term returns has resulted in a shift from “value creation” to “value extraction,” contributing to “employment instability and income inequality.”

Corporate governance must evolve into a model that balances the interests of investors, workers, consumers, communities, and the environment, allowing businesses to thrive while contributing to broader sustainability. For this to happen, it is essential that we shift the policy discussion from a single­minded focus on shareholders to a more holistic understanding of their role in the firm.

Corporate Responsibility in the News: UN Forum on Business and Human Rights, E2020 Summit

Update on our workThis week our law firm Frank Bold had the opportunity to participate in two significant conferences on responsible corporate behaviour. The prominence of the speakers and participants highlighted the growing recognition that companies should act proactively to embed sustainability into their operations and manage risk in their operations, especially in high risk regions and industries.

Enterprise 2020 Summit: The Future of Europe

CSR Europe, the European business network for Corporate Social Responsability, organised the E2020 Summit to encourage businesses to contribute to achieving the Europe 2020 goals by delivering high levels of employment, productivity and social cohesion. To that end, they brought together more than 500 participants, including high level business representatives and policymakers from across Europe. During the different sessions, there was always an underlying idea: the need for financially, environmentally and socially sustainable companies. In this sense, the European Commissioner Elżbieta Bieńkowska stated: “we want more European companies to take responsibility, and take care of all shareholders, stakeholders and society”.

A wide range of issues were tackled during this two-day event such as non-financial reporting, management and leadership, business education, sharing economy, youth employment, business and human rights.

Filip Gregor, Head of Responsible Companies at Frank Bold participated in the panel discussion “Building blocks for the Future Europe” along with Member of European Parliament Richard Howitt and the Chairman of China Golden CSR Council, Johnny Kwan. In his intervention, Filip emphasised the need to define the expectations that we as a society have on businesses and added that “it is time to be creative about re-creating the set of metrics we use to measure companies’ success”. His final conclusion revolved around the importance of corporate purpose to set the path towards sustainable management and leadership.

The Summit also saw the launch of the European Pact for Youth, which aims to develop partnerships in support of youth employability and inclusion. The Pact is supporting the creation of 10,000 quality business-education and aiming to create at least 100,000 new good quality apprenticeships, traineeships and entry-level jobs.

UN Forum on Business and Human Rights

Running in parallel with the E2020 Summit, the 4th annual UN Forum on Business and Human Rightstook place in Geneva. The UN Forum is the world’s largest gathering on Business and Human Rights, bringing together more than 4,000 experts to discuss the implementation of the UN Guiding Principles on Business and Human Rights.

Frank Bold co-organised a panel on human rights due diligence in law and practice. The UN Guiding Principles require businesses to conduct proper due diligence to avoid and mitigate human rights impacts. Richard Howitt MEP noted that European Parliament passed a resolution after the Rana Plaza factory collapse in favour of mandatory due diligence but it has not yet been adopted in EU law.

Robert Brooks from the law firm Norton Rose argued that properly conducted due diligence in multinational transactions such as mergers and acquisitions will typically uncover human rights issues at the same time as other problems, e.g. corruption, without any significant additional cost.

Sandra Cossart from Sherpa presented a draft French law that codifies a ‘devoir de vigilence’ or duty of care for businesses. The text proposes that large French enterprises put in place a due diligence plan with respect to the environment, human rights and corruption in the entirety of their supply chains, including in their subsidiaries and sub-contractors in France and globally. Sandra explained that a number of French companies support the law because it clarifies legal and societal expectations of them and ensures that businesses that act responsibly will not be exposed to civil or criminal liability. However the law was rejected by the French Senate only hours after the panel ended and will now return to the Assembly for a second vote.

Many of the sessions at the UN Forum are viewable on UN TV video from the due diligence session will be added in the coming weeks.

B Corp movement prompts debate about future of corporations

Blog post at Triple Pundit:

The B Lab was officially launched in the U.K. this past September, offering a certification scheme for companies to show that they have successfully combined profit with a commitment to making a positive contribution to society. B Lab has existed in the U.S. since 2006 and is now making the leap across the Atlantic to expand into Europe.

Origin of B Corps

The B Corp movement has captured significant attention and certified over 1,300 companies in 41 countries. So, are B Corps the future of responsible business? Yes and no. Other forms of purpose-driven organisations have always existed, whether it be as cooperatives or non-profit/charitable entities. Even a regular ‘C’ corporation can choose to pursue a social mission as part of their business and many do.

Nearly 50 leading legal scholars from universities including Cambridge and Cornell signed a statement last year concluding that: “Contrary to widespread belief, corporate directors generally are not under a legal obligation to maximize profits for their shareholders.” This gives latitude to boards of directors to make decisions that might cause a dip in short-term returns, such as Costco’s commitment to pay a living wage.

Value-add of B Corps

What is special about B Corps is that they build social commitment directly in their governance to support and protect it. Another unique feature is that B Corps have a recognizable brand that allows consumers to make educated decisions about what products to buy and companies to use. Rather than evaluating the merits of each given business, an individual may rely on B Lab to screen companies for certain requirements in terms of working conditions, supply chain management and their relationship with local communities. In this sense it is similar to the Fair Trade label but goes one step further by requiring the company as a whole to meet ethical obligations. The logic is that businesses should not be able to benefit from the label unless they can show that they are run fairly across the organization, not just for one specific product such as tea or coffee.

The focus on purpose could also help social entrepreneurs. Tom Fox, policy lead at UnLtd, which supports social entrepreneurs in the U.K., says:

“[Social entrepreneurs] are showing an increasing appetite to use a conventional business form for their social venture, but formally embedding their social purpose can be regarded as novel and unusual by some stakeholders.”

UnLtd would like to see the launch of B Lab U.K. as a “step forward in the normalization of embedding social purpose into the heart of business.”

Edging into mainstream business

Initially B Corps were mostly small start-ups and it was uncertain whether the movement would have a significant impact on mainstream business. In the past couple of years, however, we have seen increasing interest from established firms that wish to adopt the label to signal both to investors and markets that they do business differently.

Now, stock market listed companies are jumping on board and B Lab has adapted its certification process to take into account the complexities associated with large multinationals. Natura, the Brazilian beauty product company, was the first public company to be certified. Ben and Jerrys became certified and its parent company Unilever (which is publicly listed) has expressed an interest to certify the whole group.

The expansion into bigger companies has brought with it criticism. For example, Etsy maintained B Corp status after its initial public offering, which could help it to protect the company from pressure by capital markets to maximize short-term profits, but recently came under fire from NGOs for using a corporate structure that reduces its tax burden.

What does it mean to be a responsible corporation?

The certification of publicly held companies has taken B Lab into the heart of the debate about what it means to be a responsible corporation:

  • Is it possible to do ‘good’ while providing returns to investors?
  • How much tax should a responsible company pay when it is perfectly legal to “optimise” its tax burden?
  • How much should the CEO earn relative to the lowest paid or average worker?
  • Should companies avoid suppliers or countries with known labour violations or instead push to improve working conditions?
  • How should complaints by workers or local communities be handled?

Many of these questions have been debated for years by the International Labor Organization and human rights advocates in the context of the U.N. Guiding Principles on Business and Human Rights, as well as the emerging discussion on a human rights treaty covering multinational companies. However their focus tends to be on creating rules for companies to obey rather than transforming business from within.

Integrating social purpose into core business

Rather than advocating for external regulations to prevent corporations from misbehaving, the B Corp movement focuses on embedding a social purpose within a company’s DNA. As this movement gathers momentum, it highlights the need for an open debate on the purpose of the corporation, whether it be a certified B Corp or not.

Parallel Tracks of B Corp and Business and Human Rights Movements

Ahead of tomorrow’s UK launch of B Lab, the certifying body for B Corps, it is worth reading the recent paper of Joanne Bauer and Elizabeth Umlas comparing the B Corp and business and human rights movements. Both movements are relevant to corporate purpose (creating responsible business) but differ in their approaches. B Corps embed social purpose into their business strategy and legal structure, while the BHR movement seeks to impose rules to prevent human rights violations.

The authors note that “[i]n contrast to the B Corp movement, the idea of modifying company law has not been a centerpiece of the BHR movement” (p. 4). Instead, BHR advocates focus on imposing external regulations that will mitigate ESG impacts. A footnote observes:

There are signs this is changing, at least in Europe. In a number of countries, there is growing debate, led by civil society organizations, law scholars and progressive lawmakers, about the need to make companies take into account their impact on society and the environment. In some cases, reforms to company law are being discussed as part of the debate.

The paper goes on to cite a blog post I wrote for the Lawyers for Better Business as well as the work of the Purpose for the Corporation Project.

An interesting read.

EU contemplates significant changes to the Shareholder Rights Directive

The EU is contemplating a number of changes to its corporate governance framework that would affect publicly listed companies, including a revision of shareholder rights to give them a say on pay and access to certain information, among other changes. With several academic partners, I co-wrote a Commentary on the Shareholder Rights Directive, which critiques the Directive’s shareholder-centric approach to corporate governance and proposes a number of concrete amendments.

We presented our commentary in various meetings with EU policymakers at the Parliament and Commission, as well as at a conference on corporate governance at EU Parliament (audio available online and the paper is on SSRN).

The Rapporteur for the Shareholder Rights Directive subsequently published a report recognising that shareholders are not the owners of companies. The Rapporteur also recommended that shares not be a major part of variable pay; suggested that Member States should promote long-term shareholdings through tax incentives, fidelity dividends or other means; and recognized the importance of employee voice in a balanced corporate governance framework, e.g. by giving them the ability to express an opinion on remuneration policy. (See my article in Europolitics for more detail).

Only some of the Rapporteur’s recommendations were adopted at the Parliament’s plenary vote in July 2015. A notable addition at the plenary vote was the requirement of country-by-country reporting, which would see large companies disclosing their tax payments to EU states. The Directive will proceed to trilogue negotiations between the Council, Commission and Parliament this autumn.

The revision of the Shareholder Rights Directive is hopefully the first step in a broader discussion on the future of corporate governance in Europe (and elsewhere). For further analysis of the Directive and the need for deeper reform, you can read a chapter co-written with Prof. Andrew Johnston of the University of Sheffield in the new book ‘Long-term investment and the Sustainable Company‘.

OECD launches new Principles for Corporate Governance

The OECD released today (5 September 2015) its revised Principles for Corporate Governance at the G20 meeting in Turkey on 4-5 September 2015. One particularly noteworthy addition is explicit mention of the OECD Guidelines for Multinational Enterprises and the possibility in many countries of bringing a complaint before the OECD National Contact Point if there is a violation, such as of labour rights. There is also stronger recognition of the financial impact of ESG matters (p. 43):

In addition to their commercial objectives, companies are encouraged to disclose policies and performance relating to business ethics, the environment and, where material to the company, social issues, human rights and other public policy commitments. Such information may be important for certain investors and other users of information to better evaluate the relationship between companies and the communities in which they operate and the steps that companies have taken to implement their objectives.

As part of its review of the Principles, the OECD held a public consultation to receive feedback on the draft revised text. With academic partners, we submitted a commentary that critiqued the current focus on the role of shareholders in corporate governance at the expense of other stakeholders and suggested amendments. Our commentary is available on the Purpose of the Corporation Project website and SSRN. All responses are available online here. Compliance Week published an overview of the review process, which quotes our work.

The OECD is also leading a Trust and Business Project to promote implementation of the underlying values of the Principles for Corporate Governance and those on MNEs, namely responsible business behaviour. Its public consultation appears to be ongoing and a background paper is expected soon.

European lawmakers vote to increase shareholder rights

Op-ed in today’s Europolitics:

In a strong signal about the importance of fostering sustainable and transparent companies, the European Parliament’s Committee on Legal Affairs (JURI) approved, in May, a number of revisions to the shareholder rights directive that aim to enhance the role of long-term shareholders in corporate governance. The changes include the introduction of ‘say on pay’ (with employees having the right to express a view) incentives to hold shares for more than two years and country-by-country reporting.

Shareholders do not own corporations

The directive will explicitly acknowledge that shareholders do not own corporations – a first in EU law. Contrary to the popular understanding, public companies have legal personhood and are not owned by their investors. The position of shareholders is similar to that of bondholders, creditors and employees, all of whom have contractual relationships with companies, but do not own them.

Giving voice to long-term investors

In 1960, the average holding period of stock in the S&P 500 was eight years. Today, it is four months. In the 1950s, the average life expectancy of a Fortune 500 company was 50-60 years; now it is 15 years. Executives point to pressure from capital markets as making it impossible to steer companies towards sustainable, long-term growth.

The new directive seeks to tackle the problem by requiring member states to give additional voting rights, tax incentives, loyalty dividends or loyalty shares to investors who hold shares for more than two years. This will reward patient investors, who have a better understanding of the business than short-term investors.

Democratic decision making on executive pay

Executive pay at FTSE 350 companies has increased by 233% since 2000, while pre-tax profits have increased by 95% and market value has only increased by 65%. The directive will promote the accountability of senior executives by giving shareholders a right to vote on the company’s remuneration policy every three years, which must include the maximum of directors’ average pay and the ratio between the pay of directors and workers. Employees will also have a right to express an opinion, which is a positive development that may help to stimulate engagement.

The aim is to shift increase transparency and accountability to long-term shareholders, as well as better align management remuneration with company performance. Current practice varies across member states: shareholders in UK companies have a binding vote and Germany introduced advisory ‘say on pay’ votes in 2009, but the changes will be completely new for many other European countries. There is not yet any clear evidence about the effectiveness of these provisions. Indeed, critics question whether the proposed changes will fix the root causes of short-termism or rather given additional powers to stockholders at the expense of companies’ ability to steer business strategy.

Increasing tax transparency

The recent explosion of the LuxLeaks scandal, which revealed that more than 300 companies had received secret tax rulings from Luxembourg allowing them to drastically reduce their tax burden, has shown how critical it is for companies to engage in responsible tax practices and for this to be monitored through appropriate international mechanisms. EU policy makers propose to address this issue through the introduction of country-by-country reporting, which would require companies to disclose their profits, revenue generated, taxes paid and the number of employees in each country where they have an operating subsidiary.

Currently, information is disclosed in a consolidated global report that does not break down information according to country of operation, making it difficult to determine whether companies are avoiding taxes through the use of tax havens or other forms of aggressive tax planning.

Consequences of changes

Following the vote in the Legal Affairs Committee, the changes will now go to a a vote in plenary before proceeding to trilogues. If passed, it remains to be seen whether the changes to the shareholder rights directive will have any effect on the behaviour of markets. There is nearly universal consensus about the need for patient capital to invest in long-term innovation and R&D but widely diverging views about how best to foster it.

Perhaps the root challenge is that the current proposal relies almost exclusively on shareholders to drive the shift to a longer-term perspective. This myopic focus on shareholders neglects potentially valuable input from other stakeholder groups, such as employees, who have a stronger stake in the company’s competitiveness and viability. Moreover, shareholders differ considerably in their time frames and approaches. Some shareholders are committed to holding for the long term, whilst others only hold for the short term. It is important that the former group become more engaged; however, there is a danger that the proposed directive will further empower shareholders with a short-term orientation, such as hedge funds and activist investors.

Beyond the directive

Achieving sustainability in European enterprises will require modification of the legal and regulatory framework at the national and EU levels, in addition to improvements to business education, practice and culture. We need a shift away from the current shareholder-centric approach to corporate governance and company law towards a model that prioritises the long-term interests of the company, whilst respecting the interests of shareholders and other stakeholders.

Trending towards increased corporate responsibility

A short legislative update published on the Lawyers for Better Business (L4BB) website.

France is considering changes to its civil code that would require companies to integrate the effects of their business activities on the economy, society and the environment into internal decision-making and strategy. The bill proposed by the Minister of Economy would amend the definition of business enterprises so as to require them to be managed in their higher interest, in accordance with the respect of the general economic, social and environmental interest (article 1833, text below).

Leading company law professors have proposed a similar amendment to Norwegian company law to clarify that “while companies in the aggregate may and should have profit as their core purpose this should be achieved within the overarching societal purpose of sustainable development.”

Driving change from within. A small change to company law has the potential to shift how boards of directors and top management develop business strategy. Neither of these proposals would require large companies to assume responsibility for specific impacts or externalities. Furthermore, they would not significantly curtail board powers or managerial decision-making. Instead, the changes would ask companies to consider the effects of their business decisions at the highest levels of the company and integrate those reflections into core strategy.

Increased expectations throughout Europe. The present debate about company law reform occurs against the backdrop of pushes for increased corporate responsibility across Europe. Approximately 6,000 large European companies will be required as of 2017 to report on non-financial matters relating to the environment, social and employee issues, respect for human rights, anti-corruption, bribery, and board diversity.

Movement is happening at the Member State level as well. At the end of March 2015, the French National Assembly adopted a historic bill creating a ‘duty of vigilance’ that will require certain large parent companies to oversee the actions of their subsidiaries to prevent human rights and environmental infractions.

Only two weeks earlier, Swiss parliament initially accepted a motion for an analogous proposal for mandatory human rights due diligence. In an unexpected twist, interest groups successfully pressured politicians to hold a second vote the same day, which narrowly failed. This week, a coalition of civil society partners known as the Responsible Business Initiative launched a campaign to gather the 100,000 signatures required to hold a binding Swiss referendum on the issue. Taken together, these initiatives signal a fundamental shift in our societal and legal expectations of corporate citizens.

Revisiting the purpose of the corporation. Our social enterprise law firm, Frank Bold, is contributing to this discussion through its project on the Purpose of the Corporation, which explores the question of how corporate governance and company law may ensure that a public company is governed in the best long-term interests of the business itself as well as those of its stakeholders, the broader community and the environment.

We worked with a team of international academics on a series of authoritative statements on economics, law, management and accounting. They determined that no company law system requires firms to blindly maximise profits for their shareholders to the detriment of proper risk management.

Depending on the perspective, profit is the byproduct or end result of a strong vision to create excellent products and services, not the reverse. Furthermore, boards and management have broad latitude to steer businesses towards sustainability. Yet the current mainstream focus on maximizing shareholder value — reinforced by capital markets, the rise of activist shareholders, executive pay packages tied to stock options, and policy support for ‘shareholder democracy’ — has led to a narrow, short-term focus on returns.

Revisiting the purpose of the company is critical in the wake of the financial crisis and protracted economic recovery. The proposed French Civil Code reform requiring companies to review the impact of their business activities is a strong first step.

Reprinted with permission from Lawyers for Better Business.