Want a Greener Company? Clean Up Your Board First

For every public company trying to reduce its environmental footprint, there’s likely a major investor behind the scenes doing the pushing.

There’s now growing evidence that institutional investors, particularly big pension funds, more often than not drive the green agenda for corporations. They have the heft and patience that can overcome the attitudes of senior executive teams overly focused on short-term compensation and career concerns.

For these environment-first investors, the key metric is ESG. This score measures a firm’s environmental impact, social responsibility, and governance structures, such as internal controls and shareholder rights. Not surprisingly, environmentally conscious investors focus on the E. But a new study suggests they would be far more effective by focusing on the G — governance. The thinking is that a large ownership stake is not necessarily enough to win over entrenched insiders when toothless boards offer little management oversight.

The study examined the ESG performance of 3,531 firms from 41 countries outside the U.S. “We broke up aggregate ESG and specifically quantified the impact of firms’ corporate governance structures on firms’ environmental performance,” Alexander Dyck of University of Toronto told attendees at the Green Finance conference, which was organized by the Institute of Intergovernmental Relations at Queen’s University and Smith School of Business. “We wanted to see the extent to which governance is the gateway drug to get E.”

Dyck conducted the study with Karl Lins (University of Utah), Lukas Roth (University of Alberta), Mitch Towner (University of Arizona), and Hannes Wagner (Bocconi University).

Insiders Versus Outsiders

The researchers focused on four markers that determine how much real power is vested in outside investors. Three are fairly standard: majority director elections; the percentage of a board that is independent; and the number of entrenched board members (based on age and tenure). The fourth is a much less traditional route to better governance: the presence of at least one female director. Previous research has shown that female board members are much more likely to be independent.

The study revealed the outsized influence of good governance as an enabler of better environmental practices in both family firms and public companies.

Family-controlled firms, in which insiders are entrenched, have up to 13 percent lower environmental performance. When majority voting requirements are introduced, firms' environmental performance improve six to nine percent (depending on the measure used and the governance structure).

The results were even more promising for widely-held companies. Those with a majority voting provision have up to 10 percent greater environmental performance than companies without such a rule. Adding one independent director boosts environmental performance by two percent. And turning over an “old” or “stale" board is associated with up to nine percent improvement.

Looking at these results, Dyck said, “we conclude that corporate governance is fundamental for the environmental component of sustainability — that is, G drives E.”

The Power of Female Directors

The most striking finding, though, relates to the presence of female board members: environmental performance improves significantly when a woman is elected to a board of directors. This holds for both family and widely-held firms. For family firms, having at least one female board member leads to 12 to 13 percent better environmental performance. For widely-held firms, the figure is 13 to 16 percent.

The researchers say there could be a couple of factors at play. As they point out, female board members have different skill sets than male board members. They also have stronger “other regarding” preferences than men — they are more concerned with others than with themselves. So when given control rights as board members, they are more motivated to improve a company’s environmental performance.

Whatever the reason, Dyck said, “short-termism is a real issue.” And it’s one that institutional and other investors should account for when agitating for greater environmental sustainability.

“If you don’t understand the important role that governance plays in facilitating these other changes,” he said, “you might be just interested in trying to push firms to do their environmental activities when you really would be better off pushing them to improve their governance first and only then trying to move their environmental and social fronts.”

—Kate Irwin and Alan Morantz