Environmental Social Governance (ESG)

The implications of COVID-19 for corporate governance

By Emily Woodland
CFA, BA(Hon), M(SocSc) Head of Sustainable Investment Hong Kong, China

Though corporate governance may not be an obvious focus during a pandemic, it is during these testing periods that leadership and management structures are tested, exposed for their strengths or flaws, and remembered by stakeholders in the long-term1.

The current context requires companies to assess the immediate health, social and economic factors facing their immediate survival, without losing grip on their long-term prospects. It is a challenging array of competing issues to confront.

Though some ESG (environmental, social and governance) issues are not front of mind for steering through this pandemic, the ‘G’ in ESG is a vital ingredient to coming out the other side strongly.

In the short term, poor governance structures are likely to be exposed during such periods of crisis, while well-governed companies will act more decisively to contain its impacts and provide much-needed transparency and consistency to their stakeholders.

In the long-term, the capacity for a company to effectively and appropriately manage and navigate its way through this pandemic will be remembered by its investors and clients. Crises been and gone have been the ‘make or break’ moment of many companies throughout the course of history.

For us, the most critical considerations we are engaging with our investee companies on are as follows:

Capital management

Financial prudence is a necessary outcome of the current situation. We aim to work with our companies to ensure that financial resources are appropriately allocated to stakeholder management and balance sheet and business resilience. The appropriateness of planned activities such as dividends and share buybacks must be carefully weighed against this near-term necessity.

COVID-19 has prompted changes to workforces and shareholder experience, which is leading to discussion and actions around remuneration schemes, including those of executives. There are a number of examples of reductions in executive remuneration in recognition of the changed environment. Changes in pay ratios of executives to average workforce and/ or adjustments to equity compensation plans, among other remuneration features, are likely to come under heightened scrutiny. We anticipate increased interest of shareholders in remuneration proposals over the coming year.

Board structure & oversight

The COVID-19 crisis has also given weight to the case for assessing the diversity and capacity of boards and those who hold board positions respectively.
Given the average demographic of those most likely to be impacted by the virus23- namely older males- the continuity and diversity of boards and executive teams may be increasingly called into question. Furthermore, busy directors who serve on multiple boards may have constrained capacity to provide adequate oversight at such a critical time.

We are engaging with our investee companies to ensure that governance and oversight processes are still functioning effectively and with robust meeting attendance rates, with clear succession planning a critical priority.

Risk management

COVID-19 has undoubtedly uncovered a widespread lack of stress-testing and deficiencies in disaster preparedness and scenario planning4, which is reflected in the number of emergency capital raisings occurring at present and the pausing of planned growth projects- particularly in the resources sector.

Going forward, we anticipate there will be far more scrutiny over a company’s risk management, crisis management and business continuity planning. Companies will be expected to disclose more details on their risk management frameworks and undertake rigorous stress testing, preferably aligned to international best practice standards such as ISO31000, as well as to maintain strong board-level risk management experience.

Cyber security

Cyber security has been a growing threat across all industries in recent years which, in our experience, companies have varied levels of preparedness for. The need for social distancing and rapid shift to the work-from-home economy has exponentially increased our reliance on the internet, and in turn raised our vulnerability to cyber-crime567.

We have been engaging with companies for some time already on having the appropriate cyber governance structures and risk management frameworks in place. Companies that have invested in shoring up their cyber defences will be more resilient in the current paradigm than those facing severe risk of major cyber disruptions to their operations.

In summary

Rather than ESG being simply a “nice-to-have” or a box to be ticked, the COVID-19 crisis has served to highlight that the consideration of material non-financial factors is increasingly integral to assessing long-term business resilience in the 21st century. As demonstrated, governance is no exception to this. The pandemic provides us with a unique opportunity to stop and reflect on the new paradigm we are facing into, and the fact that our economic model is unavoidably tied to the way in which we interact with these factors.

 

1https://www.glasslewis.com/everything-in-governance-is-affected-by-the-coronavirus-pandemic/
2https://edition.cnn.com/2020/03/24/health/coronavirus-gender-mortality-intl/index.html
3https://www.cdc.gov/coronavirus/2019-ncov/need-extra-precautions/older-adults.html?CDC_AA_refVal=https%3A%2F%2Fwww.cdc.gov%2Fcoronavirus%2F2019-ncov%2Fspecific-groups%2Fhigh-risk-complications%2Folder-adults.html
4https://www.afr.com/chanticleer/virus-catches-many-boards-napping-20200331-p54fi1
5https://fraudwatchinternational.com/active-scams/COVID-19-has-long-term-effects-on-cyber-security/
6https://www.us-cert.gov/ncas/alerts/aa20-099a
7https://www.securityworldmarket.com/int/News/Business-News/during-COVID-19-no-one-is-immune-to-cyber-attacks

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Emily Woodland, Co-Head of Sustainable Investment
  • Environmental Social Governance (ESG)
  • Opinion
  • Research
  • Sustainable Investment Insights
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