Key Governance Factors in ESG Investing

Governance is the managerial and supervisory framework dictating how companies function. It is fundamentally the interplay between people and processes, aiming to nurture a culture that drives strong business performance, minimises risks, and ensures ethical conduct. Board members are central to this, responsible for a company's oversight, especially in larger and more complex entities. Effective governance serves as a foundation, transforming policies and codes of conduct into real-world practice, setting the stage for a company's growth and aligning with stakeholder prosperity.

Corporate governance's evolution has been shaped by financial scandals and subsequent corrective measures. The establishment of the Cadbury Committee in 1991 after financial scandals in the UK culminated in the 1992 Corporate Governance Code, setting guidelines for transparency and responsibility in director roles and power divisions. Today, while most countries have their governance codes reflecting local history and culture, the primary aim remains: fostering responsible and transparent corporate management. Periodic financial scandals have led to reforms, underscoring the ever-evolving nature of corporate governance.

Investors should focus on several governance factors. The board's structure, with an emphasis on its diversity, effectiveness, and independence, is pivotal for sound decision-making. Executive remuneration, encompassing salaries, benefits, bonuses, and share incentives, often ties to KPIs, especially those incorporating ESG criteria, requiring close scrutiny. Adherence to standards like the UK’s 2018 Corporate Governance Code ensures that reporting is transparent and balanced. Financial integrity and capital allocation decisions are also critical, as they can influence shareholder sentiments. Lastly, a company's business ethics, spanning employee treatment to community relations, reveal its moral standing and potential for sustainable success.