How do large companies take climate issues into account?

On April 4, 2022, Working Group III of the IPCC (Intergovernmental Panel on Climate Change) published a new report dedicated to solutions to reduce greenhouse gas emissions. It is based on the conclusions of working groups I and II which draw up an inventory of the climate crisis and identify the effects of climate change.

On this last point, it is established that the risks linked to climate change (physical, transitional, legal) will have a considerable economic impact on companies.

However, the latter still have a limited understanding of these risks, which hinders their field of action in terms of ecological transition.

Several initiatives were then developed in order to improve information on climate risks, such as the establishment of benchmarks for reporting extra-financial volunteers (the GRI, CDP (Intergovernmental Panel on Climate Change) and the IIRC), or the implementation of the Task Force on Climate-related Financial Disclosures (TCFD).

The objective of these initiatives is twofold: to encourage companies to disclose to financial players information on the nature and intensity of the climate risks weighing on their activities and to identify and assess the environmental consequences of their strategic decisions.

Upstream, for this information to be transmitted correctly, an effective corporate governance model must be put in place. Its goal: to regulate the power of governing bodies so that they engage effectively in the ecological transition.

Information, at the heart of the relationship between investors and managers

Financial and extra-financial information is generally produced by the management of the company (top management) and then transmitted to market participants (investors), in particular shareholders, who can then make informed decisions on their future investments.

Le top management, who is directly involved in the decision-making process, thus has the more insight into company strategies than any other stakeholder (including investors).

This informational advantage can lead him to adopt opportunistic behavior likely to harm the interests of the other partners.

For example, he may be tempted to disclose partial and/or biased information, by communicating more willingly on the actions of the company which are favorable to the ecological transition while concealing those which are less favorable to it.

Risks related to information asymmetry

To limit such risks, the company must be able to build a effective monitoring and incentive system.

Large companies can, for example, follow "good practices" in terms of openness of boards (more independent members, more diversified profiles representing shareholders, etc.), so as to exercise effectively and independently. their power to control the decision.

The generalization of specialized working groups in the form of “risks”, “CSR”, “ethics” or “sustainable development” committees is part of the same perspective.

These committees and following the best practices facilitate the deliberations on environmental issues in particular by seeking to identify climate risks and to set transition and adaptation objectives.

Made up of non-executive directors appointed by the board of directors, they work independently of the top management and inform, through their opinion, the decisions taken by the board to accelerate the company's responses to the demands of sustainability.

There are also incentive systems top management to effectively integrate climate risks and opportunities into their company's development strategy. These can be monetary and non-monetary.

For example, the compensation of senior executives may include a short- and/or long-term variable portion depending on extra-financial performance and sustainability criteria.

Formal and informal motivation practices (benefits in kind, opportunities for rooting, proposal of differentiated responsibilities, etc.) for managers who are actively committing their company to the path of ecological transition can also contribute to align the interests of top management on the expectations of shareholders and investors.

Taking climate issues into account in the governance model

When we study these corporate governance devices on the SBF120 (i.e. the 120 largest French stock market capitalizations), we note that in 2019, within the top management, the positions or management committees in charge of climate issues are: the Chief Sustainability Officer (CSO, 53,42%), the Chief Executive Officer (CEO, 26,03%) and the Sustainability Committee (SC, 19,18%).

These actors are responsible for both the assessment and the management of climate risks, thus revealing the inseparable nature of these functions to maintain an optimal flow of information and therefore improve the decision-making process.

Furthermore, within the board of directors, the CSO (53,42%) and the CEO (26,03%) are also the two main actors responsible for climate issues.

The Board is informed of the decisions of the top management quite regularly, 4 times a year (49,32%).

With regard to the specialized working groups, 2/3 of the boards of directors have a committee dedicated, totally or partially, to CSR (compared to 47% in the UK and 8% in Germany). The inclusion of the environment and the climate in the issues of the board is even more diffuse and lasting when we consider the committees with similar names mentioning sustainable development, ethics, the environment, compliance, etc.

In terms of encouraging the top management, we see that companies have largely opted for the establishment of monetary incentives (95,89%) and to a lesser extent (34,25%) for non-monetary incentives.

These results raise two obstacles to overcome if companies wish to effectively integrate climate risks into their long-term development strategy: the combination of functions and the lack of data.

Combination of functions unfavorable to climate transparency

The actors in charge of the climate in French companies are mostly members of the top management who often combine the status of administrator.

But how can these officials impartially monitor the climate strategy that they themselves are implementing, when they are not necessarily specialists in the subject?

The company can fight against this risk of opportunism by ensuring clear and transparent separation of functions.

On the one hand, the top management could only define and operationalize the climate strategy and climate risk management.

Its specific missions would therefore be to propose GHG emission reduction targets for the activities operated by the company within a given timeframe, to analyze possible transition scenarios to achieve these targets, to propose a the carbon intensity of the energy products used by the company's customers, to stimulate investment initiatives in new technologies capable of reducing CO emissions₂ or to order a diagnosis of the carbon footprint of the company's activity.

On the other hand, the administrators would control the decisions implemented, with the specific prerogatives of validating the implementation of the reporting climate change and monitoring the information it contains, voting on the introduction of an internal carbon price in the company's activities or even determining and revising, if necessary, the company's target climate performance over a given.

Following this logic, a board of directors and/or supervisory board made up of independent members and climate experts would limit information asymmetry and constitute an effective counterweight to the top management of the company in the decision-making process on climate issues.

A lack of climate performance data

The incentive schemes of the top management are prevalent in the SBF120 but suffer from a lack of sufficient and reliable data.

In particular, data on the climate are scarce: the reporting change is a recent practice which is most often voluntary.

The data are also heterogeneous and therefore not very comparable, due to the difficulty of evaluating the different types of greenhouse gas emissions, and the lack of consensus on the methodologies used to calculate them.

Therefore, it is necessary to specify the content of the information expected to improve its relevance, quality and comparability, and to make this information a management tool for the low-carbon transition.

This is precisely the goal of the European Directive 2014/95/EU on the reporting extra-financial and regulation on the taxonomy of green activities (which comes into force in 2022).

The European Commission's project to create a European extra-financial standard setter by 2025 goes even further. It aims to standardize the processes for collecting and processing information (verification of information by independent third parties and sanctions in the event of non-performance).

So many community texts that contribute to improving the integration of climate risks into corporate governance.

Cecile Cezanne, Lecturer-HDR in economics, Côte d'Azur University et Sandra Rigot, Lecturer in Economics, associated with the “Energy and Prosperity” Chair, Sorbonne Paris North University

This article is republished from The Conversation under Creative Commons license. Read theoriginal article.