PART 3 (Final) - ESG - ENVIRONMENT, SOCIAL AND GOVERNANCE - WHAT ORGANIZATIONS SUPPOSED TO ASSESS - by Nik Zafri

3. GOVERNANCE

These criteria focus on the leadership, policies, and internal controls of the organization.

i. Board/C-Suite diversity

Evaluation of composition in the organization's board of directors or C-Suite in terms of gender, ethnicity, and expertise.

• Review the Current Composition - Start by examining the current makeup of the board of directors/C-Suite. Look at the names, backgrounds, and qualifications of each member.
• Gender and Ethnicity Representation -  Assess the gender and ethnicity diversity of the Board/C-Suite. Look for a balance that reflects the diversity of the organization's stakeholders and the broader community. Compare the representation of women and minority ethnic groups to their presence in the general population or relevant industry.
• Expertise and Skills -  Evaluate the expertise and skills present on the Board/C-Suite. Consider factors such as industry experience, financial acumen, strategic planning skills, legal knowledge, technological expertise, and international business experience. Ensure that the board collectively possesses a diverse set of skills necessary for effective governance and decision-making.
• Benchmarking - Compare the composition of the Board/C-Suite to industry benchmarks and best practices. Many organizations and advocacy groups publish reports and guidelines on Board/C-Suite diversity and composition. Use these resources to assess whether the organization's Board/C-Suite aligns with accepted standards
• Stakeholder Engagement -  Consider the perspectives of various stakeholders, including shareholders, employees, customers, and community members. Engage with these groups to understand their expectations regarding Board/C-Suite composition and diversity.
• Long-term Strategy -  Evaluate whether the current composition of the Board/C-Suite aligns with the organization's long-term strategic goals. Consider factors such as market trends, technological advancements, regulatory changes, and global expansion plans. Ensure that the Board/C-Suite has the expertise and diversity necessary to guide the organization through future challenges and opportunities.
• Continuous Improvement -  Recognize that Board/C-Suite composition is not static and should evolve over time. Encourage ongoing efforts to enhance diversity and expertise through recruitment, training, and succession planning initiatives.

ii. Executive Compensation

Assessing whether executive pay is aligned with organization performance and shareholder interests to better evaluate whether executive pay is aligned with organization performance and their interests.

• Performance Metrics Alignment -  Review the performance metrics used to determine executive compensation. Ensure that these metrics are closely tied to the organization's strategic goals and long-term shareholder value creation. Common performance metrics include :revenue growth, earnings per share (EPS), return on equity (ROE), return on investment (ROI), and total shareholder return (TSR).
• Pay-for-Performance Sensitivity - Evaluate the sensitivity of executive pay to performance outcomes. High levels of variable compensation, such as bonuses and stock-based awards, should be directly linked to achieving predetermined performance targets. Analyze how changes in organization performance correspond to changes in executive pay.
• Peer Group Comparison - Compare executive pay levels and structures to those of peer organizations within the same industry or sector. This analysis helps determine whether executive compensation is competitive and reasonable relative to market norms. Consider factors such as organization size, complexity, and financial performance when selecting peer organizations for comparison.
• Long-Term Incentives - Assess the proportion of executive compensation tied to long-term incentives, such as stock options, restricted stock units (RSUs), and performance shares. Long-term incentives align executive interests with those of shareholders by promoting sustained value creation and discouraging short-termism.
• Say-on-Pay Votes - Monitor shareholder voting results on executive compensation during annual "say-on-pay" votes. Pay attention to the level of support or dissent expressed by shareholders regarding the organization's executive pay practices. Significant shareholder opposition may indicate concerns about alignment with organization performance and shareholder interests.
• Executive Pay Ratio - Calculate the ratio of CEO pay to median employee pay within the organization. While not directly related to performance alignment, this ratio provides insight into the fairness and equity of executive compensation relative to the broader workforce. Excessive pay disparities may raise concerns among shareholders and other stakeholders.
• Transparency and Disclosure -  Evaluate the transparency and disclosure of executive compensation practices in the organization's proxy statements and annual reports. Look for clear explanations of the rationale behind pay decisions, performance targets, and the alignment between pay and performance.
• Board/C-Suite Oversight - Assess the effectiveness of the board of directors/c-suite in overseeing executive compensation practices. Consider the independence and expertise of the Board/C-Suite's compensation committee, as well as its engagement with shareholders on compensation-related matters.

iii. Disclosure of Information

Examining the disclosure of information to stakeholders and adherence to ethical standards involves thorough analysis and evaluation of the organization's communication practices and ethical framework.  By doing so, stakeholders can gain insights into the organization's disclosure practices and ethical standards, enabling them to make informed decisions and hold the organization accountable for its actions.

• Review Corporate Governance Policies - Start by reviewing the policies and codes of conduct. Look for explicit commitments to transparency, integrity, and ethical behavior. Assess whether these policies are regularly updated and effectively communicated to employees, management, and the board of directors/c-suite.
• Transparency in Financial Reporting - Examine the transparency and comprehensiveness of the organization's financial reporting. Evaluate the clarity and accessibility of financial statements, including balance sheets, income statements, and cash flow statements. Look for adherence to accounting standards and disclosure requirements set by regulatory bodies.
• Disclosure Practices - Analyze the organization's disclosure practices regarding key business operations, risks, and performance indicators. Review annual reports, quarterly filings, investor presentations, and other public communications to assess the quality and timeliness of information provided to stakeholders. Look for transparency regarding strategic initiatives, competitive positioning, and potential challenges facing the organization.
• Stakeholder Engagement - Evaluate the organization's engagement with various stakeholders, including shareholders, employees, customers, suppliers, and the local community. Assess the effectiveness of communication channels, such as annual general meetings, investor conferences, employee town halls, and customer feedback mechanisms. Look for evidence of active dialogue, responsiveness to stakeholder concerns, and efforts to solicit feedback and input.
• Ethical Standards and Compliance - Examine the organization's commitment to ethical standards and legal compliance. Assess the effectiveness of internal controls, risk management processes, and compliance programs in preventing misconduct and unethical behavior. Look for evidence of training programs, whistleblower mechanisms, and disciplinary actions taken against violations of ethical standard.
• Supplier and Partner Relationships - Consider the organization's relationships with suppliers, business partners, and third-party vendors. Evaluate the organization's efforts to ensure ethical sourcing practices, fair labour conditions, and environmental sustainability throughout its supply chain. Look for policies and initiatives aimed at promoting responsible business conduct among partners.
• Independent Audits and Reviews - Review the findings of independent audits, reviews, and assessments conducted by external parties. Evaluate the scope and rigor of these audits, as well as any identified areas of concern or improvement. Look for certifications or accreditations that demonstrate the organization's commitment to ethical and responsible business practices.
• Public Perception and Reputation - Monitor public perception and reputation of the organization regarding its disclosure practices and adherence to ethical standards. Pay attention to media coverage, analyst reports, industry rankings, and social media sentiment. Look for any indications of reputational risks or controversies that may reflect shortcomings in transparency or ethical conduct.

INDUSTRIES (EXAMPLES)

Industries where governance criteria are critical include finance (regulatory compliance and risk management), real estate (corporate governance in property management), and telecommunications (fair competition and anti-corruption measures).

Here are critical governance criteria for each of the mentioned industries:

A)       FINANCE (Regulatory Compliance and Risk Management)

I. Regulatory Compliance - Ensure adherence to relevant financial regulations and laws, such as those governing banking, securities, and insurance activities. Monitor changes in regulatory requirements and implement necessary controls and procedures to maintain compliance.

II. Risk Management Framework - Establish a robust risk management framework to identify, assess, and mitigate various types of risks, including credit risk, market risk, liquidity risk, and operational risk. Implement risk monitoring tools and internal controls to mitigate potential threats to financial stability.

III. Board/C-Suite Oversight - Ensure active oversight and involvement of the board of directors/c-suite in monitoring regulatory compliance and risk management practices. Establish clear lines of responsibility and reporting to the Board/C-Suite's audit or risk committee.

IV. Internal Controls and Reporting - Implement effective internal control mechanisms and reporting systems to ensure the accuracy and reliability of financial information. Conduct regular audits and reviews to assess the effectiveness of internal controls and identify areas for improvement.

B)       REAL ESTATE (Corporate Governance in Property Management)

I. Property Portfolio Management - Develop and implement a comprehensive strategy for managing the organization's real estate portfolio, including acquisition, development, leasing, and disposition of properties. Ensure alignment with the organization's overall business objectives and risk tolerance.

II. Compliance with Regulations and Zoning Laws - Ensure compliance with local, state, and federal regulations governing real estate development, construction, and property management. Adhere to zoning laws, building codes, environmental regulations, and other legal requirements.

III. Tenant Relations and Customer Service - Maintain positive relationships with tenants and prioritize customer service and satisfaction. Address tenant concerns promptly and fairly, and ensure transparent communication regarding lease terms, property maintenance, and other relevant issues.

IV. Financial Management - Implement sound financial management practices, including budgeting, accounting, and financial reporting for real estate assets. Monitor operating expenses, rental income, and capital expenditures to maximize returns and ensure financial sustainability.

V. Risk Management - Identify and mitigate risks associated with real estate investments, such as market volatility, property valuation fluctuations, and legal liabilities. Develop contingency plans and insurance strategies to protect against unforeseen events and minimize potential losses.

C)      TELECOMMUNICATIONS (Fair Competition and Anti-Corruption Measures)

I. Fair Competition Practices - Promote fair competition in the telecommunications market by adhering to antitrust laws and regulations. Avoid anti-competitive behaviors such as price-fixing, collusion, and monopolistic practices. Encourage innovation and consumer choice through open and transparent market competition.

II. Anti-Corruption Policies and Procedures - Establish comprehensive anti-corruption policies and procedures to prevent bribery, extortion, and other corrupt practices. Conduct due diligence on business partners, vendors, and third-party agents to mitigate corruption risks. Provide training and guidance to employees on ethical business conduct and compliance with anti-corruption laws.

III. Transparency in Pricing and Service Delivery - Ensure transparency in pricing, billing, and service delivery to customers. Provide clear and accurate information about telecommunications products and services, including terms of use, fees, and charges. Avoid deceptive or misleading marketing practices that could undermine consumer trust and confidence.

IV. Data Privacy and Security - Safeguard the privacy and security of customer data and communications. Comply with regulations governing data protection, confidentiality, and cybersecurity in telecommunications operations. Implement robust security measures to prevent unauthorized access, data breaches, and cyber-attacks.

CONCLUSION

By considering ESG criteria, investors aim to support organizations that prioritize sustainability, social responsibility, and ethical practices, potentially leading to long-term value creation and positive societal impact.

• Sustainability

refers to the ability of a organization to meet its present needs without compromising the ability of future generations to meet their own needs. In the context of environmental sustainability, it involves minimizing environmental impacts, such as carbon emissions, waste generation, and resource depletion, while promoting conservation and responsible stewardship of natural resources. Sustainable practices also encompass economic and social dimensions, ensuring the long-term viability and resilience of businesses, communities, and ecosystems.

• Social Responsibility

entails the organization's commitment to act ethically and contribute positively to society, beyond its legal obligations. This includes initiatives to promote diversity and inclusion, ensure fair labour practices and human rights throughout the supply chain, support community development and philanthropic activities, and address social issues such as poverty, inequality, and access to education and healthcare. Socially responsible organizations strive to balance profit-making objectives with the well-being of stakeholders and the broader community.

• Ethical Practices

involve conducting business with integrity, honesty, and transparency, and adhering to high moral and ethical standards in all interactions and transactions. This encompasses fair treatment of employees, customers, suppliers, and other stakeholders, as well as compliance with laws, regulations, and industry standards. Ethical considerations may include avoiding conflicts of interest, respecting privacy and confidentiality, preventing corruption and bribery, and upholding human rights and ethical labour practices

• Long-Term Value Creation

focuses on generating sustainable and resilient financial returns for shareholders while considering the interests of other stakeholders and the broader society. This involves strategic decision-making that balances short-term profitability with long-term growth and value preservation. Organizations that prioritize long-term value creation invest in innovation, research and development, employee training and development, and stakeholder engagement to drive competitive advantage, market leadership, and enduring success over time.

• Positive Societal Impact

refers to the beneficial effects that organizations can have on society and the environment through their business activities and operations. This includes efforts to address social and environmental challenges, such as climate change, poverty, inequality, and access to basic needs and services. Organizations can achieve positive societal impact by integrating sustainability, social responsibility, and ethical practices into their core business strategies, products, and services, and by collabourating with stakeholders to create shared value for communities and society as a whole.