Non-Executive Directors Can Make Climate Neutrality A Reality

The business community’s response to the coronavirus pandemic reveals national differences. In the US and in the UK, the answer is primarily dividends. In Germany, where the social market economy is highly influential, the answer is primarily jobs. This is also true for the climate crisis with German companies calling for any COVID-19-related stimulus package to be linked to climate action, but also employment and growth.

Germany’s system of corporate governance is different from many other countries. Its publicly traded companies are required to have a two-tier board of directors: one, a management board with executive directors responsible for operations; and, two, a supervisory board with non-executive directors responsible for governing and advising. The supervisory board includes employee representatives, appoints management board members, and approves major corporate decisions.

In March, ESMT Berlin joined the World Economic Forum’s Climate Governance Initiative (CGI) and initiated CGI Germany, joining partners from government (German Council for Sustainable Development) and industry (Board Academy e.V.). We jointly examined the role of non-executive directors on supervisory boards in steering the environmental, social, and governance (ESG) solutions of German companies.

Four key strategies emerged in what corporate non-executive boards can do to help transition to climate neutrality and sustainability: involve your employees in sustainability decision-making, diversify your board of directors, build sustainability expertise, and incentivize. With these, non-executive directors and supervisory boards of directors can be even stronger drivers of corporate environmental responsibility and sustainability.

Strategy #1: Involve your employees in sustainability decision-making

It is no doubt that all directors who serve on boards have an important role in steering the long-term sustainability of their companies. “Companies increasingly place sustainability at the core of corporate values and strategy,” said Simone Bagel-Trah, chair of the supervisory board and of the shareholders’ committee at Henkel, a German multinational chemical and consumer goods corporation. The codetermination principle, however, allows for more integration of diverse sustainability issues, be it economic, environmental, or social. Codetermination allows employees to take an active role in decision-making, especially through the employee representation in supervisory boards. “Workers representation is an important matter to foster dialogue and thus, applying social governance,” said Joe Kaeser, chair of the supervisory board of Siemens Energy.

According to a 2020 report titled “Codetermination for the Sustainable Company,” companies with a high level of codetermination are more likely to integrate sustainability in their daily decision-making, be part of a sustainability index, publish a sustainability report, explain their stakeholder engagement strategies, and link executive remuneration partially to sustainability goals. This demonstrates that structured employee involvement in sustainability can lead to improvements in sustainability performance.

Furthermore, according to researchers at the WZB Berlin Science Center, there is “a positive relationship with ‘substantive’ policies such as the adoption of targets for reducing pollution, but not with ‘symbolic’ policies, such as membership in the UN Global Compact.” Setting and achieving clear environmental goals is essential for reducing greenhouse gas emissions and achieving climate neutrality.

Employee involvement is not only crucial for setting the strategic sustainability priorities, but also for agreeing on the best way forward to achieve them. “It is not enough to agree on the climate targets,” said Reiner Hoffmann, president of the German Trade Union Confederation (DGB) and a member of the supervisory board of Bayer AG. “It will become even more important to define how we will reach these targets. Therefore, we have to take employees into consideration. Giving workers a voice in the process, recognizing them as drivers of change and innovation, and allowing new perspectives to emerge is the way to go.”

Strategy #2: Diversify your board of directors

Another smart strategy for achieving climate transition and other sustainability goals is to cultivate a broad spectrum of ideas in the non-executive board of directors. As the recent study by the global leadership advisory firm Egon Zehnder and the University of Göttingen shows, this might be achieved through appointing directors from different backgrounds with diverse demographic characteristics and professional perspectives. Supervisory boards with a higher proportion of women and young directors as well as shorter tenures – as demonstrated in the “Fresh Impetus for Greater Sustainability in Boards: The Significance of Board Composition in European Companies” study – are linked to better sustainability performance.

This is confirmed by experience of Kaeser, who worked for Siemens for more than 40 years and led the company as president and CEO for the past seven. “We need to make sure that there is enough diversity of experience, international standards, and gender. And we need to push for more ethnic diversity going forward.”

Appointing diverse non-executive directors can provide the impetus for the sustainability transformation of companies.

Strategy #3: Build sustainability expertise

Non-executive directors must also gain knowledge and capabilities for addressing climate change and other sustainability topics and aligning business models with ambitious climate policies. “Supervisory boards have a special role to play in monitoring the strategic direction of companies,” said Werner Schnappauf, chair of the German Council for Sustainable Development and a member of the CGI network. “In order to be able to assess climate-related opportunities and risks, further expertise is required at this level.” The creation of specialized sustainability committees with the proper expertise can also improve corporate sustainability performance.

Having knowledge and expertise on sustainability topics within boards of directors as well as exchanging views and best practices with other companies and boards can lead to better integration of sustainability in the business.

Strategy #4: Incentivize

Establishing an incentive structure for sustainability is one of the key tasks of the supervisory board. Henkel, for example, includes ESG targets in the remuneration of the management board. The ESG targets are part of the individual contribution toward implementing strategic priorities. At Siemens, the compensation system for executives includes the long-term sustainability component as well as specific and measurable targets on social aspects (such as employee engagement), on environmental matters (such as reducing CO₂ footprint), and on governance (such as diversity).

Having incentives for acting sustainably can lead to more focus on the environmental and social impacts of the company rather than the mere achievement of financial goals.

Conclusion

The codetermination principle – as seen in the German corporate governance system – provides a solid foundation for achieving climate and sustainability goals. However, this is a global fight. The involvement of employees needs to be coupled with more diversification parameters used for appointing non-executive directors as well as building sustainability expertise and proper incentives for acting sustainably. The Climate Governance Initiative in Germany among others can help non-executive directors in becoming stronger and even more capable sustainability ambassadors within their companies.

This article was originally published by Forbes on May 27, 2021, and republished with permission.