On Friday 31 July, the European Commission published the results of its study on directors’ duties and sustainable corporate governance. It launched its work on the same day, publishing an inception impact assessment for a legislative proposal expected in 2021.
Before taking action, the European Commission first wanted to assess the causes of ‘short-termism’ in corporate governance and identify possible solutions at an EU level.
The study, which was carried out by EY for the European Commission, reveals a tendency for listed companies in the EU to focus on short-term profits intended to reward shareholders, but at the detriment of the long-term interests of the company. This trend could hamper critical investments in transitions to sustainability, innovation and employee training, it noted.
The data that was analysed show an increase in dividends paid to shareholders, which have quadrupled from 1% of profits in 1992 to nearly 4% in 2018, while the ratio of capital and R&D investment to profits has been declining since the beginning of the 21st century.
The study shows that ‘short-termism’ in corporate governance is mainly rooted in regulatory frameworks and market practices. It also noted that the current remuneration structures for management boards posed problems for sustainability.
It also determined that increasing pressure from investors to focus on short-term horizons tended to increase the Board’s focus on short-term shareholder returns at the expense of sustainable value creation.
The study concluded that EU intervention was needed to extend the time horizon for decision-making at an enterprise level and thereby promote governance that would encourage sustainability.
Kick-off of the work
The Commission had already committed itself to presenting a legislative initiative in 2021 on a mandatory duty of care for companies with regard to their supply chains (see EUROPE 12477/24). This second section on the duties of directors and sustainable corporate governance rounds off this work.
In its inception impact assessment, the Commission was of the opinion that an EU-level initiative in this area could include a combination of obligations, including obligations for companies to monitor how well they respect human rights, including child labour, and to mitigate any negative environmental impacts that might arise from their operations and supply chains.
Furthermore, in the view of the European Commission, managers should be required to take into account the interests of all stakeholders that are relevant for the long-term viability of the company in when making decisions.
The European initiative could also include an “appropriate facilitating, enforcement and implementation mechanism accompanying these duties”, including possible remediation where necessary.
The European Commission has not ruled out other possible corporate governance arrangements, specifically with regard to the remuneration of directors.
The study can be viewed here: https://bit.ly/39KWzH0 and the inception impact assessment viewed here: https://bit.ly/3gkmkAg (Original version in French by Marion Fontana)