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Dennis Marketos is a Chartered Accountant and Managing Director of Metrix Software Solutions, developers of IsoMetrix, a leading software solution for the management of Corporate Governance, Risk and Compliance. It’s hard to conceive of a million years, let...

The Evolution of Governance

Dennis Marketos is a Chartered Accountant and Managing Director of Metrix Software Solutions, developers of IsoMetrix, a leading software solution for the management of Corporate Governance, Risk and Compliance.

It’s hard to conceive of a million years, let alone a billion. That is why it is so difficult for us humans, who live for less than a hundred years, to imagine the slow advance of adaptational improvement that has given rise to the bewildering complexity of organisms that inhabit our earth. The past three and a half billion years has seen life evolve from simple, single celled prokaryotes to the myriad forms of life that surround us today. Right now, in each of us, in each of the 100 trillion cells that make up our bodies, complex chemical reactions are taking place that enable us to type, to read, to think.

Evolutionary thinking can be applied to governance as well.  The timescales are much shorter than for the evolution of life: the first corporation, the Dutch East India Company, was established as recently as 1602. Yet, in the time since then we have witnessed significant evolution in the way in which companies are governed. While the phrase ‘corporate governance’ was first used only in 1960, it is now an intrinsic part of institutional thinking and has evolved to the extent that detailed codes of governance, such as King III, describe best practice in governing a corporation.

From the crash of 1929 through to Enron and the sub-prime crisis, it has become ever clearer that the impact of poor governance extends far beyond the shareholders of an entity itself. Simply put, poorly governed businesses are not sustainable, for their staff and shareholders and also for the stakeholders on whom they impact. Awareness has grown also that good governance encompasses far more than just compliance. The enforced compliance approach driven by Sarbanes-Oxley, a knee-jerk response to the Enron scandal, is now seen as inadequate.   Good governance does not mean a box-ticking adherence to legislation; it is more important that the culture of a company, and the behaviour of its employees, favours positive outcomes for all people and entities within its ecosystem.

Investors and other stakeholders are now far more inclined to analyse whether a business is sustainable.  Focus is moving beyond how much money is being made to how it is being made: what is the impact on society and the environment. But, in the same way that bacteria inhabit our gut in a symbiotic relationship, creatures with the best long term viability are those whose actions do not adversely affect the environment they live in.

And this is the crux of the matter. Just as the best adapted creatures are most likely to survive and prosper, so are the best governed businesses likely to be the most profitable over time.  Robert Eccles, of Harvard University, in a study of 180 companies, 90 classified as High Sustainable firms and 90 as Low Sustainable, has shown that, for the 18-year period under review, “High Sustainability firms dramatically outperformed the Low Sustainability ones in terms of both stock market and accounting measures.”  (The Impact of a Corporate Culture of Sustainability on Corporate Behavior and Performance). In an important caveat, however, he notes that “the results suggest that this outperformance occurs only in the long term.” Perhaps the largest obstacle to sustainable business is the short term, quarterly mind-set of most investors, and the four or five yearly focus of politicians.

Good governance, and by extension good management of strategy, risk and compliance leads to sustainable, long-term business. And isn’t that what evolution favours?  Of course, simply managing risk and compliance is not enough. Unlike in nature where evolution is a blind process, companies have the advantage of being able to shape their own futures, to continually reinvent themselves. This adaptability is shaped by the strategic plans they adopt. Survival of the fittest means those who fit best, who are best suited to a changing environment. And in the modern business world the environment changes quickly, as the likes of Kodak discovered all too late.

There is a cost to governance, just as there is a cost to humans having a large brain, or cheetahs being able to run quickly. To govern well, a company needs committees, such as the Social and Ethics committee. It needs systems that highlight areas of risk, and ensure compliance is being closely monitored. It needs the effort of getting people to behave in a way that accords with the company’s values.  And even before that, it needs the company’s directors to define the values they subscribe to, and to lead by example.

The cost of this complexity is outweighed by the benefit. Short cuts, like sharp practices, may produce greater short term profits, but lead to demise.

There is a bigger picture to all of this as well. With the closest known potentially habitable exoplanet, Gliese 581d, being a mere 189 trillion kilometres away, the Earth truly is the only home we have.  Through sustainable business practices, driven by the evolution of good governance, we might be able to protect our home and prevent our species from heading down its own evolutionary dead end.