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.
In this last point, it is established that the risks linked to climate change (physical, transitory, legal) will have a considerable economic impact on companies.
However, the latter still have a limited understanding of these risks, which makes their field of action in terms of ecological transition difficult.
Several initiatives were then developed to improve information on climate risks, such as the establishment of benchmarks for communicating voluntary non-financial organizations (the GRI, the CDP or the IIRC), or the creation of the Task Force on Climate Related Financial Disclosures (TCFD).
The objective of these initiatives is twofold: to encourage companies to disclose information to financial agents on the nature and intensity of climate risks that weigh on their activities and to identify and assess the environmental consequences of their strategic decisions.
Upstream, for this information to be transmitted correctly, it is necessary to implement an effective corporate governance model. Its objective: to regulate the power of government bodies so that they are effectively involved in the ecological transition.
Information, at the heart of the relationship between investors and managers
Financial and extra-financial information is usually produced by the company’s management (high admnistration) and then transmitted to market participants (investors), in particular shareholders, who can make informed decisions about their future investments.
The high admnistrationwho is directly involved in the decision-making process, therefore has more information about the company’s strategies than any other stakeholder (including investors).
This informational advantage can lead you to adopt an opportunistic behavior, susceptible to harming the interests of other partners.
For example, he may be tempted to divulge partial and/or biased information, communicating more willingly about the company’s actions that are favorable to the ecological transition while hiding those that are less favorable to it.
Risks related to information asymmetry
To limit these risks, the company must be able to build an effective monitoring and incentive system.
Large companies can, for example, follow “best practices” in terms of opening their boards (more independent members, more diversified profiles of shareholder representation, etc.), in order to exercise 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 ad hoc facilitate deliberations on environmental issues, including seeking to identify climate risks and establish transition and adaptation goals.
Made up of non-executive directors appointed by the board of directors, they work independently of the high admnistration and inform, through their opinion, the decisions taken by the board to accelerate the company’s responses to sustainability demands.
There are also incentive systems high admnistration effectively integrate climate risks and opportunities into your company’s development strategy. These can be monetary and non-monetary.
For example, senior executives’ compensation may include a variable short-term and/or long-term portion, depending on extra-financial performance and sustainability criteria.
Formal and informal motivating practices (benefits in kind, opportunities for rooting, proposal for differentiated responsibilities, etc.) for managers who are actively committing their company to the path of ecological transition can also contribute to aligning the interests of high admnistration in the expectations of shareholders and investors.
Taking climate issues into account in the governance model
When we study these corporate governance systems in the SBF120 (that is, the 120 largest French stock market capitalizations), we see that in 2019, within the high admnistrationthe management positions or committees responsible for climate issues are: o Sustainability Director (CSO, 53.42%), the CEO (CEO, 26.03%) and the Sustainability Committee (SC, 19.18%).
These actors are responsible for both the assessment and management of climate risks, thus revealing the inseparability of these functions to maintain an optimal flow of information and, thus, 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 Council is informed of the decisions of the high admnistration quite regularly, 4 times a year (49.32%).
With regard to specialized working groups, 2/3 of the boards of directors have a committee dedicated, totally or partially, to CSR (against 47% in the UK and 8% in Germany). The inclusion of the environment and climate in the board’s issues is even more diffuse and lasting when we consider the committees with similar names that mention sustainable development, ethics, environment, compliance, etc.
In order to encourage the high admnistrationwe found that companies 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 are to effectively integrate climate risks into their long-term development strategy: the mix of roles and the lack of data.
Combination of unfavorable functions for climate transparency
The actors responsible for the climate in French companies are, for the most part, members of the high admnistration which often combine admin status.
But how can these officials impartially monitor the climate strategy they themselves are implementing, when they are not necessarily subject matter experts?
The company can combat this risk of opportunism by ensuring a clear and transparent separation of functions.
On the one hand, the high admnistration could only define and operationalize 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 period, analyze possible transition scenarios to achieve these targets, propose the carbon intensity of energy products used by the company’s customers, stimulate investment initiatives in new technologies capable of reducing CO emissionstwo or request a diagnosis of the carbon footprint of the company’s activity.
On the other hand, administrators would control the implemented decisions, with the specific prerogatives of validating the implementation of the communicating 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 climate performance target for a given.
Following this logic, a board of directors and/or fiscal council composed of independent members and climate experts would limit information asymmetry and constitute an effective counterbalance to the high admnistration of the company in the decision-making process on climate issues.
The lack of climate performance data
The incentive schemes of the high admnistration are prevalent in SBF120, but suffer from a lack of sufficient and reliable data.
In particular, data on climate are scarce: the communicating change is a recent practice, most of the time 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 information content that is expected to improve its relevance, quality and comparability, and make this information a management tool for the low carbon transition.
This is precisely the aim of European Directive 2014/95/EU on communicating and the regulation on the taxonomy of green activities (which comes into force in 2022).
The European Commission’s project to create an extra-financial European 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 case of non-compliance).
So many community texts that contribute to improving the integration of climate risks in corporate governance.