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2018 address by Judge Professor Mervyn King, Chairman of the Council, IIRC

Posted 12 March, 2018

The first industrial revolution, which began in the late 18th century, focused on the benefits of water and steam power to mechanize production. Machines started to be used instead of human or animal labour. Although there had been pollution prior to this time, the emissions from mechanised factories was the beginning of the dangerous anthropogenic emissions as we know them today.

By the middle of the 19th century, wealthy families had contributed risk capital to organisations which had unlimited liability. In consequence, in addition to the risk capital, these wealthy families were also liable for all the claims of creditors and employees in the event of bankruptcy. They started to baulk against this. As with today the politicians of the time wanted more jobs to be created and started thinking of creating an artificial person with limited liability.

This was met with opposition, particularly from theologians. It was Lord Thurlow, in 1844, who said how can man, and ladies, it was man in those days, have the audacity to create a person. Only the Almighty can create a person. Further, the creation of such a person will be one “who has no body to be kicked, no soul to be damned and no conscience.”  The theologians were correct, because the company is an artificial person which has no heart, mind or soul of its own.  Directors, once appointed, become the heart, mind and soul of the company. This understanding gives content to the development from the 19th century of the common law fiduciary duties of directors to a company, of good faith and loyalty as well as duties of care, skill and diligence. Those are exactly the duties of the curator of an incapacitated young human being. The common denominator is incapacity.

There were consequences of wealthy families providing equity capital and several of their members becoming directors of the company. One of those consequences was that other stakeholders, particularly employees, saw these shareholders as the owners of the company. Shareholders were also given primacy of place in regard to all the other stakeholders involved in the business of the company; suppliers, creditors, financiers, employees, advisers, etc.

In the late 19th century and early 20th century, the second industrial revolution started with mass production driven by a constant flow of energy, namely electricity. One of those benefitting from mass production was Henry Ford and the Ford Motor Company. There was great demand for his Model T Ford and in 1919 the company made an excessive profit of US$60,000, probably US$6 billion today. The Ford Motor Company announced that the company intended increasing the wages of its employees to work longer hours during the week and weekends so that the company could meet the demand for its Model T Ford. The Dodge Brothers, who were minority shareholders of the Ford Motor Company Limited and later a competitor, contended that the company had a duty to pay the excessive profits as a special dividend to shareholders before increasing the wages of employees because of the primacy of the shareholder. This was disputed by Ford.

The Dodge Brothers instituted an action in 1919 for a declaratory order that the Ford Motor Company was obliged to declare that excessive profit as a special dividend to shareholders before considering increasing the wages of employees. The Court upheld this contention and consequently the concept of the primacy of the shareholder and that directors should steer a company to ensure the maximisation of shareholder wealth, became entrenched.

The concept of shareholder primacy was then reinforced by the Nobel Laureate economist Milton Friedman, who in the 70’s wrote: “The sole purpose of the corporation is to make profit without deception or fraud.” Tacit in that statement was that the company was not integral to society and that as long as the company was increasing its profits, without deception or fraud, it could do so at any cost to society or the environment. The consequence was that the governance of companies, right towards the end of the 20th century, was focused on increasing the monetary bottom line even if it was at a cost to society and the environment. It will be seen that directors were acting lawfully but causing the company to commit wrongs against society and planet earth. The response of society represented by governments was to treat the adverse impacts or actions of how a company made its money with regulation, for example environmental impact laws instead of tackling the source of the adversity viz. how the board decided the company should make its money – its business model – with those decisions driven by the shareholder centric governance model of the day – maximisation of shareholder wealth.

During the second industrial revolution there were also the two great world wars. The second world war of 1939 – 1945 caused two Polish lawyers to flee Poland from Nazi occupation. One emigrated to America, the other to the United Kingdom.

Both were concerned about the violation of human rights being carried out by the Nazis in Poland and subsequently in other places. Both became international law experts and questioned the international legal principle that the State has control over its citizens. With the atrocities being carried out by the Nazi regime, the professor who emigrated to America, Professor Lemkin, said there should be a crime for such atrocities and he coined the word “genocide” developed from the Greek “gen”, “people”, and Latin “cide”, “to kill”. Professor Lauterpacht in the United Kingdom said that international law had to change to give the individual rights which should be universal and override State sovereignty over its citizens. He favoured “crimes against humanity.”

Prof Lauterpacht’s thesis was for governments to embrace the “revolutionary immensity” of a new international law that would protect the fundamental rights of the individual. The intent of his thesis, which is now part of international law, was that even if persons were leaders in a State they could not escape the “outraged conscience of the world” as a result of their crimes against humanity.

President Roosevelt, in January 1941, said the world should have four essential human rights: freedom of speech, religion, want and from fear. His speech became the driver of the Nuremberg trials.

At the cessation of world war two the conquering powers decided that the Nazi rulers had to be tried and punished for the atrocities they had afflicted on humanity. To the great disappointment of Prof Lemkin, the Nazi rulers were indicted for crimes against humanity. It was argued by the lead prosecutors, a retired American judge and an English Silk, that no State could overrule the rights of the individual to life, liberty and security of person.

While international law was starting to oblige governments to act or to refrain from acting in certain ways, companies continued to lawfully carry on business as usual, namely maximising profit even if it was at a cost to society and the environment. The anthropogenic emissions from factories, plant, machinery and vehicles started exacerbating the polluted world which had started as a result of the first industrial revolution. At the same time in the second half of the 20th century, single use plastic in or with manufactured goods became the norm. Millions of tonnes of plastic were being manufactured each year and finding their way into landfills or rivers and subsequently into the oceans. Plastic has started polluting life below the blue line and an island of plastic waste twice the size of Texas has formed in the middle of the Pacific Ocean, the currents driving plastic buckets, plastic bottles, plastic bags etc. into a mass of plastic waste. Cheaper child labour in supply chains. Exportation decreasing absorption of CO2 emissions and creation of O2.

Industrial farmers started fertilizing their lands with chemicals and the rain washed these chemical fertilisers into streams and rivers which eventually found their way into the ocean. There are now dead zones in the oceans of the world where there is less oxygen in the water and marine life either dies or flees the area. These habitats which had been teeming with life have become biological deserts. The sea life which escape these dead zones are then caught in modern nets spread between two trawlers. As is well known our seas have been overfished.

Society’s reaction during the 20th century of these adverse impacts from companies’ business models was to ask its governments to regulate against them and expect NGO’s to deal with them instead of advocating that they should have been dealt with at source – the primacy of the shareholders and how the company made its money. In medical terms society dealt with the symptoms of profit at any cost instead of the cause.

During the latter part of the 20th century, the third industrial revolution started with electronics and information technology automating production. Globalisation and information technology led to trade in a borderless and electronic world. Input costs such as labour were reduced which led to a growth of economies that could provide labour at a much lower cost than developed economies. These developing economies grew without regard to the adverse impacts on society and the environment. This is evidenced by the explosive growth over the last fifty years of the Chinese economy and the consequent present dangerous pollution levels in its industrial cities.

Likewise in India. With the increase of industry and motor vehicle ownership the pollution of major Indian cities has become acute. On 8th to the 11th November 2017 the Delhi local government closed all the schools in the city because the levels of pollution were dangerous to health. And a cricket test match between India and Sri Lanka was stopped.

The development of information technology enabled research to be done much more quickly and this research showed that towards the end of the 20th century, major companies listed on some of the great stock exchanges in the world had only 30% of their market capitalisation represented by additives in a balance sheet according to financial reporting standards. The focus right through the 19th and 20th centuries on financial capital had changed. It changed because of a realisation that natural assets were finite and that ecological overshoot had been reached, namely companies and individuals were using natural assets faster than nature was regenerating them, unsustainable development. Further, landfills had started toxifying underground water systems and planet earth was running out of suitable space for landfills.

The other 70% of market capitalisation was made up of what became known as intangible assets. Asset owners and asset managers had realised that a company which had a long term strategy of value creation in a sustainable manner would probably survive and thrive in the changed world of the 21st century whereas a company that focused only on improving the bottom line at any cost would eventually fail. Further, society was starting to turn its face against companies that were having a negative impact on society or the environment. Wireless and mobile communication started galvanizing civil society against poor corporate citizenry.

At the beginning of the 21st century I was asked to chair the United Nations on Governance and Oversight and to redo the governance framework of the various agencies in the UN, which included UNEP and UNCTAD. At about the same time, on the northeast coast of America, thought leaders in Boston were trying to work out how the boards of companies could report on the 70% of value on which there was no accountability in an annual report which consisted only of the balance sheet, profit and loss statement and related notes according to financial reporting standards. In Boston they started in earnest drawing guidelines for sustainability reporting which led to the founding of the Global Reporting Initiative (GRI) which moved its headquarters to Amsterdam. That is when I was asked to become the chairman of the GRI.

Companies now started reporting in two silos – the annual financial statement and a sustainability report according to the then GRI Guidelines now GRI Standards.

At the beginning of 2010 the International Federation of Accountants (IFAC) and the UN Community on Trade and Development called a meeting at the UN headquarters in Geneva. The invitees included, inter alia, the World Chairmen of the Big Four, the World Bank, the Institute of Internal Auditors, major asset owners, asset managers and regulators. The meeting was held under Chatham House Rules.

At that meeting, the IFAC stated that it was clear that annual financial statements, as we had been doing them since the great depression of the 1930s were critical but on their own not sufficient to discharge a board’s duty of being accountable. I was able to say, as chairman of the GRI, that a sustainability report, without the numbers, was meaningless. But I went on to argue that to continue reporting in two silos was divorced from reality.

No company has ever operated on a basis that financial capital was in one building, human capital in another, natural capital in yet another, intellectual capital somewhere else, as with social and manufactured capital. There has always been a symphony of these sources of value creation because of their interconnection and interdependency together with the relationships between the company and its stakeholders, such as its employees, suppliers, lenders of money, service providers, shareholders, etc. These sources of value creation and relationships have always been integrated.

His Royal Highness, Prince Charles, had in 2006 started the Accounting for Sustainability Trust (A4S) because he argued that the annual reports of companies in which the Royal Family invested had not reported on how their business models had impacted on society and the environment.

Sir Michael Peat, who was then the treasurer to the Royal Household met with me towards the end of 2009.  This led to the historic meeting at St James’ Palace, called by his Royal Highness Prince Charles, in which the great institutions in the world, the great regulators, the Big 4 auditing firms, great asset owners, asset managers were invited and the discussion was, how did a board of directors discharge their duty of accountability to the incapacitated company that was so dependent on it if it didn’t report on how the company was operating, namely on an integrated basis? The outcome was the formation of the International Integrated Reporting Council (IIRC) of which I became the chairman and I am still the chairman.

In the International <IR> Framework it was pointed out that in a value creation situation, there are inputs, and the major inputs can be listed under six capitals, viz. financial, manufactured, human, intellectual, natural and social, which would include the relationship between the company and its stakeholders. A company should build these six capitals into its business strategy in the resource constrained world of the 21st century, and not merely focus on financial capital. The sustainability issues critical to the business of the company, such as the conservation of water to the brewer of beer should be part of the company’s long term sustainable value creation strategy. Now the board was dealing with the outcomes of a company’s business model rather than leaving them to regulators and NGO’s.

The biggest user of natural assets and the biggest polluter are both private and public companies. Companies had been acting lawfully because of a shareholder centric governance model but committing wrongs against society and the environment. Lawful wrongs is an oxymoron but directors were lawfully directing companies to maximise profit instead of focusing on the long term health of the company as pointed out by Prof Lynn Paine of Harvard University.

The outcomes based approach of integrated reporting is to look at the value creation chain from inputs into the company’s business model, its output, being its product or service and the affects that that product or service has when it goes out into society on the three critical dimensions of sustainable development, the economy, society and the environment. This outcomes based approach is now recognised in the Sustainable Development Goals of the UN of April 2015 in which the UN states that in order to achieve sustainable development by 2030, account has to be taken of the indivisible and integrated dimensions of the economy, society and the environment. The goal is to achieve this by 2030 otherwise planet earth may not be sustainable for those who come after us by the end of this century.

We have now entered the fourth industrial revolution based on digitisation, artificial intelligence, the internet of things, nano-technology, bio-technology and 3D printing but with diminishing natural assets and continuing population growth, 7.4 billion people at present, 9.3 billion by 2045 according to the extrapolation done by the UN. It is clear that it is no longer an option to carry on business as usual. Society, with radical transparency at its fingertips through social media, no longer accepts these lawful wrongs against humanity committed by a company. It wants the collective mind of boards to act in the best interests of these incapacitated artificial persons which society created and of which society is the licensor, so that they have positive impacts on the economy, society and the environment.

A major study has been done by the Boston Consulting Group on the “Total societal impact, a new lens for strategy.” It is reported: “For decades, most companies have oriented their strategies toward maximising total shareholder return (TSR).

Now, however, corporate leaders are rethinking the role of business in society.  Investors are increasingly focusing on companies’ social and environmental practices as evidence mounts that performance in those areas affects returns over the long term. Standards are being developed for which environmental, social, and governance (commonly referred to as ESG) topics are financially material by industry, and data on company performance in these areas is becoming more available and reliable, increasing transparency and drawing more scrutiny from investors and others.

The great companies that will survive and thrive into the 21st century are those which have their boards applying their collective minds to the fact that the corporate tools of yesterday can no longer be used today, that the mindset of the board has to change to one on an integrated basis, hoping to achieve positive outcomes on the three dimensions of the economy, society and the environment.

Companies have to have a business strategy which results in long term value creation in a sustainable manner. Every company should address at the end of each financial year what were the positive and negative impacts of how the company made its money on the economy, society and the environment.

Good corporate citizenry demands that a board should develop strategy as to how the company will enhance the positive impacts on the three critical dimensions and eradicate or ameliorate the negative impacts on them. In this way, the company will be creating holistic value for society. By focusing on the financial only a company may well be destroying value.

Good corporate citizenry is consistent with human rights. Poor corporate citizenry is inconsistent with human rights.

In July 2000, the United Nations launched the 10 principles of its Global Compact. It was based on the unprecedented rise in partnerships between business, civil society, governments and the United Nations leading to the Sustainable Development Goals of April 2015.  The UN stated that business has to be a part of a solution to the global challenges of people, planet and profit.

The Global Compact contains 10 principles for a company to exhibit good corporate citizenship. The 10 principles are derived from the universal Declaration of Human Rights, the international labour organisations Declaration on Fundamental Principles and Rights, the RIO Declaration on Environment and Development and the UN Convention against Corruption.

Principle One is that business should support and respect the protection of internationally proclaimed human rights and make sure that they are not complicit in human rights abuses. Further business should promote a greater environmental responsibility and encourage the development and diffusion of environmentally friendly technologies.

Human rights are defined in the United Nations as rights inherent to all human beings or rights to which a person is inherently entitled simply because he or she is a human being, regardless of nation, location, language, religion or ethnic origin. It is based on the foundation that all human beings are born free and equal in dignity and rights. Everyone has the right for an environment adequate for his health and well-being.

The consequences of companies not being good corporate citizens are too horrible to contemplate. There will be no sustainable development and the outraged conscience of society against poor corporate citizenship will continue.

We are in the fourth industrial revolution. We are in the age of immediacy. Tomorrow is another day but it is a day of radical transparency where no company can keep a secret in its corporate closet anymore. Boards have to think on an integrated basis about the long term health of the company. That is when a company will be seen to be a good corporate citizen in a world which is not what it used to be. Boards can no longer continue to operate, quite lawfully, on trying to maximise profit but having a negative impact on society and the environment. That is poor corporate citizenry and committing wrongs against humanity.

And after all, there is not only a corporate necessity to do this. There is moral duty to ensure that development is sustainable. We have to achieve sustainable development that meets the needs of the present, without compromising the ability of future generations, your children, your grandchildren, to meet their needs. This is a primary ethical and economic imperative. While we have crimes against humanity, we also cannot afford lawful wrongs against humanity. There has to be a change from shareholder centric governance models to company centric models – the long term health of the company.

Nelson Mandela in his “Long Walk to Freedom” said, “Action without vision is only passing time, vision without action is merely day dreaming, but vision with action can change the world.”

There is a revolutionary immensity in the vision of integrated thinking resulting in a business model which embraces sustainability issues pertinent to the business of the company, with positive impacts on the three dimensions of sustainable development. It has the outcome of dealing with lawful wrongs at source, in the boardroom, and meeting the outraged conscience of the world to corporate profit subsidised by society and the environment. That has been the free part of the free economy.

When Pacioli in the 15th century recorded the double entry bookkeeping system of the Merchants of Venice he created the foundation of accountancy as we know it today. But that was purely financial. What is needed is a multi-capital approach to reflect value creation in a knowledge-based naturally resource constrained world. Integrated thinking and doing an integrated report matches double entry bookkeeping for its global applicability and its resonance to the needs of today’s business and society.

The Harvard Business School has collected evidence which shows that sustainable companies deliver significant positive financial performance and investors are beginning to value them more highly. The American Consultancy, Arabesque, and the University of Oxford have reviewed academic literature on sustainability and corporate performance and found that 90% of 200 studies analysed concluded that good environmental, social and governance standards lower the cost of capital; 88% show that good environmental and social governance practices result in better operational performance; and 80% show that stock price performance is positively correlated with good sustainability practices. In short it has become good, hard-nosed business to ensure that a company’s business model does not have adverse impacts against humanity.

As there is universal recognition of crimes against humanity, which connotes conduct with wilful intent, there should be universal recognition of wrongs against humanity by steering a company for the maximisation of profit at any cost instead of focusing on its long term health which is in the better long term interests of all its stakeholders. Such focus is a moral necessity for those who come after us. After all, we are transient caretakers of this planet and have a duty to leave it in a state that will not further prejudice the needs of those who come after us.

Replace the negative outrages of society against corporate wrongs with positive corporate outcomes on all three of the dimensions of the economy, society and the environment, then we will have a good corporate citizenry and humanity having its right to clean water, clean air and arable land – in short – the right to life.