The ‘G’ in ESG: Exploring Governance in Private Equity

In environmental, social, and governance (ESG) initiatives, the “E” and “S” often consume most of the limelight. In a Morningstar Sustainalytics survey, only 25% of respondents ranked corporate governance as their top ESG priority. However, while environmental and social concerns may dominate agendas and headlines, good governance ultimately forms the bedrock of a robust ESG strategy. What’s more, many corporate scandals and breaches of environmental or social commitments are often a result of ineffective corporate controls.

In private equity and venture capital, understanding the governance practices and internal controls across portfolio companies proves essential for identifying and mitigating governance risks that could result in material financial impacts on returns. Notable corporate failures in the private markets in large corporations like FTX tied to deficient governance standards underscore the significant losses governance risks can yield for sponsors and their LPs.

Further, as institutional investors increasingly continue to seek granular transparency around governance metrics like board data, compensation policies, and more, GPs need efficient mechanisms for collecting and aggregating this data at scale. Here, we delve into corporate governance pillars, the challenges of monitoring governance in ESG efforts, and how investors can leverage technology to better collect and monitor qualitative governance data in their portfolio companies.

Governance Pillars and the Important Role of Governance in ESG Efforts

Corporate governance frameworks include rules and policies that foster responsible, ethical, and transparent operations. Private equity firms must ensure portfolio companies maintain proper internal and corporate controls to mitigate substantial financial risks arising from poor ethical, operational, or financial decisions.

Numerous internationally recognized frameworks have established best practices for corporate governance, with standout examples being the G20/OECD Principles of Corporate Governance and the ICGN Global Governance Principles. While governance frameworks may vary slightly, they generally align on key pillars, encouraging firms to assess governance across common areas:

Board Composition

Corporate governance frameworks recommend that boards consist of a blend of executive and independent directors and be staffed with individuals who collectively have the skills and experience required to provide adequate oversight of a company’s strategy. Diverse board representation has also emerged as a high-profile governance issue, particularly in private equity, as many institutional investors have demanded better representation of women and minorities on corporate boards and executive teams.

Business Ethics

Fostering high standards of business ethics and cultivating a corporate culture that champions ethical conduct and aligns with the company’s mission is another key tenant of corporate governance. Most commonly, implementing anti-corruption and whistleblower policies, establishing procedures to address allegations of misconduct or ethical breaches, and other key ethics policies are considered best practices for nurturing a healthy corporate culture grounded in ethical behavior.

Remuneration and Compensation Policy

Private equity investors have traditionally used compensation incentives to enhance management performance during the hold periods of their investments. With this in mind, frameworks recommend clear, documented remuneration policies that tie executive compensation with company performance while promoting the long-term value creation of the company to benefit all stakeholders.

Shareholder Rights

While most governance frameworks advise aligning shareholders’ voting rights directly with their financial stake in the company, in asset classes like venture, deviations from this setup are common initially. This may involve “sunset clauses,” which typically establish a timeframe after differential voting rights expire, equalizing voting rights for all shares.

Financial Auditing and Reporting Procedures

Governance frameworks advocate for established, documented internal processes for internal and external financial auditing and reporting to ensure optimal integrity. 

Ultimately, there is no universal governance approach suitable for all privately backed companies. For instance, a seed-stage startup focused on growth with limited revenue will not need the same internal controls as a company with a billion-dollar-plus valuation. This said, establishing governance controls is not a one-and-done process. As companies advance through the lifecycle of a PE or VC portfolio, adjustments to their governance practices become necessary to accommodate growth and scale and mitigate risks accordingly.

How Private Equity Investors Can Streamline Governance Data Collection with Chronograph

Challenges in prioritizing governance in ESG efforts often stem from data collection complexities. Unlike environmental and social factors, which are often quantifiable, governance data can be challenging to collect in a systematic manner due to its qualitative nature. Excel and templates commonly used for ESG data collection often lack the formatting to effectively gather and aggregate qualitative data at scale across reporting periods. As a result, firms can struggle to comprehensively understand governance implications across their portfolio.

A flexible data collection tool like Chronograph offers a broad range of features to gather qualitative data essential for gaining visibility into governance structures in portfolio companies and contextualizing that information in tandem with standard financial and operating data. For example, with Chronograph, firms can utilize various survey-like features to collect governance data in diverse formats:

• Using Chronograph’s table functionality, firms can allow portfolio companies to easily populate their board information, including the names and info of all board members, the breakdown of voting rights, and more.

• Conditional questions enable firms to seamlessly gather extra information pertinent to specific events for particular portfolio companies, such as ethics policy violations or whistleblower events.

• Firms can also use long-form text boxes to gather detailed descriptions of various governance policies in their ESG questionnaires, encompassing auditing procedures, compensation policies, and more.

Further, Chronograph’s versatility enables firms to effortlessly adapt surveys at the company level, reflecting the organic evolution of governance policies in portfolio companies. This eliminates the intricate configuration typically associated with updating questions and adding new sections in Excel workbooks.

Moreover, by centrally storing governance data in the cloud, firms can conveniently monitor changes in governance metrics over time from a centralized location and alongside the context of valuable financial data. Tracking shifts in board composition and voting rights, identifying anomalies in reporting procedures, and examining the handling of breaches in ethics policies empower firms to effectively execute their ESG goals and mitigate risks across their portfolio. 

Ultimately, Chronograph’s ability to collect and process qualitative and quantitative information equips investment professionals with tools to form the most complete view of their portfolio companies’ performance. 

Request a demo to discover how private equity and venture capital firms use Chronograph to streamline governance data collection and enhance governance risk mitigation across their portfolio.