Can we use the DAO phenomenon to improve sustainability standards?

The search - and demand - for sustainability in company activity has been a recurring issue over the years.

The study of corporate law has permanently moved towards the search and distinction - if there is one - between social interest and the purpose of corporations. The evolution of corporate governance has gone through different stages: strengthening the accountability regime for directors and promoting genuine involvement of partners and shareholders.

And in that search to create more resilient companies and businesses more committed to long-term value, sustainability requirements have been vital.

Now, what does all this have to do with DAOs?

Incorporation of ESG criteria in companies

Companies must be sustainable’ has been the mantra for years and has accompanied the evolution of corporate governance.

It is a long journey from the first requirements in non-financial information reporting to the enforceability and design of the current European regulatory framework concerning ESG criteria.

ESG stands for environmental, social and governance, but what does each letter mean?

• The E for environmental encompasses the effect of companies’ activities on the environment - directly or indirectly.
• The S for social includes a specific company's impact on its social environment in the community.
• The G for governance alludes to the company’s corporate governance - for example, the composition and diversity of its Board of Directors, transparency policies for its public information, or its codes of conduct
  

The European framework has two principal regulations in this area: the Directive on Corporate Sustainability Reporting and the Proposed Directive on Corporate Sustainability Due Diligence. Despite this long road and the complex regulatory framework, the objective that has always been pursued can be defined simply: transparency about the role of companies in society.

The objective is for the company to explain what it does, how, and why.

The transition from soft law to hard law is accompanied by a deep analysis of the interplay between sustainability and corporate governance – in particular, the reformulation, or not, of the duties of directors. The important thing is that this European regulation wants to properly enforce the actions of companies in the market, creating a source of liability, legitimation of third parties to demand it and the competence of the authorities to sanction non-compliance with the law.

Companies must develop a ‘due diligence strategy’ in their value chain. The challenge is ensuring that all links in the chain monetize the value created in it and the obligation to be held responsible for the damages generated by the chain's activities.

Those are the critical problems.

How in the scope of a company, understood as a value chain, can risks be controlled and compliance with respect for human rights in the first place and sustainability in the second place?

What role do distributed ledger technologies (DLT) – particularly Blockchain – play in achieving this?

Not only is there the potential that blockchain has in identifying chain risks, monitoring them, and the possibility of implementing solutions for information exchange within the framework of ZKP schemes, but also, mainly from the point of view of governance. And this is where DAOs appear.

Is the DAO phenomenon suitable for implementing key sustainability factors within the governance parameter?

Governance has received the least attention from the three areas that make up the sustainability criteria. The emphasis on the fight against so-called greenwashing and climate change made the environmental aspect a priority. Concern continued for incorporating the social dimension, gender, and diversity.

Only recently has governance emerged as the key to achieving true sustainability.

What is the optimal corporate governance design to achieve sustainability in terms of governance? What indicators can be analyzed?

If we look at the documents that developed the Directive, particularly the European Sustainability Reporting Standards (ESRS), among other elements that comprise the governance parameters, ‘stakeholders' engagement and ‘incentive structures’ are discussed. They are two elements that seem ‘natural’ to the DAO phenomenon.

Let us remember that the DAO can be defined as an organization model in which a group of people interact with each other following a protocol defined in code and executed on Blockchain. Power is distributed equally among the participants via governance tokens. The concept refers to a scalable, open, self-organized network coordinated by crypto-economic incentives, which bases its operation on self-executing codes in a blockchain.

These two vital elements of the “G” parameter - ‘stakeholders engagement’ and ‘incentive structures’ can be analyzed in terms of ‘corporate governance’, mainly studying the problem of how ‘control’ is distributed in the DAO through different voting systems and how to create adequate incentive mechanisms in DAOs that fight against issues such as token holder apathy.

But these elements can also open another line of analysis: Given that DAOs, today, at least in Europe, have no regulation, thinking about ‘traditional’ companies transitioning to a DAO, which today presents a significant degree of legal uncertainty linked to the lack of legal personality, does not seem realistic.

Perhaps more realistic would be to think that within the organizational structure of the companies obliged by the aforementioned European regulations, that is, obliged to carry out sustainability reports, a ‘committee/commission/body’ would be created whose function would precisely implement those sustainability parameters. And that ‘committee/commission/body’ would be a DAO.

Creating a ‘sustainable governance’ committee in companies through a DAO

As we have seen, achieving genuine involvement of stakeholders in the company and designing appropriate mechanisms to encourage this involvement are two factors that make up parameter "G" from the view of sustainability.

The search for this involvement has led, within the framework of capital companies, to legal modifications that, for example, have to do with creating specific classes of shares - "loyalty shares"- or with measures to energize General Meetings.

All these measures must be understood in the logic of a business model with a distinction between a General Meeting and a Board of Directors. With the need to look for channels to ‘connect’ and ‘align’ interests. Given the weaknesses that, at times, the corporate governance model of capital companies has.

What is proposed here is not so much to "retouch" the axioms of the functioning of the General Meetings or the role of the directors, but rather that this ‘putting in contact’, this ‘alignment’ of interests can be done using the model of the DAO, creating a space within the company so that taking into consideration the interest of each one of the stakeholders and the incentive for a real long-term vision can be achieved.

This makes it necessary to analyze several issues:

Clarify the “organic” role of the DAO within the company.

The  ‘sustainable governance DAO’ committee would be the company's organ. What legal nature, for example, do audit committees have in big companies?

This is relevant because company Law leads us to defend that these committees are not liable. Is the regime of representation and liability of the director's company maintained, even though we create this internal ‘body’, the DAO, to comply with the requirements regarding sustainability?

Defining the elements of the  ‘sustainable governance DAO committee’

It would be necessary to determine the aspects of that DAO, choose the blockchain in which it will operate, make the tokenomic design, and decide who would be the token holders (for example, would all the stakeholders mentioned in the standards be token holders?)

In this aspect, it should be remembered that we talk about different types of stakeholders:

AFFECTED STAKEHOLDERS

Individuals or groups whose interests are affected or could be affected – positively or negatively – by the company's activities and its direct effects and indirect commercial relationships along its value chain;

USERS OF SUSTAINABILITY STATEMENTS

Primary users of the sustainability report (existing and potential investors, lenders and other creditors, including asset managers, credit institutions, and insurance companies) and other users of sustainability reports. Finally, the ‘common category of stakeholders’ includes employees, suppliers, consumers, clients, end users, local communities and people in vulnerable situations, and public authorities, including regulators, supervisors and central banks.

Establish what the function of the DAO is

DAO must create incentives so that improvements occur in the involvement of all token holders. For example, if we consider that companies from the entire value chain (suppliers, distributors) should be token holders, could we design “act to earn” type systems creating crypto-economic incentives – perhaps NFTs – if they implement measures that help to the sustainability of the network as a whole.

In short, the DAO phenomenon is a governance model that offers tools to implement the “G” of ESG criteria differently and perhaps more quickly.

The preparation of sustainability reports is certainly complex. A look at the already mentioned ESRS shows it. Mistakes linked to past reports of non-financial information must be avoided. We must also avoid converting the information on sustainability that companies give to the market into mere formal, convoluted justification, with a multitude of items and sections and subsections. Therefore, it is proposed in this article to explore the potential of DAOs, as part of the company structure, to achieve a correct identification of interest groups and a correct design of incentives and alignment of these interest groups with the promoting long-term vision.