March 14, 2016 / Regnan Archive
From 14 March 2016
Much of the recent discourse on the pros and cons of holding boards accountable for corporate culture, particularly in financial institutions, has focused on technical/legal difficulties, with the business imperative for a proper response reduced to a foot note. The law is always a minimum standard expression of society’s expectations, the reasonable expectations of investors, customers, and other stakeholders to act ethically, should also be part of a board’s accountabilities.
As representative of long term investors, we have been considering the role of culture in risk and sustainable value creation for well over a decade. Our primary focus has been on the board’s responsibility to act as stewards of corporate culture, and to foster that culture beyond the tenure of the current CEO. Of particular interest are indicators of a culture going bad, where deviant and value-destructive behaviour becomes normalised, and where countervailing influences are silenced.
Unfortunately of the many conversations we have had with listed company directors on this topic over the years, most involve the propagation of the “bad apples” argument, i.e., that these are decisions of rogue individuals made in isolation. The argument usually follows this line:
- The board’s most important function is appointing the right CEO;
- The right CEO will set the tone for the culture, and will hire the right people and implement the right processes which will cascade throughout the organisation;
- The board obtains comfort that the right culture(s) are in place through management reporting, talking to staff and board site visits – sometimes even surprise visits, that can’t be overly sanitised;
- Where this does not work, it is usually the fault of ‘a few bad apples’, who are fired, once an incident has been identified, too often by the media;
- It is impossible for a board to guarantee that all of its employees will behave though somehow this is expected to be within the capabilities of the CEO.
While we accept that there will always be bad people who will get up to bad things, we do not accept that this alone explains the many examples we have of things going wrong and continuing to go wrong. In fact dismissing individual incidents in this way without further validation is a risky assumption to make. The malfeasance exhibited by workers in VW, Enron and the plethora of financial institution scandals provide evidence that more than “bad apples” are at play with significant impacts to company value, and we have no doubt there are countless more that are never exposed. We further suggest that more stringent, structured board oversight is likely to mitigate the risk of value-destructive corporate cultures emerging.
It is our view that stewardship of a productive and positive culture is at least, if not more, important than the selection of the CEO. Culture, often described as a “shared set of values and behaviours”, can take years to develop, and years to change, often a lot longer than the tenure of a given leader. In fact the relentless focus on the CEO has led to what we call “Great Man Syndrome”, i.e., the notion that one super individual can wholly transform an organisation, which may work in North Korea but highly questionable for a diverse, educated workforce performing knowledge work in a functioning democracy. This focus on the CEO, along with other undesirable consequences such as inflated pay, has arguably led to board’s abrogating their responsibility for culture.
But rather than ask how directors can possibly know about every incidence of bad behaviour in a large, geographically diverse organisation, which we agree is impossible (and is not what we are asking), shareholders should be able to get comfort that the board is capable of ensuring the “settings” for culture are right for the business and for long term value creation.
Firstly, as we have argued for many years, they should have a proper handle on the risks inherent to their particular business, and ensure the right mitigants, policies and procedures are in place and that the possibility for unintended consequence or mixed ethical signals are reduced. As an example, some research suggests that abnormal behaviour, such as defrauding a customer, is more likely to occur the greater the distance between the ethical decision maker and customer. We would expect a board to have an understanding of such predictors and to implement a process (such a face to face contact) as mitigation.
Secondly, they should insure these mitigants, such as Chinese walls for financial institutions, codes of conduct and whistleblowing policies are live, through rigorous and continuous assessment of indicators such as consequences for breaches etc.
Thirdly, they should possess the skills to properly interrogate management and their reports on issues relevant to culture. For example, an unusually high turnover of new recruits can point to unrealistic sales goals – a precursor to cutting corners. Employee engagement surveys should be scrutinized with a good dose of skepticism, especially where their results are linked to so-called “performance pay”. Too often we are told boards have the requisite skills to understand human capital metrics because the directors themselves have managed large teams. General management experience, in our view, does not necessarily provide an individual with the skills to triangulate complex sets of human capital data into meaningful analysis and appropriate interventions. The reasons for poor conduct are often complex and cannot be easily abated with training programs or posters but rather require a holistic assessment of the cultural signals an organisation sends, understanding and addressing this requires the kind of long term and overarching view that board directors are paid to provide.
Finally, public disclosures should include reporting on cultural indicators so shareholders with a long term view can be assured that this most vital of elements is accorded the right weight by the people entrusted with their money.