Boards of directors neglect one essential duty: oversight of the relationship between governance and corporate culture

December 2016  |  SPOTLIGHT  |  CORPORATE GOVERNANCE

Financier Worldwide Magazine

Corporate culture should be a set of authentic behaviours, set forth by a founder or management team of a company, which is embraced by the entire organisation. Certainly, each culture is distinctive and many diverse elements go into creating each one.

But far too few corporate boards consider how, and in what ways their governance structures contribute to corporate cultures laden with risks including, for example, internal competiveness, fear of flagging or reporting misconduct or quality concerns, and false consensus on material issues because speaking ‘truth to power’ carries far greater risk than reward. As a consequence, nearly every corporate crisis or perilous reputational event involves a culturally driven, but preventable, series of behaviours and actions of commission or omission that destroy value.

In two separate 2016 surveys, for Spencer Stuart and for PwC, directors agreed that their boards should spend more time on strategy, competition, CEO succession, talent, cyber security and crisis management. If we consider the biggest recent corporate crises which seriously damaged the reputations of companies, be they a bank, a retailer, a manufacturer or a services enterprise, one single issue invariably emerges as a dominant contributing factor for the crisis – corporate culture.

Most boards appear to view a company’s stated values as irrelevant. At publicly traded companies in particular, far too often they are unable to sustain integrity as a corporate value because there is no mandate to evaluate how performance cultures drive value, optimisation and risk reduction. This happens when directors, like their management, suffer what has been called ‘ethical fading’ and they view questionable behaviour as merely part of a business decision, rather than an ethical inflection point.

It is time directors embed into their governance ‘check and balance’ obligations evaluative criteria regarding management’s ability to cultivate and maintain performance cultures that generate durable and lasting ethical behaviours and reputations. Why? Because, ultimately, boards are accountable for their companies’ performance and reputation and the ability to prevent performance breakdowns internally falls within the parameters of material and preventable risk.

Director behaviours that foster a strong culture

So what behaviours are most important in nurturing a board and company culture that forges effectiveness and corporate performance? Recently, Russell Reynolds Associates, another executive search firm, asked that question to 369 supervisory directors from 12 countries.

Despite the wide range of corporate governance regimes represented, the directors expressed a surprising degree of consistency in the importance of five behaviours, including: (i) possessing the courage to do the right thing for the right reasons; (ii) willingness to challenge management constructively when appropriate; (iii) demonstrating sound business judgment; (iv) asking the right questions; and (v) possessing an independent perspective and avoiding ‘group think’.

These behaviours are similar to the board-centric model of corporate governance promoted by the largest long-term institutional investors and pension funds, such as BlackRock, State Street, Vanguard, CalPERS, Hermes and PGGM. Together, they serve to hold board independence as a central theme, along with a board’s ability to challenge management and hold it accountable.

Yet, do these behaviours truly tackle the essential duties of a board in identifying, promoting and overseeing a company’s behaviours and beliefs – its culture? They are a start, but much more is required. Directors simply cannot talk about and demand corporate values, a mission statement and a corporate culture that delivers the best in an organisation and its performance.

The role of incentives

Given that employee and management behaviour almost always focuses on how a company incentivises its people, it has become a predictable science that an organisation gets the kind of behaviour it incentivises – tacitly or directly. When we consider some of the biggest corporate ethical situations of the past, such as the Ford Pinto case in the early 1970s when the automaker knew that the new car – known as ‘Lee’s car’ for the company’s then president Lee Iacocca – represented a serious fire hazard when struck from the rear, even in low-speed collisions. The result – a number of fire-related deaths.

Despite various ways to make the Pinto’s gas tank safer, at an estimated cost of $5 to $8 per vehicle, Ford officials opted for the existing design for six years to meet their production timetable. They relied on a then-accepted cost-benefit analysis, reasoning that, in monetary terms, relates to the expected costs and benefits of doing something. Based on Ford’s numbers, the cost of making the changes was $137m. The price tag put on the deaths, injuries and car damages from the defect was $49.5m. Though Ford employees said at the time they never told Iacocca about the defect because they believed he would have asked them if fixing it would hurt the timetable for Pinto deliveries.

In that instance, the corporate culture did not consider whether a decision was ethical or not but whether it was legal. And the board of directors apparently did not consider how a price can be put on saving a human life.

The Ford Pinto case is not all that different from the inadequacies of corporate cultures that emerge from studying most major corporate crises. The inadequacy may vary, but it almost always relates to a corporate class system – that does not incentivise constructive conflict, horizontal quality control and candour and transparency from the bottom up and top down.

What a board should do about culture?

Directors and boards seeking to truly understand their company’s corporate culture must be truly independent and not rely on senior leadership or the HR department to relate their own perceptions about company behaviours, particularly as it relates to employee-satisfaction surveys popular at many companies. Boards must do their own inquiries and use third-party firms that deliver absolute anonymity to measure employee sentiment.

However, boards cannot stop there. Directors (and, preferably, at least one that truly understands performance cultures and their drivers of success) must gain assessments of a representative sample of former employees and managers to better assess the organisation’s culture. They should also study companies with strong performance cultures – Google and Pella Windows, for example – and then continually ask senior leaders what they are doing to ensure that the organisation strives to follow suit.

To help boards on this mission, there are seven questions directors must discuss and thoroughly check. How does the board understand and measure the cultural integrity of the organisation? How is culture communicated and incentivised across the organisation? How are employees at the lowest level of the company treated, and what message communicated on ethics, integrity, and honest stewardship? When was the last time the company measured its ethical culture? If the company has grown through an acquisition, when and how is the organisation going to harmonise the culture? What expectations on culture should the board communicate to management, and should associated accountability metrics be factored into executive composition, both positively and negatively?

Strategy, cyber security risks, CEO succession, talent, competition and crisis management are all important for boards of directors to keep apprised of continually. But, for their own sake and the reputation, stability and risk mitigation of their organisations, directors must spend a great deal more time understanding and assessing their corporate culture.

Harlan A. Loeb is the global practice chair of crisis & reputation risk at Edelman. He can be contacted on +1 (312) 240 2624 or by email: harlan.loeb@edelman.com.

Mr Loeb is a recognised expert in crisis and reputational risk management. With extensive experience in global crisis preparedness, he has developed a reputational risk decisional model for corporate officers. Mr Loeb has worked across all industry sectors representing clients including: Enron, Hangzhou Zhongce Rubber Co., Chevron, Gilead Sciences, Harley-Davidson, Juniper, Notre Dame, Waste Management, CME Group, Mitsubishi Corporation, Dow Chemical Company, HSBC, Kraft, Grosvenor, GE Healthcare and SC Johnson. Before joining Edelman, Mr Loeb was a founding principal of Financial Dynamics’ Chicago office and a member of its US board of directors.

© Financier Worldwide

BY

Harlan A. Loeb

Edelman

Email author