Recently, corporate cultures—or, more particularly, serious lapses in same—have emerged as flashpoints at many businesses and even entire industries, often with significant negative press coverage and severe economic consequences. As a result, this new report from the National Association of Corporate Directors, The Report of the NACD Blue Ribbon Commission on Culture as a Corporate Asset, couldn’t be more timely. The report suggests that boards would be well-served by paying more attention to oversight of company culture—not just for scandal avoidance, but also “as a way to drive sustained success and long-term value creation.” A “healthy culture,” the report asserts, can serve as “a competitive differentiator.” The report includes a Toolkit with sample documents, questions and other useful materials.
The report suggests that directors’ experience and independence may actually be helpful in picking up on early warning signs that a member of management —who is typically immersed in the culture—may miss. But unfortunately, the report asserts, corporate culture “does not get the level of boardroom attention it deserves until a problem arises.” The BRC contends that “this has to change”: directors need to take “a proactive, forward-leaning stance on culture oversight.” However, “taking a proactive stance with respect to culture oversight does not mean directors have to factor a new, additional set of responsibilities into their already-crowded agendas. Instead, culture should be one facet of existing activities, including the board’s own governance and continuous-improvement practices, strategy and risk discussions, CEO selection and evaluation, decisions about rewards and recognition, and shareholder/stakeholder communications.”
What is corporate culture?
The report views the concept of “culture” as a “series of assumptions individuals make about the groups in which they participate, visible through artifacts (including public statements, organizational structures, and key processes), stated goals and aspirations, and basic (i.e., taken-for-granted) beliefs.” Corporate culture is evidenced by the behavior of all employees at all levels, as well as in interactions with external stakeholders. One insight into company culture comes in response to questions about problem-solving: “In uncertain situations, or when people are under pressure, what do they do instinctively? What decisions and trade-offs do they make? That tells you a lot about a company’s culture.” Organizational cultures comprise elements such as explicit and implicit rules and norms, ethics policies, incentives, training, processes for decision-making, communication flows and leadership styles. A healthy culture can be a “unifying force” and reinforce “the elements of the strategy and business model in a productive way. Conversely, a dysfunctional culture has the potential to undermine the business model and create significant risk for the company.”
The BRC argues that two sets of standards must be clearly identified: “first, the values and behaviors that help the company excel and that are to be encouraged, and second, the behaviors for which there are zero tolerance.” To that end, the BRC suggests that the board ask the CEO to create a short narrative of the desired cultural foundations and to explain how the company’s incentives, controls and policies support those foundations.
The BRC advocates that healthy cultures should be viewed as corporate assets: studies have shown a positive relationship between strong positive cultures and positive business attributes, such as customer satisfaction, safety and profitability. In addition, social media can increase the speed and impact of scandals on corporate reputations, particularly in light of negative popular perceptions regarding business in general, and many institutional investors and regulators have put corporate culture under a spotlight. In the BRC’s view, “board members need to achieve a level of discipline with respect to culture oversight that is comparable to leading practices in the oversight of risk.” While there is no one size fits all, the BRC identifies the following as “signifiers of healthy culture in the organization as a whole, and also in the boardroom”:
- There must be consistency between the company’s statements about its culture and the actual behaviors, as evidenced by “observed, day-to-day behaviors throughout the organization.” Obviously, the absence of consistency can lead to cynicism.
- Culture is everyone’s responsibility throughout the organization. The BRC suggests that a “healthy culture of accountability is one where ‘mistakes are identified, remedied, and regarded as a source of learning rather than of blame.’”
- Processes for internal and external communications should be well-developed and distinguished not only by quality but also “by the tone (of respectful candor) and the content. As a director at an NACD roundtable put it, ‘[in transparent cultures] bad news takes the elevator and good news takes the stairs.’”
- The company’s cultural foundations “must be able to withstand stressors from outside and inside sources,” but also be “able to change in a conscious and deliberate manner, in order to adapt to new business dynamics and competitive realities.”
In overseeing corporate culture, what should be the board’s priorities for action?
The BRC identified six priorities:
- Board oversight responsibilities. In light of the close connections between corporate culture, on the one hand, and strategy and risk, on the other, the BRC believes that oversight of culture should be the ultimate responsibility of the full board, although board committees can also play roles in overseeing specific culture-related activities. Oversight of culture should not be limited to overseeing executives, but should extend throughout the company, and directors should be on the lookout for local deviations from the desired culture. However, in a recent NACD survey, only half of directors reported that they understood the “‘buzz at the bottom’—the collective behaviors, norms, and values at the front lines of their organizations, among their rank-and-file employees.” Accordingly, in overseeing corporate culture, the report suggests that directors acquire some “firsthand visibility” into “how the culture is lived” by regularly spending some “time ‘on the ground’ where business is being done, in order to gain exposure to a cross section of employees at different locations and levels of seniority.”
- Assessing boardroom culture. The report points out that there is an interplay between board culture and company culture. The BRC advises that directors thoroughly review the board’s culture on a regular basis, giving consideration to, among other things, areas of strength and concerns, alignment between the cultures of board and the company and the extent to which “the design and structure of the board’s work program reflect the importance of establishing and overseeing a healthy corporate culture.” How significant a component is the issue of culture in, for example, board agendas, board refreshment practices, protocols for boardroom dialogue and protocols for interactions with management or culture-related training? More formally, the board’s annual self-evaluations should address the effectiveness of board culture. The results of all of these reviews “should inform board composition, succession planning—especially for leadership roles on the board—and continuous improvement efforts in board operating processes.”
- Embedding culture into discussions about strategy, risk and performance. The report observes that, while culture can help drive strategy, it can also “eat strategy for breakfast” by, among other things, exacerbating risks. The BRC advised that boards clearly define roles of management—particularly the GC and heads of internal audit/risk management— and, collectively, employees, in supporting the desired culture. A discussion of culture should also routinely be on agenda, incorporating “questions about culture into strategy reviews, evaluations of operating performance, and discussions with management about proposed initiatives, current and emerging risks, relationships with customers and suppliers, leadership-development activities, entering new markets, partnership opportunities, and so on.” Boards should also consider inserting discussions of culture into other discussions with management, focusing in particular on identification of any red flags, such as these:
- “Focus on performance with little regard to how results were achieved
- High performers are allowed to operate outside established policies. Behaviors that are not consistent with the company’s stated values/code of conduct are rewarded.
- Frequent ‘near-misses’ of adherence to code of conduct, risk-appetite limits, etc., or frequent requests for exceptions to these policies in order to meet performance targets
- Excessive focus on consensus/collegiality leading to prevalence of ‘go along to get along’ attitudes
- Relationships outweigh skills and/or performance in determining promotions or other recognition to an inappropriate degree
- Sharing bad news is discouraged (or, bearers of bad news are punished outright).”
In discussions about financial results, the BRC advises directors to
“emphasize that the way in which results are achieved is as important as whether or not a given goal is met. The way directors formulate questions during reviews of business results and operating performance sends an important signal: an overly transactional approach to problem-solving or an excessive focus on quantifiable gains and losses (whether in terms of revenue, profits, market share, or other measures) can obscure or diminish the importance of purpose, values, and behaviors. Boards should ask how employees handle situations where goals and objectives are in conflict. How do they make trade-offs in these situations?”
The report recommends that the board “set clear expectations about the due diligence and evidence required,” posing questions about whether they are receiving a sufficiently holistic view, adequate unfiltered data and high-quality and reliable data. Data from outside sources, such as outside auditors and engaged third-part reviewers, should be taken into account. Directors should also assess how the company is addressing any issues.
- CEO selection and evaluation. Both oversight of the current CEO as well as conduct of the succession planning process should include considerations of culture, including asking CEO candidates about the strengths and weaknesses of their corporate cultures and how they could be improved. In addition, the board should set the expectation that the CEO’s “tone at the top” will “create a cascade of positive influence on culture…throughout the organization.”
- Reward and recognition systems. The BRC advises that directors review the company’s executive compensation philosophy, as well as the details of executive incentive compensation plans, to “ensure that they support the desired culture, and eliminate any components that might undermine culture.” The board and compensation committee should also examine other critical employee pay plans to assess their impact on corporate culture, such as whether they encourage high-risk behavior. However, the board should not ignore “the influence of other types of rewards on the firm’s culture. Promotions, opportunities to participate in leadership development activities, and nonfinancial rewards and recognition are also important ways in which some types of performance and behaviors are celebrated and others are not.”
- Communication with shareholders and stakeholders. The BRC “anticipates that company culture will be the next focal point for investors’ dialogue with management teams and boards, in the context of long-term strategy and key risks.” Also noted was the focus of institutional investors’ corporate governance teams on key drivers of culture; boards will need to prepare to answer “questions from investors about how they know that the firm’s culture is more than just a written code of conduct. Accordingly, directors should review the firm’s core shareholder communications channels, including the proxy statement, letters from the board in the annual report, direct-engagement discussions, and content on the corporate governance and/or investor relations sections of the company website, with an eye toward incorporating descriptions of the board’s culture-oversight activities.”
As discussed in this PubCo post, BlackRock’ s “Investment Stewardship” priorities for 2017-2018 including human capital management. BlackRock indicates that, as part of its engagement, it seeks “to ensure companies are adopting the sound business practices likely to create an engaged and stable workforce. As part of the engagement, [BlackRock is] interested to know if and how boards oversee and work with management to improve performance in these areas. Such engagement also provides a lens into the company’s culture, long-term operational risk management practices and, more broadly, the quality of the board’s oversight.”