The Financial Reporting Council (“FRC”) has published the results of its study on the relationship between corporate culture and long-term business success in the UK. The report explores the importance of culture to long-term value and how corporate cultures are being defined, embedded and monitored. It also sets out the FRC’s observations on the key elements which boards should be considering in order to create a culture that delivers sustainable good performance. The report is based on the findings of a research project conducted by the FRC in collaboration with a number of partners (including the City Values Forum, the Institute of Business Ethics, the Chartered Institute of Management Accountants, the Chartered Institute of Personnel and Development and the Chartered Institute of Internal Auditors. Each of the FRC's partners in the collaboration have also published separate reports which focus on particular aspects of the culture project, including stakeholder engagement (by the IBE), embedding and assurance (by the IIA), business models (by the CIMA), people issues (by the CIPD) and board leadership in purpose, values and culture (by the City Values Forum working with Tomorrow's Company).
The FRC embarked on the project to gain a better understanding of how boards are currently addressing culture, to encourage discussion and debate and to identify and share good practice to help companies. According to the introduction to the report, the FRC believes there are valid questions about how effectively existing corporate governance arrangements address the board’s responsibilities to stakeholders other than shareholders, as envisaged in the Companies Act 2006. Shareholder primacy can encourage a short-term focus, but short-termism can drive poor business behaviours and conduct, such as inappropriate incentives, market-rigging, poor customer service, low levels of investment and opaque financial structures and arrangements. The view of the FRC is that the UK governance model remains an efficient and effective means of meeting stakeholder objectives; however, success depends upon the spirit with which companies and investors apply the principles and use the flexibility they have.
Key observations in the report
Key findings of FRC's study include the following:
- To recognise the value of culture: a healthy corporate culture is a valuable asset, a source of competitive advantage and vital to the creation and protection of long-term value. The board’s role includes determining the company's purpose, and ensuring it is aligned with the company's values, strategy and business model and should not wait for a crisis before directors focus on company culture;
- To demonstrate leadership: a company's leaders, particularly its chief executive, must embody the desired culture and embed this across all levels and aspects of the business. Boards have a responsibility to act where leaders do not deliver;
- To be open and accountable: openness and accountability matter at every level and good governance should be demonstrated in the way the company conducts business and engages with and reports to stakeholders;
- To embed and integrate values: the company's values should inform the behaviours that are expected of all employees and suppliers. Human resources, internal audit, ethics, compliance and risk functions should be empowered and resourced to embed values and assess culture effectively and their voice in the boardroom strengthened;
- Evaluation: indicators and measures used should be aligned to desired outcomes and material to the business. The board has a responsibility to understand behaviour throughout the company and to challenge where it finds misalignment with values or where better information is required;
- Values and incentives to be aligned: recruitment, performance management and reward should support and encourage behaviours consistent with the company’s purpose, values, strategy and business model. The board is responsible for explaining this alignment to shareholders, employees and other stakeholders; and
- Stewardship: effective stewardship should include engagement about culture and encourage better reporting. Investors should challenge themselves about the company behaviours they are encouraging and to reflect on their own culture.
The FRC states that it will be monitoring reporting on culture by companies and investors over the next year. It also invites feedback on the report, which will inform its review of its Guidance on Board Effectiveness in 2017.