Other stakeholders must have stronger role in monitoring culture

Every director worth their fees understands the importance of corporate culture. They know bad culture kills strategy, exposes the organisation and its board to significant legal risk, damages corporate reputation, and destroys shareholder value.

As custodians of corporate culture, high-performing boards ensure executives understand, measure, monitor and report on the organisation’s beliefs and behaviours. Governance techniques range from assessing employee, customer and investor surveys, to site visits and discussions with front-line staff, to “fireside chats” with key executives.

The growing length of sustainability reports shows just how active listed companies have become in monitoring and reporting activities that affect culture. Westpac Banking Corporation, for example, delivered an 82-page 2015 Sustainability Performance Report and provides a useful interim sustainability report to measures its progress.

But is this focus enough? Not according to the Australian Securities and Investments Commission, at least as it relates to organisation culture. ASIC has been at war with the big banks this year over perceptions it is trying to “regulate” corporate culture.

To recap, ASIC last year recommended amendments to the Corporations Act 2001 and the Australian Securities and Investments Commission Act 2001. The laws would extend Part 2.5 of the Criminal Code Act 1995 to provisions of the Corporations Act that regulate financial services and markets.

Directors could be charged with criminal or civil offences if their organisation’s corporate culture encouraged, tolerated or led to non-compliance, or if the organisation failed to maintain a corporate culture that complied with relevant provisions.

ASIC is reminding boards that they must have a clear understanding of what the organisation’s culture ought to be; measure the extent to which that culture is true; and ensure any identified cultural gaps are being addressed and not left to compliance or “box ticking”. The governance community believes ASIC is overstepping its mark in this area.

I appreciate both arguments. ASIC is, rightly, responding to recurring scandals in the financial services sector that go to the heart of organisation culture. Corporate Australia, justifiably, says culture is not easily measured, should never be regulated, and that organisations and boards have taken steps to understand, monitor and measure culture since the 2008-09 GFC.

A market response needed

A big part of the problem is the lack of sharemarket mechanisms to identify and reward companies with good culture and penalise those with poor behaviours. If corporate culture is so important to long-term organisation performance and sustainability, why doesn’t the sharemarket focus more on it and value it appropriately?

I question whether 11 directors of a bank that has 46,000 employees and is worth $129 billion (Commonwealth Bank) can ever oversee corporate culture adequately. And whether it is too much to expect part-time non-executive directors, most of whom have never worked at the bank they govern and some of whom built their careers outside financial services, to be legally responsible for the culture of giant organisations that can have many sub-cultures.

That is not to downplay the seriousness of banking scandals, absolve directors of their responsibility to govern organisational culture, or trivialise the importance of culture. Rather, it recognises that the growing speed and complexity of global business requires different thinking about how organisation culture is monitored, rewarded or penalised. And that more stakeholders must play a stronger role in influencing organisation culture.

Debate is needed on why the market pays insufficient attention to corporate culture. Look through stockbroking analyst reports and ask how many refer to corporate culture or factor it into valuation models. Most valuations still rely on traditional metrics such as price-earnings (P/E) multiples or using discounted cash flow techniques. Barely any consideration is given to culture (or other non-financial metrics for that matter) as a valuation input or considered in analyst recommendations to buy or sell stocks.

Investors tend to react to organisation culture problems, punishing a listed company’s valuations when problems emerge, rather than identify which organisations are more susceptible to bad behaviours and factor it in share prices. We need to be more forward-looking with organisation culture and create measures of value around it.

Australia’s $2-trillion superannuation industry has a key role in this regard. It is not doing enough to encourage faster change in the investment community with respect to Environmental, Social and Governance (ESG) metrics. Most analysts still focus on short-term earnings forecasts, even though the bulk of money comes from investors (or their intermediaries) who invest retirement savings and have an interest in longer-term governance issues such as corporate culture.

Progress in this area is scant. Some investment banks have hired ESG analysts and produce good research in this area. The proxy advisory industry has expanded and industry super funds are spending more time with chairmen to understand organisation governance. But the efforts are inadequate in the context of our superannuation system and what is at stake.

Imagine if more superannuation funds insisted that intermediaries, such as fund managers, give serious consideration to ESG factors, such as corporate culture, in their investment decisions, or risk losing super mandates and fees. That, in turn, would incentivise investment banks and stockbroking firms to increase their coverage of ESG issues, consider them in valuations, take a long-term view, and sharpen the market’s focus in this area. It’s happening, but too slowly.

Greater market analysis of corporate culture would send forward-looking price signals to investors. It would help them better allocate capital to companies with strong, sustainable cultures and withdraw capital from those with weak cultures, assuming it is one of several considerations in their investment decisions.

Directors can work with the investment community on culture

Boards, too, can do more to educate investors on corporate culture. Those of ASX 200 companies can lift their investor relations (IR) efforts with industry superannuation funds and other long-term institutional investors. Most IR efforts from the board are limited to the chair’s role when they should be spread across directors.

Like it not, IR will become a bigger board task in the next five to 10 years as investors demand greater say on strategy and as shareholder activism rises.

Ensuring the market has the right data to make informed decisions on corporate culture should be a board priority. Too many sustainability reports have become overwhelming, have little impact in the market (relative to the effort in producing them), and are, frankly, a public relations or internal communications exercise. Their data, which taken together presents a picture of corporate culture, is too important to be buried.

Large organisations must simplify their communication of corporate culture. In addition to presenting an array of ESG statistics, such as employee turnover or occupational health and safety, they could build an index of their culture, explain the assumptions behind it, benchmark the index across time and industry, and consistently report it to the market.

Organisations spend too much time talking about culture and not enough quantifying it for investors, transparently reporting on it, and explaining the results in plain English.

As an investor, I want to know if an organisation’s corporate culture, as defined by the board, is improving or declining and if so, why? I want to see the culture progress or lack therof of a multi-year timeframe? And know whether the board has identified gaps in organisation culture and how it is addressing them.

Sceptics will argue this requires yet another layer of reporting and that culture is not easily defined or measured. My counter-argument is that culture can be measured and that extra effort in communicating it to investors is a small price to help the market monitor culture, reward organisations that excel in this area, and better protect boards.

Boards, of course, should do everything they can to monitor organisation culture. But having thousands of investors monitor culture through stronger market price signals, either directly or indirectly via financial intermediaries, is surely more effective in the long run.

I would back the market doing a better job of monitoring culture than a handful or two of part-time directors, provided the right information is disclosed and that superannuation funds use their influence to force the investment community to analyse corporate culture.

Allowing market forces to reward or penalise organisation culture has to be more effective in the long run than an extra layer of black-letter law, in such a grey area as culture.

Tony Featherstone is a former managing editor of BRW and Shares magazine and consulting editor of the AICD Governance Leadership Centre.