Management of human capital an investor-engagement priority


    Boards’ approach to organisation culture under increasing scrutiny.

    Institutional investors are focusing more on the governance of organisation culture and seeking greater engagement with Chairs on Human Capital Management issues.

    Organisation culture has become a hot topic for boards after the Financial Services Royal Commission this year and the Australian Prudential Regulatory Authority’s report last year on the Commonwealth Bank. Both investigations found shortcomings in the governance of culture.

    From an investor-engagement perspective, culture has had a lower profile than Environmental, Social and Governance (ESG) issues such as climate change and diversity. That is changing as investors examine the link between organisation culture and risk management.

    BlackRock is very interested in how boards approach organisation culture and it’s something we will be spending a lot more time on. We don’t expect directors to micro-manage on this issue, but we want to know how they assess their organisation’s culture and look under the bonnet on it.

    Institutions want to know that boards are fulfilling their duty as custodians of organisation culture and holding management accountable on it. Investors are also paying closer attention to employee engagement, turnover and other data on culture performance.

    Iris Davila, Head of Investment Stewardship at BlackRock in Australia, says the firm is having more conversations with boards about culture. “BlackRock is very interested in how boards approach organisation culture and it’s something we will be spending a lot more time on. We don’t expect directors to micro-manage on this issue, but we want to know how they assess their organisation’s culture and look under the bonnet on it. What we don’t want to see is a meaningless reference to organisation culture on page 95 of a Sustainability Report.”

    BlackRock, the world’s largest asset manager and a vocal proponent of governance change, this year nominated Human Capital Management (HCM) as one of its top-five engagement priorities with boards. In its latest Investment Stewardship commentary, BlackRock said it expects companies in their corporate strategy to explain “how they establish themselves as the employer of choice for workers on whom they depend”.

    BlackRock added: “HCM is both a board and a management issue. We would expect a company’s board to be deeply engaged in the oversight of a company’s strategy and the defining of a company’s purpose – to help ensure the effective strategic implementation of HCM throughout its organisation.”

    When engaging boards on HCM issues, BlackRock says it is likely to discuss:

    • Whistleblowing and other policies that protect employees;
    • Processes that align HCM initiatives with healthy organisation culture and behaviours;
    • Reporting to the board on the integration of HCM risks into risk-management processes;
    • Current board and employee composition as it relates to diversity;
    • Consideration of linking HCM performance to executive pay;
    • Board visits to organisation assets to independently assess culture.

    BlackRock wants to know that boards have a systematic approach to governing culture, says Davila. “First, we want to see that HCM is part of corporate strategy. Second, we want to understand the board’s process or framework for assessing culture. We also want to know which performance markers of culture the board is focused on, how it tests and interprets that data, and extra steps it takes, such as site visits, to go deeper on culture.”

    Davila looks for clues in board responses about culture. “We want to know if the organisation has a learning or blame culture and if employees are empowered to do their best work and the right thing. And if bad news travels quickly to the top of the organisations, and if there are consequences for doing the wrong thing. Most of all, we want to know how boards think about these issues.”

    Davila says fund managers are factoring culture into investment decisions. “The number one question our investment team wants answered when we engage with boards, is ‘does the company have a good culture and good people?’. It goes to the heart of risk; if the board’s not thinking about culture and the data suggests the organisation’s culture is not what it should be, investors become nervous. Obviously, culture is one of many factors in an investment decision but it is becoming increasingly important to the investment community.”

    Super funds lift culture focus

    The Australian Council of Superannuation Investors (ACSI) has also lifted its focus on organisation culture. ACSI in May 2019 called on companies – and, by default, their boards – to re-examine workplace culture and diversity.

    “It is widely accepted that poor culture is a key contributor to major behavioural and governance failings, which harm investors, consumers and markets,” says ACSI CEO Louise Davidson in a statement. “Australia’s response to cultural failings has traditionally been reactive, happening only after significant consumer and investor harm has occurred. Our proposals would focus companies on the risks and opportunities associated with their corporate culture.”

    The first proposal is that all listed company boards should be required to assess their organisation’s culture regularly and disclose any action taken. “We think boards should openly and transparently conduct culture assessments for the entities they lead,” said ACSI in its May 2019 discussion paper, Towards Improving Corporate Culture and Diversity.

    ACSI’s second proposal was on gender-diversity targets. It said listed companies should be required to set a timeframe within which they will achieve gender balance on their boards and said regulatory intervention should occur if companies are unwilling to set a reasonable timeframe or do not improve gender diversity by 2025.

    ACSI’s definition of gender balance is a minimum 40 per cent of either gender, with 20 per cent unallocated, to allow for board-composition flexibility and renewal. “This is the logical next step in supporting diversity on boards,” says Davidson. “If companies are not willing to set and achieve a target for gender balance within a reasonable timeframe, then there is a role for further regulation.”

    Ed John, Executive Manager, Governance and Engagement at ACSI, says listed companies are starting to improve their disclosure of culture performance indicators. “There’s no perfect template, but there is an opportunity for listed companies to provide more detail on culture-related data to the market, and for boards to be more transparent about their oversight of organisational culture.”

    John says companies have an opportunity to present more detail to investors “A listed company could disclose a framework of how it assesses its culture, the key performance markers it looks at, and the data behind that performance. The board would disclose the steps it takes to assess that framework and the culture performance.”

    John says this approach would be markedly better than current practice. “We don’t know enough about how boards oversee culture, and data on it is often incomplete or scattered across a sustainability report. This lack of transparency makes it hard for investors to assess culture from the outside looking in.”

    Change on the reporting of culture data will take time, says John. “There’s a lot of good work being done internally by companies to better understand and measure their culture. The challenge, now, is to get more of that data to the market.”

    John is optimistic of change. “Boards, management, regulators and investors understand the importance of organisation culture and acting on it. There’s a desire to be more open about culture, partly in response to regulators and investors, and also because boards have seen the damage poor culture can make. Boards clearly see themselves as ‘custodians of their organisation’s culture’. That wasn’t the case five years ago.”

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