Boards must be alert to early-warning signs on culture.
Expecting company directors to be responsible for the culture of billion-dollar organisations with thousands of employees has become an “almost impossible contract” for boards.
That is the view of Neil Waters, a partner at executive and board search firm, Egon Zehnder International. “It’s naïve to believe part-time, non-executive directors can govern the culture of organisations they don’t work at every day or the behaviour of people they do not see,” he says.
Waters chooses his words carefully. The search industry veteran, soon to lead Egon Zehnder’s
board practice from Hong Kong, has advised some of Australia’s largest companies, including banks, on executive and board appointments. He acknowledges that boards are ultimately responsible for organisation culture and behaviour, but says it is hard in practice.
“Some of these companies have become so large and complex,” he says. “You question how boards can dig deeper into organisation culture and behaviour and have tougher conversations with management – as APRA’s report on the Commonwealth Bank recommends – without moving to a more full-time, executive-style role.”
Board efforts are failing
Waters says board efforts to ensure organisations measure, reward and punish different behaviours, and identify signs of deteriorating culture, are failing. “These bigger companies have lots of comprehensive systems around organisation culture and behaviour, and very competent people at executive and board level monitoring these systems. Yet there were well-documented shortcomings in culture (exposed through the Financial Services Royal Commission).”
Equally, board efforts to choose CEOs who can lead and sustain positive cultural change are not enough. “Talk about boards now choosing CEOs who are strong on driving cultural change is overstated,” says Waters. “Companies have always wanted CEOs who can lead change and grow earnings. Culture is part of that, but I’m yet to see a board chose a CEO mostly based on their skills in this area. I would say its necessary but not sufficient.”
Changing board composition is a likelier outcome from APRA’s report on CBA, says Waters. “I suspect we’ll see boards (or large companies) change. Increasingly, they’ll look for industry specialists over governance generalists. That probably means more ex-CEOs appointed to boards and fewer accountants, lawyers and consultants. But that approach brings different limitations and I am not sure people are considering those yet.”
A sudden loss of revenue from a longstanding client or market segment could be a sign of an emerging culture problem. As could a sudden spike in disputes and litigations with customers. Executive and board turnover are often key signs.
Should it occur, a move towards industry specialists on boards could limit gains in diversity. A lift in ex-CEOs on boards in theory almost certainly means more men and older directors. “Boards now might be less willing to take a risk on, say, a younger director who does not have extensive management experience,” says Waters. “I hope this trend does not affect the push toward greater diversity on boards in gender, age, race and so on. It was breathtakingly poor that gender so quickly became an issue during the recent AMP decisions.”
Waters says APRA’s report on CBA could make it harder for the banks to find “excellent directors”. “There’s always lots of directors wanting to join these boards, but the exceptional ones by definition are much more discerning and they are asking whether they can realistically fulfil the contract they sign when joining a bank board around stewardship of organisation culture, behaviour and risk.”
Water says regulators, market and community expectations of boards will become a larger governance conversation. “At some point, boards will question whether these expectations have become unreasonable. There’s only so much boards can do with organisation culture given the current governance model.”
A different view on culture and CEOs
Alison Gaines, GAICD, manging partner Asia Pacific of Gerard Daniels, believes regulatory focus on organisation culture is already affecting CEO appointments and succession planning. She believes executives who can lead cultural change are in higher demand.
“The cost-cutting, transformational CEO who ‘right-sized’ organisations during the downturn in the Australian economy after the GFC was important,” says Gaines. “But the most successful leaders I see are those with high emotional intelligence and great attention to culture. These leaders transform organisations and align people and culture around rapid change.”
Gaines says boards must move from viewing culture as a one-dimension issue led by the CEO, to a multi-dimensional issue that the executive team owns. “I still think companies and boards focus too much on organisation culture as it applies to employee-related issues. There’s not enough recognition that there are lots of cultures within organisations and that different executives and managers need different skills to lead these sub-cultures.”
Gaines gives the example of an organisation’s risk culture. “The board should be satisfied that the Chief Financial Officer is skilled in leading and sustaining a strong risk culture across the organisation. And that the Chief Information Officer is adept at building a culture of information security, and the Chief Operating Officer can lead the organisation’s safety culture.”
Gaines adds: “Boards can no longer focus almost entirely on the CEO and his or her ability to drive culture. Essentially, boards will have to spend more time with executives beyond the CEO if they want to be satisfied that various cultures are appropriately led.”
Greater focus on how middle management drives cultures should be prioritised, says Gaines. “It’s often at the general manager or mid-manager level where lots of decisions are made and implemented quickly. Boards must consider the skills of managers who do a lot of the heavy lifting on day-to-day issues. Of course, there’s only so much boards can do, but the days of relying only a few executives to lead and maintain organisation culture are fading.”
Gaines says strong systems, policies and reporting can help boards fulfil their stewardship of culture. “First and foremost, boards must ensure the executive team has the right people with the right skills leading different sub-cultures. Then, directors must be satisfied that there are the right systems to monitor behaviour and incentivise desired outcomes.”
Developing systems that identify cultural deterioration – and ensuring boards receive that information promptly – is key, says Gaines. “A not-for-profit, membership-based organisation, for example, might have detailed systems that measure how long it takes to respond to members, and members’ attitude to the organisation. A for-profit organisation with a large employee base might look at staff turnover and industrial disputes as culture indicators.”
Gaines says boards must be alert to early-warning signs on culture. “A sudden loss of revenue from a longstanding client or market segment could be a sign of an emerging culture problem. As could a sudden spike in disputes and litigations with customers. Executive and board turnover are often key signs; directors sometime retire from a board because they recognise huge cultural problems in the organisation and lack the energy to fight management or other directors for change. Positive or negative media coverage can be another early marker of organsiation culture issues.”
Culture starts and ends with CEO
Korn Ferry head of board services, Robert Webster, says an organisation’s CEO overwhelmingly influences its culture and behaviour. “The CEO is ultimately the Chief Culture Officer and sets the tone from the top on this issue. If the CEO doesn’t demonstrate the right behaviour, the company’s culture will always suffer. That said, boards are spending more time with other executives to understand their approach to corporate culture.”
Korn Ferry research shows boards are placing greater weight on values, ethics and an ability to drive culture gains, when choosing a CEO and in succession planning. “There’s a lot more focus on this than there has been in the past,” says Webster. “Boards are asking extra questions when interviewing candidates about whether they can drive change and grow the business, while strengthening organisation culture at the same time.”
Webster says boards are encouraging CEOs to make their direct reports more available to directors. “Boards want to understand how the broader executive team views corporate culture, not just the CEO. A CEO who is reluctant to expose senior executives to the board can be a sign of a deeper cultural problem within the company.”
Boards want to understand how the broader executive team views corporate culture, not just the CEO. A CEO who is reluctant to expose senior executives to the board can be a sign of a deeper cultural problem within the company.
Greater focus on culture will affect board preference for internal and external CEO appointments, says Webster. “If the company has cultural problems, if often makes sense to appoint a CEO from another firm or industry to shake things up. If the culture is positive, it makes sense to appoint a CEO from within who knows the business and can continue the work.”
Korn Ferry’s insightful 2016 report, “The Tone from the Top: Taking Responsibity for Corporate Culture”, interviewed 13 directors and CEOs on leading and governing organisation culture. An overwhelming theme in the report was that the CEO sets the standard for culture and that directors must get out of the boardroom and talk to stakeholders to sense the culture and identify emerging problems.
The report identified 10 “red flags” or culture “derailers” for boards to watch (summarised here).
- CEO: Beware the command-and-control “God-like” CEOs who can’t bring staff on the journey.
- Strategy: Is organisation culture aligned to strategy? Bad culture kills good strategy every time when organisations resist change.
- Executive team: Is the executive team sufficiently independent and diverse, or an “echo-chamber” for the CEO? Does the CEO make executives readily available to the board?
- Talking culture. Can the board and executive team articulate culture? Do staff at all levels understand the organisation’s values, ethics and desired behaviours? If not, there are problems.
- Whistle-blowers: Is there a formal whistle-blower program and policy? Does the board have timely access to whistle-blower reports? Are the reports acted on?
- Toxic subcultures: Understand and measure the organisation’s key subcultures. A spike in safety incidents, for example, could signal emerging culture weaknesses.
- Media noise: Negative media stories in print or online can be an early warning-sign of cultural malaise. Look for inconsistency in what you read and what you know.
- Be a customer: Nothing beats experiencing for yourself the organisations you govern. Phone the call centre, visit the stores, buy products and even try to return them. Understand the company’s values, ethics and behaviour from the perspective of customers.
- Engagement surveys: Use data to be forensic in reviews of organisation culture. Staff turnover that is consistently higher than industry average could be a culture red flag, for example.
- Recognition and rewards: Ensure remuneration structures have the right incentives for desired behaviours. Be prepared to stick to those structures in good and bad markets, rather than turn a blind eye to inappropriate behaviour when sales are down.
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