Boards getting to grips with company culture

Keeping a finger on the pulse of values and setting the pace for change.

Frank Cooper AO FAICD believes organisation culture has “more currency” in Australian boardrooms a year after the Banking Royal Commission, but is not convinced boards have fully embraced their role in culture or taken enough steps to enhance its governance.

“Culture is such an ethereal topic,” says Cooper. “Some boards struggle to define their organisation’s culture and there is a real risk of it being overcomplicated. Boards still have quite a bit of work to do in their understanding and oversight of culture.”

Cooper, a non-executive director of Woodside Energy, South32 and St John of God Health Care, says progress is being made. “Culture is getting a better hearing in boardrooms and many directors are trying to better understand the culture in their organisations through site visits and talking to staff at different levels. The governance community is acutely aware of the importance that regulators have placed on board oversight of organisation culture and its role in risk management.”

Released in February 2019, the Final Report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry devoted a chapter to culture, governance and remuneration – and emphasised the board’s responsibility for organisation culture.

That followed the Australian Prudential Regulation Authority’s 2018 report on the Commonwealth Bank. APRA’s report – considered a governance landmark – recommended for CBA “cultural change that moves the dial from reactive and complacent to empowered, challenging and striving for best practice in risk identification and remediation”.

Elizabeth Arzadon, the psychologist used by the Australian Securities and Investments Commission to analyse boardroom discussions of more than 20 listed companies last year, warned that Australia's financial-sector culture is broken and that boards are lagging on culture.

One of Australia’s leading Chairmen told the Governance Leadership Centre, under the condition of anonymity, that the debate about boards and organisation culture was “vastly overdone”. “Culture is a wonderful word, but tell me what you mean by it? There’s no magic bullet for boards to suddenly govern culture more effectively. Good boards have always focused on ensuring their organisation strives to do the right thing. Culture is hardly new to them.”

Still, the message from recent regulatory reviews is clear: boards are responsible for culture and they and senior management “set the tone from the top”. Also, that boards can do much through governance to ensure their organisation has a healthy, sustainable culture.

Cooper has thought deeply about firm culture for years and is known for a proactive approach in this area. He believes organisation culture is the first and most important line of defence in risk management, followed by quality of people, systems and processes, and policies and procedures.

“Good organisation cultures tend to attract good people,” says Cooper. “Having the right culture and quality people gives companies time to get their systems, policies and procedures up to scratch where needed. Boards must be satisfied that the organisation’s culture enables and encourages the right behaviours and quickly identifies and holds people accountable for the wrong behaviours.”

Striving to have every decision and every action consistent with the values is the cornerstone of building the right culture, says Cooper. “Companies sometimes talk superficially about values. They uphold a set of values until they have to make the ‘right business decision’, which in my experience, is almost always a euphemism for compromising the values. When boards reflect on culture, in my view they should start with the culture in the boardroom and in their relationship with the CEO and the executive.”

Cooper has two key tests in assessing the alignment of values and behaviours. The first is assessing the gap between “the company walk and the talk on values”. “Directors must spend time talking to people inside and outside the organisation, to get a sense of whether the firm’s values are being upheld. Boards can also get a sense of values in how management decisions are made, and by observing the behaviour of the CEO and executive team.”

Cooper’s second test is whether everybody in the organisation can speak their mind without fear of retribution. “A healthy culture is built on people throughout a firm being able to call something out. Does bad news flow quickly to the top? Do staff feel like they will be punished if they report bad news? How does management act on this information? How are customer complaints handled and what remediation is made?”

He adds: “Boards can’t possibly know that every interaction in the company is consistent with organisation values, but directors can get a sense of whether the firm’s culture supports all staff to speak up if they are alert to it during the various dealings they have with them .”

Cooper believes boards should consider confirming whether each paper presented to the board  aligns with organisation values. “There’s merit in having the proponent sign-off to say that everything in the board paper is consistent with the firm’s values. Some will see this as another layer of ‘tick-the-box’ compliance, but someone still has to tick that box about values and culture and hopefully think about it, including the board.”

Response overstated

Sir Ralph Norris, a former CEO of Commonwealth Bank and a former chairman of listed companies, believes the current governance focus on organsiation culture is overdone. “In my experience, good boards and management teams have always ensured their organisation acts fairly and ethically, that staff strive to do the right thing, and that decisions pass the ‘front-page test’. All the negativity towards business these days unfairly suggests the opposite is happening.”

Norris questioned the main findings from APRA’s report on CBA and the Banking Royal Commission. “In many cases, the banks self-reported problems and were a long way towards fixing them by the time of the Royal Commission. Unfortunately, there seems to be a ‘gotcha’ mentality pervading our regulatory authorities that is damaging their relationship with companies. It’s not healthy when companies self-report problems to a regulator, take steps to fix them and remediate customers, then are badly named and shamed in public.”

Many bank problems, says Norris, were due to product complexity or technology-system faults rather than fatal flaws in culture. “I don’t for a minute believe organisational culture in the banking sector is anywhere near as bad as implied in the regulatory reviews. Yes, serious mistakes were made, but I believe the vast majority of banking staff did not set out to act malevolently or in a culturally inappropriate way. Look at how many organisations, including governments, have underpaid staff because of poor internal systems rather than bad cultures.”

Norris does not downplay the importance of culture or the need for directors to take extra steps to understand and test it. “I’ve always thought directors should get out of the boardroom, talk to staff across the company and test the culture for themselves. Just because something is in a board pack doesn’t make it true. There is always a risk that some data points are presented selectively and that boards get false comfort from information showing healthy staff-engagement ratings.”

However, Norris believes too much is expected of boards on organisation culture. “Non-executive directors have part-time roles and are not buried in the depths of a business. Yet we are heading towards an environment where boards are held responsible for every single problem that occurs in their organisations, and in some cases their Chair is expected to resign. We have to be realistic when directors are governing highly complex corporations with tens of thousands of employees, and multiple cultures within that organisation.”

Excessive board focus on organisation culture following the regulatory reviews could have unintended consequences, says Norris. “We’re starting to invert the pyramid, with too much focus on Environmental, Social and Governance (ESG) issues now at the top, and too little focus on firm strategy and performance at the bottom. Organisations have limited bandwidth: boards must be careful that they are not overloading management with issues that do not improve strategy and performance. The reality is, firms that consistently perform well tend to attract good people and develop strong cultures – and have fewer serious problems over time.”

A governance talent drain for listed companies could be another outcome of excessive focus on culture and ESG issues. “Personally, I’ve found private-equity governance a breath of fresh air compared to listed companies,” says Norris. “Listed companies risk becoming so bound up with red tape and issues around culture that they could struggle to attract top talent to their boards.”

Asking the right questions

Steven Cole, FAICD, Chairman of Neometals, Perth Markets, Queen Elizabeth II Medical Centre Trust and a non-executive director of Matrix Composites & Engineering, says there is too much “governance hype” about organisation culture.

“Despite its buzz-word popularity I am concerned that many have a limited understanding of the fabric of organisational ‘culture’,” says Cole. “There’s been a lot of rhetoric about culture in the year since the Banking Royal Commission, but much of what’s been discussed has been about boards ensuring their organisation stamps out bad behaviours. Culture and behaviour are related, but not the same thing. Culture is so much more nuanced and integral to effective organisational governance and strategic performance outcomes.”

Cole adds: “Boards also need to know what they are asking for when they try to assess culture. Often they have not sufficiently teased out what culture best suits their organisation and the delivery of its strategic objectives, how there can be different cultures in different parts of the firm, and how to measure and monitor it. Or the organisation’s culture has lost its strategic focus, with the firm losing its drive to deliver sustainable stakeholder value through managing and taking measured risk, essential in the case of a commercial corporation.”

The starting point for boards is defining the organisation’s desired culture, says Cole. “A smaller enterprise, for example, might need a boardroom culture that is more hands-on and focused on managed risk taking. All boards shouldn’t strive for the same type of culture, because it will differ by firm (responding to its industry dictates, regulatory environment, competitive positioning, people and resource availability), and by function within firms, for example the role of internal audit versus the R&D division, versus the customer-service division.”

The next step is defining the firm’s culture. “The board and management must work together to understand the current culture, desirably what it needs to be, and then the policies, processes, education, communication, incentives and disincentives needed to drive that change. Then the board, again in conjunction with management, must ensure there are leadership driven systems in place to help incubate that targeted culture through the firm, and checks and balances to measure and refine culture if needed. Essentially, it’s a top-down, bottom-up exercise to build and maintain culture.”

Cole believes boards must own organisation culture and cannot “fob it off” to management.  “I liken it to throwing a pebble into a lake. If the board consistently lives the chosen organisation culture, its actions will ripple out to the executive and management team, and down the line then to its reports and so on]. The executive team inevitably models board behaviours, good and bad, so it’s up to directors to become living, breathing examples of what the organisation’s culture should look like.”

Culture central to good governance

A leading company director, Nora Scheinkestel, FAICD, says the Banking Royal Commission has encouraged boards to look deeper into organisation culture.

“Culture has always been important – and, yes, Hayne threw a spotlight on aspects (of culture) and all the boards I’m involved with have taken the opportunity to reflect following Hayne – and the APRA and ASIC commissioned reports, and most recently on non-financial risk and Elizabeth Arzadon’s report.”

Scheinkestel, who Chairs Atlas Arteria and is a non-executive director of Telstra Corporation, and AusNet Services, argues that boards should not spend extra time addressing organisation culture only because of regulatory reviews. “Culture is fundamental to creating the sort of companies that attract and retain great talent. That is, the whole notion of business for purpose and leadership that acts consistently and visibly so with their stated values.”

She adds: “Culture is fundamental to our markets and customers – there have been boycotts against companies seen to behave badly and to our investors through ESG and other screens. Culture is how we create high-performing companies that are sustainable.”

Scheinkestel says a shift has occurred in the expectations of key organisation stakeholders: that companies – and their boards and executives – behave in a way that balances the interests of all stakeholders. “Boards won’t always get it right – and part of that desired culture is to acknowledge it and be upfront about it and move quickly to fix it. And even when we do (get it right on culture) it will be a judgement call and not all will be happy.”

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