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The Bruce Column — The growth in the importance of corporate culture

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11 Aug 2016

Combining effective corporate culture and good corporate governance is increasingly seen as being down to people rather than processes. Our regular, resident columnist Robert Bruce takes a look at the latest thinking on how to achieve this.

Combining effective corporate culture and good corporate governance is increasingly seen as being down to people rather than processes. Our regular, resident columnist Robert Bruce takes a look at the latest thinking on how to achieve this.

As recent events and parliamentary inquiries have clearly shown corporate success or failure and reputational risk or failure, is often down to people rather than processes.

And the latest survey and resulting report from the Financial Reporting Council confirms this. It engaged the consultants Independent Audit to carry out an extensive survey of 44 FTSE chairmen and 33 FTSE company secretaries, and to interview 22 FTSE chief executives and 58 FTSE chairmen. This was added to the work from FRC roundtables and discussions and has produced ‘a rich insight into the views and practices of companies’. The result is an FRC report: ‘Corporate Culture and the Role of Boards’. At its heart is the FRC view that ‘the UK governance model remains an efficient and effective means of meeting the objectives of, and arbitrating between, the many stakeholders in the market’. It goes on to say: ‘Leaders, in particular the chief executive, must embody the desired culture, embedding this at all levels and in every aspect of the business. Boards have a responsibility to act where leaders do not deliver’. But it also adds a caveat: ‘Success depends, however, on the spirit with which companies and investors apply the principles and use the flexibility they have’. And the report also makes clear that the importance is in the achieving of the cultural goals rather than devising more processes. ‘While legislation, regulation and codes influence individual and corporate behaviour, they do not ultimately control it’, the report says. 

This is important. In the wake of recent events there has inevitably been a rising tide of the public wanting more regulation, process, and legislation. There is a telling quote in the report from Javed Ahmed, chief executive at Tate & Lyle. ‘I do not believe you can just command and control anymore’, he says. ‘Business now is just not like that – especially with so many outposts and the “instancy” in this internet age. You have to work by having and sharing very deep-seated beliefs across the organisation. It is about beliefs, not just rulebooks’.

Where this falls down and produces less than optimal results is in two areas: remuneration and non-executive directors. And it falls down because it is harder, in the present structures, for the jobs to be done satisfactorily. The FRC survey reports that: ‘Remuneration practices are often cited as a driver of poor behaviour. The incentives created by performance related pay, and the corresponding impact on employee behaviours, is something that should be of utmost concern to boards and remuneration committees, which could do more to apply a cultural and values lens to the design of remuneration policies and individual remuneration decisions’. And the difficulties for non-executive directors are the traditional ones. It is difficult for them to find the right balance. They occupy a business space which is too ambiguous, ranging from being too close to the company to be fully objective to having a certainty in their views which may not be borne out by the underlying corporate facts. They need to be tough on the executives, to hold their feet to the fire, as the old cliché has it. But it is difficult to do so with the absolute confidence that they are right. ‘An important role for boards and audit committees’, says the report, ‘is to spot misalignment between behaviour, purpose and values. Where they spot gaps or misalignment, they should be challenging robustly and taking action to investigate further and where necessary to redirect management. Boards need to challenge themselves and build a cultural lens into their discussions and decision-making, for example, by asking questions with a culture focus’. 

The FRC also draws attention to the complexity of the external auditors’ work and responsibilities around the culture within a company. It says that this is important particularly in auditors’ work ‘around the control environment and in identifying specific risk issues’. But this will not cover the full range of the culture within the organisation. ‘The external auditors’ focus will be on behaviours which impact integrity over the financial statements and hence some aspects will fall outside the scope of a typical external audit. This makes it difficult’, says the FRC, ‘to give a formal view on culture as part of their audit opinion’.

But the external auditors’ privileged access gives them advantages in observing what is going well, and what is not. A comment from Rupert Soames, CEO at Serco, in the Independent Audit report, illustrates this. ‘They say a fish rots from the head, but it can rot from the finance department in corporate life, if they forget that their job is to make sure that management and owners understand the truth and know what is going on’, he says. ‘Culture goes wrong when people are more interested in what they would like the truth to be, rather than in what it is’. The finance function needs to underpin a healthy culture.

But examining and reporting back on that culture can be difficult. Participants at one of the FRC roundtables, this time for audit committee chairs, ‘agreed that external auditors are a useful source of insight into culture, but observed they can be reluctant to share views that are not backed up by hard evidence’. 

Corporate culture, in other words, can still be an elusive element in the governance structure. 

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