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For this report on 2020 corporate governance trends, consultant Russell Reynolds Associates interviewed over 40 governance professionals, including institutional and activist investors, pension fund managers and proxy advisors to “identify the corporate governance trends that will impact boards and directors in 2020.”  As components of ESG, corporate culture and human capital management have been a focus of major institutional investors for several years. RRA reports that investors want more transparency regarding board oversight of culture and HCM to ensure that oversight is adequate and that culture “is robust and can withstand transformation and change.” RRA suggests that data and analysis regarding corporate culture will be key to oversight. In addition, RRA advises that boards will need to understand the relationship between culture and “hiring, retention and productivity. Management will need to satisfy the board that the company has the culture and talent needed to successfully execute on strategy.” (See this PubCo post.)

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Of course, the concept of corporate culture comprises the behavior of workforce sexual harassment, but it also extends well beyond it to include behaviors such as honesty, ethics and accountability. Serious lapses in corporate culture have sometimes emerged as flashpoints at many businesses and even entire industries, often with significant negative press coverage and severe economic consequences. In this 2017 report from the National Association of Corporate Directors, The Report of the NACD Blue Ribbon Commission on Culture as a Corporate Asset, the Blue Ribbon Commission suggests that boards would be well-served by paying more attention to oversight of company culture—not just for scandal avoidance, but also “as a way to drive sustained success and long-term value creation.” The report views the concept of “culture” as a “series of assumptions individuals make about the groups in which they participate, visible through artifacts (including public statements, organizational structures, and key processes), stated goals and aspirations, and basic (i.e., taken-for-granted) beliefs.” Corporate culture is evidenced by the behavior of all employees at all levels, as well as in interactions with external stakeholders. A “healthy culture,” the report asserts, can serve as “a competitive differentiator.”

The report suggests that directors’ experience and independence may actually be helpful in picking up on early warning signs that a member of management—who is typically immersed in the culture—may miss. But unfortunately, the report asserts, corporate culture often “does not get the level of boardroom attention it deserves until a problem arises.”  The BRC contends that “this has to change”: directors need to take “a proactive, forward-leaning stance on culture oversight.” However, “taking a proactive stance with respect to culture oversight does not mean directors have to factor a new, additional set of responsibilities into their already-crowded agendas. Instead, culture should be one facet of existing activities, including the board’s own governance and continuous-improvement practices, strategy and risk discussions, CEO selection and evaluation, decisions about rewards and recognition, and shareholder/stakeholder communications.”

In light of the close connections between corporate culture, on the one hand, and strategy and risk, on the other, the BRC advises that oversight of culture should be the ultimate responsibility of the full board, although board committees can also play roles in overseeing specific culture-related activities. Oversight of culture should not be limited to overseeing executives, but should extend throughout the company, and directors should be on the lookout for local deviations from the desired culture. However, in a recent NACD survey, only half of directors reported that they understood the “‘buzz at the bottom’—the collective behaviors, norms, and values at the front lines of their organizations, among their rank-and-file employees.”  Accordingly, in overseeing corporate culture, the report suggests that directors acquire some “firsthand visibility” into “how the culture is lived” by regularly spending some “time ‘on the ground’  where business is being done, in order to gain exposure to a cross section of employees at different locations and levels of seniority.”

The report observes that, while culture can help drive strategy, it can also “eat strategy for breakfast” by, among other things, exacerbating risks. The BRC advised that boards clearly define roles of management—particularly the GC and  heads of internal audit/risk management— and, collectively, employees, in supporting the desired culture. A discussion of culture should also routinely be on agenda, incorporating “questions about culture into strategy reviews, evaluations of operating performance, and discussions with management about proposed initiatives, current and emerging risks, relationships with customers and suppliers, leadership-development activities, entering new markets, partnership opportunities, and so on.” Boards should also consider inserting discussions of culture into other discussions with management, focusing in particular on identification of any red flags, such as these:

• “Focus on performance with little regard to how results were achieved
• High performers are allowed to operate outside established policies. Behaviors that are not consistent with the company’s stated values/code of conduct are rewarded
• Frequent ‘near-misses’ of adherence to code of conduct, risk-appetite limits, etc., or frequent requests for exceptions to these policies in order to meet performance targets
• Excessive focus on consensus/collegiality leading to prevalence of ‘go along to get along’ attitudes
• Relationships outweigh skills and/or performance in determining promotions or other recognition to an inappropriate degree
• Sharing bad news is discouraged (or, bearers of bad news are punished outright).”

In discussions about financial results, the BRC advises directors to

“emphasize that the way in which results are achieved is as important as whether or not a given goal is met. The way directors formulate questions during reviews of business results and operating performance sends an important signal: an overly transactional approach to problem-solving or an excessive focus on quantifiable gains and losses (whether in terms of revenue, profits, market share, or other measures) can obscure or diminish the importance of purpose, values, and behaviors. Boards should ask how employees handle situations where goals and objectives are in conflict. How do they make trade-offs in these situations?”

The report recommends that the board “set clear expectations about the due diligence and evidence required,” posing questions about whether they are receiving a sufficiently holistic view, adequate unfiltered data and high-quality and reliable data. Data from outside sources, such as outside auditors and engaged third-part reviewers, should be taken into account.  Directors should also assess how the company is addressing any issues. (See this PubCo post.)