Culture and remuneration

Sarah Ryan understood the value of site visits early in her governance career. In a previous board role, management told Ryan and her fellow directors that a small division of the company was high-tech and potentially high growth. It continually underperformed.

Frustrated by the results, the board travelled halfway around the world to see the business. Everything looked okay, but the business “smelled of new paint”, as Dr Ryan puts its. She spoke to staff, inspected machinery and toured the shop floor.

At the next board meeting, Ryan outlined her concerns. The energy-sector expert knew this was a solid business, but hardly high-tech or likely to grow quickly. Ryan constructively challenged management’s view on the business and it was later sold.

“It’s easy to accept information that management provides on assets”, says Ryan. “But directors sometimes have to test that view and form their own opinion. That usually involves getting out, seeing the operations for yourself and listening to people. And not being afraid to hold management to account if they are blindsiding the board on an asset.”

Ryan’s experience reinforces the benefits of directors spending more time outside the boardroom to assess organisation risk and culture – issues that go to the heart of findings for boards from the Financial Services Royal Commission and after the Australian Prudential Regulation Authority’s (APRA) landmark report on the Commonwealth Bank last year.

Anecdotally, ASX 200 boards are spending more time than ever on understanding organisation culture, behaviour and values. The days of relying mostly on averages in employee-engagement surveys to govern culture are fading as high-performing boards dig deeper.

This can involve more board meetings held on site in different locations; extra tours of company operations; greater engagement with middle management and front-line workers; more time assessing the “employee experience” and how that influences the “customer experience”; directors touring operations on their own (with the CEO’s approval); and experiencing the product or service through store visits.

The counter-view is that directors trying to assess the culture of large, complex organisations with limited site visits is dangerous.

Sampling error is a risk: forming a view on a culture based on a few store visits, for example, has limited value. A director might encounter a good store on a bad day and witness an aberration in organisation culture. Boards would be better off ensuring their company uses latest technologies to assess actual behaviours rather than culture.

Still, Ryan’s experience with the underperforming business provides three key lessons for boards that want to assess organisation culture and risk.

First, the value of having industry experts on boards who know operational detail and can test management on technical issues, where needed. Ryan had a distinguished career in the energy sector, working across 50 countries for multinationals, investment firms and start-ups. She is a non-executive director of Woodside Petroleum, Viva Energy Group, MPC Kinetic and Akastor ASA, the Norwegian oil-services investment giant.

Second, the value of boards that do not blindly accept management information. The underperforming business Ryan toured was a lower priority for the company and in another country. The board could have accepted management’s bullish outlook, but chose to probe it. Their findings said as much about management at the time, as the asset.

Third, the value of site visits and directors who see operations for themselves. And of having boards that do not engage in “governance tourism” – highly staged tours that show an operation in its best light – and who want to scratch below the surface of an operation.

Ryan says there is value in directors visiting company sites on their own. “Board tours are important, but sometimes the best insights come from a director conducting his or her own visit. Everything is less staged and staff are often more open when the full board is not there. Also, an individual visit means I can spend extra time on issues that interest me and go looking for information, compared to a board visit that is carefully planned.”

Ryan visits at least a few company operations on her own each year. “The CEO and Chair are usually very supportive of having a director visit an operation. It’s another set of eyeballs on the ground and I’m very open with the feedback to the board.”

Site tours are not just about finding problems. Ryan recalls visiting a factory on an Indonesian island. “I like to travel and used to work in Indonesia. So, I took a day to visit the facility and see it for myself. The gardens were well kept; staff wore their uniforms correctly; there was an obvious safety culture; the machinery was in good order; and staff seemed to like their job. When you sit in a boardroom, it’s easy to develop prejudices and think an Indonesian factory must have higher risk. But this factory was as well-run as most you’d see in Australia.”

Informing staff on the board’s role is another benefit of site tours, says Ryan. In one board role, directors have lunch with staff in the canteen of a mining site, each leading a table. “In my experience, workers appreciate meeting directors and learning what the board does. They realise the board is passionate about the organisation and they become more open to sharing their views with directors.”

Understanding middle management

Launa Inman, MAICD, says all boards have elevated their focus on organisation culture after the Financial Services Royal Commission. “Culture is an absolute governance priority,” says Inman. “Boards have seen the damage a small group of disengaged workers can do. Boards generally want to understand culture across all levels in their organisation and deeper than they have in the past. A rigorous culture assessment is central to their risk-management focus.”

Inman, a non-executive director of Super Retail Group and Precinct Properties New Zealand, says understanding middle-management and organisation culture is key. “Directors tend to spend most of their time with the senior leadership team, who are usually engaged in the organisation’s vision and culture. In my experience, boards don’t spend enough time with the next level down and understand their view and how that shapes culture.”

“A survey says 75 per cent of staff are highly engaged and the company is better than its competitors on that metric, so the board is satisfied. We need to spend more time on the 25 per cent of staff who are less engaged, understand why, and ensure management has a strategy to lift overall engagement.”

Disengaged middle managers can be a source of inappropriate behaviour, says Inman. “Senior leadership may not clearly articulate the company’s vision and values to middle management, or hold them accountable. Or a middle manager may resist change and that influences how they deal with their staff, and how frontline employees deal with customers.”

Relying mostly on employee-engagement surveys to understand organisation culture is problematic, says Inman. “Benchmarking can blindside directors. A survey says 75 per cent of staff are highly engaged and the company is better than its competitors on that metric, so the board is satisfied. We need to spend more time on the 25 per cent of staff who are less engaged, understand why, and ensure management has a strategy to lift overall engagement.”

Inman says boards are asking leadership teams to bring more of their staff to board presentations. “Boards are spending extra time with the sub-leadership team, so they know more people in the organisation, have a better sense of what is happening, and a clearer view on internal succession planning and culture. Boards must build relationships beyond the executive team.”

Inman, a former managing director of Target Australia and Billabong International, visits stores of companies she governs. “I try to understand the customer experience; were staff helpful?; was there sufficient stock?; was the store clean? And so on. If it’s possible, I’ll talk to the store manager to get his or her take on the business and report any relevant findings to the board and CEO. It’s just another way of developing a deeper understanding of organisation culture.”

Companies can better use exit interviews. “Unfortunately people leaving a business do not always give the real reason, says Inman. “However, analytics of the exit interviews can help boards understand more, and signal issues. Why is staff turnover rising? Why are more staff leaving a particular department? Are we failing to retain key people? What advice do departing staff have to improve the organisation? These are questions boards should be asking.”

Systematic approach needed

Diane Smith-Gander AO FAICD says boards should test how the leadership team thinks about organisation culture and measures it. “It’s obvious if an executive team doesn’t have a framework to understand the culture and its key performance markers. A strong framework guides boards on culture and helps them determine the information they need to assess it. Boards then look for different ways to understand markers of culture performance.”

Smith-Gander, a non-executive director of Wesfarmers and AGL Energy, says boards should test management on how quickly bad news flows to the top. “If a significant issue is identified, the board should determine if its view of the problem’s severity aligns with management’s view. And how quickly it took for the problem to get to the executive team and board. Organisations with strong cultures report bad news quickly and don’t hide things.”

Management’s response to a problem says much about culture, says Smith-Gander. “Boards are asking more questions about how the issue was resolved. If a customer was charged incorrectly, was he or she repaid in full, and when? Was the problem only identified because the customer complained? Boards are asking management to explain their thought process about why they chose to fix the problem in a particular way. Essentially, the board keeps peeling back the onion to understand how problems are resolved and what that says about culture.”

Accountability is an important culture marker, says Smith-Gander. “Good cultures have a ‘single throat to choke’ because one person is ultimately accountable for the problem. Bad cultures allow cosy collectives to form, where the group is responsible for a problem and blame is shared. Boards need to know there is individual accountability and appropriate consequences, across the organisation, for inappropriate behaviours.”

Like others interviewed for this feature, Smith-Gander says boards must move away from employee-engagement averages when assessing organisation culture. “The average is your enemy, not your friend. Boards must spend more time understanding the views of ‘outlier’ staff, customers or other stakeholders who are unhappy with the organisation. That comes from listening to more people across the organisation and beyond it.”

But site visits have limited use in understanding culture, says Smith-Gander. “Directors absolutely have to ‘smell the smoke’ in their organisation and that comes from interacting with the leadership team, middle-management and touring sites. However, relying too much on a site visit can lull boards into false security. Site tours should be seen as one of several techniques in a holistic board assessment of organisation culture.”

Smith-Gander adds: “Directors are unlikely to uncover a significant risk in a large organisation by stumbling across it in a single site visit. That’s too random. A better approach is understanding that management has the skill and processes to drive the right culture for the organisation – and the board testing aspects of the approach in a structured way.”

Tony Featherstone is Consulting Editor of the Governance Leadership Centre and a former managing editor of BRW and Shares magazines.