Australian company directors should do more to close the gap between values espoused at board level and the differing actions of executives, according to governance expert Barry Rafe FAICD who teaches the AICD’s Company Directors Course.
In a research paper which includes two case studies from the financial services Royal Commission, Rafe finds that values espoused by large complex organisations are often not applied in practice in routine actions taken by CEOs or the senior executive team.
“Board members individually and the board as a whole seem to be serious about ethics. The problem is that when it actually comes to the practice values in the organisation, they're different,” he told the AICD in an interview.
If companies want to avoid a repeat of the poor behaviours exposed at the Hayne Royal Commission, boards need to close these gaps and serious flaws in board governance practices, he said.
“I think the board needs to have at least some insight - but not oversight - as to how their senior management team make trade-off decisions on values.”
In a paper, titled ‘CEOs Say One Thing and Do Another: An Insight Provided by a Royal Commission’, published by the Actuaries Institute but representing the views of the author, Rafe recommends that boards;
- establish espoused values that can be operationalised by the senior executive team;
- routinely review decisions made by the senior executive team and determine if they align with espoused values; and
- design remuneration systems that penalise senior executives for practising values that do not align with the organisation’s values.
The stated values set by the board “need to be more than just for ‘branding’ and ‘marketing’ purposes, they need to set the tone for how decisions are made”, the paper says. It adds: “Executives need to be rewarded for making decisions in line with espoused values.”
“Senior executives need to assess their own behaviours to see if there is a gap between their values and those practised on a daily basis, with any discrepancies being raised with the board,” Mr Rafe said.
Banking case studies
In his research, which focussed on two case studies from the Royal Commission dealing with activities at Westpac and CBA, Rafe said there was a disconnect between the values of the organisation and routine actions taken by the CEOs and the senior executive team. He said misconduct and poor behaviour could not be blamed on ‘weak’ boards, but on the CEO and executive team’s focus on ‘maximising profit within the bounds of the law’.
The boards of the organisations studied appeared to be fully engaged and committed to acting ethically, but the CEOs consciously made decisions that breached their espoused values to maximise short-term profit. Maximising profit within the bounds of the law was the only value considered by the CEOs examined, and they traded off values in daily decision-making, according to the research paper.
“If you're a CEO, making the hard grind of decisions day in, day out, how do you operationalise that you have trade-offs between profits, community and customers?” Rafe asked during the interview.
“So I looked at how they manage their trade-offs. And what happened was they defaulted to normal, to basically just sit within the law.” However, companies and their officers instead need to go beyond simple compliance levels with the law to fully embrace espoused values, he said.
Otherwise they will be exposed to more non-financial risk, which later becomes financial risk.
Stress tests, scenarios and feedback loops
Boards need to perform stress tests and scenario planning and set up feedback loops to improve how CEOs and managers can adhere to company values in operations, says Rafe. ‘So, when a board makes a decision about customer first, what does it actually mean in various scenarios against decisions that might come through to the CEO?”
Boards could also request a monthly CEO report in which company directors can gain insights into what is occurring within the management team. “The CEO report every month might have an item in there about three or four decisions made that month on how they made trade-offs.”
The big issue for directors is how to really know what's going on, adds Rafe. “Boards have [gone to] a lot of effort to try and resolve that and are doing more site visits, but I think there is a certain part that's missing. That is that boards need to understand the criteria used by senior executives in decision-making.”
Rafe is a former President of the Actuaries Institute and an expert on governance, who teaches the AICD’s Company Directors Course.