The role of the board in corporate culture

Given the significance of culture to an organisation’s success, change must be driven and supported by the leadership of those who govern, writes Sally Pitkin.

There has been vigorous recent discussion in governance forums and the media on corporate culture. This article looks at why culture should be a topic for ongoing consideration by boards and management of organisations in all sectors, and specifically the role of the board in developing, strengthening and maintaining an effective organisational culture.

Organisations across all sectors in Australia are recognising the critical role culture plays in how their organisation operates and performs. Failures of large corporations and public revelations of corporate wrongdoing have focused attention on the contributing role of corporate culture. The Australian Securities and Investments Commission (ASIC) and the Australian Prudential Regulation Authority (APRA) have identified corporate culture as a key driver of conduct in the financial services industry, and argue that poor culture often leads to poor outcomes for investors and consumers, impacts the integrity of financial markets, and can erode investor and financial consumer trust and confidence. This view is shared by prudential regulators in other jurisdictions, including the UK and the US.

The lack of a compliance culture can mean a company and its directors being criminally liable under the Commonwealth Criminal Code. Although over the last 20 years there has only been one court judgment that has referred to this criminal liability, the courts have often considered corporate culture in determining the penalty for breaches of regulatory provisions.

For example, in ASIC v Chemeq the court declared the company had breached its continuous disclosure obligations and imposed significant financial penalties. In determining the quantum of the penalties, the judge considered the company’s compliance culture and systems. He found senior people, including the board, did not appreciate their continuous disclosure obligations and the company did not have in place an effective compliance system.

Although research established some time ago a relationship between corporate culture and corporate performance, it has only been in recent times that the causal effect of cultural effectiveness on corporate performance has been clearly shown. With the world changing rapidly, driven by fundamental advances in technology and software disrupting every industry, an effective organisational culture needs to be a critical part of an organisation’s response in order to maintain relevance and competitiveness and achieve growth in a digital world.

What is culture?

Culture is the set of shared norms in the organisation, a consensus about what things mean and how things get done. Edgar Schein’s extensive empirical research shows that this consensus builds over time from shared experiences about what has “worked” in the past, both in responding to changes in the external environment and the systems and processes needed internally to accomplish organisational goals.

There can be outward signs of culture, such as statements of values, but these may not reveal everything about an organisation’s culture or be an accurate reflection of the shared norms that are the deepest and most fundamental elements of culture. We know that culture is best revealed through observing interaction, and so specific methods are required to reveal and monitor culture, and great skill to change because changing shared norms requires managing new learning. And so we now understand culture as a stable, resistant and difficult-to-see phenomenon.

It is concerning that at present consideration of the issue of corporate culture is being shaped in the public arena by the simplistic notion that culture is a binary of either good or bad, without recognition that it is a complex, stable, resistant and difficult to identify and explain phenomenon, that will necessarily be different from organisation to organisation. It has only been in more recent years that we have deepened our understanding of corporate culture as a driver of business success and developed the tools to assist an organisation’s leadership to define and assess culture, and to manage cultural change.

Organisational leaders continually face the dilemma of how to maintain stability in their organisations while providing creative adaption to outside forces, stimulating innovation, changing technology, working methods, roles and relationships, and the cultural norms that determine what people pay attention to, what things mean, how to react emotionally to what is going on and what actions to take in various kinds of situations.

One model of culture, developed by leading consultant and researcher Professor Daniel Denison, identifies four core cultural traits for organisational effectiveness – a strong mission, high levels of employee engagement, internal consistency, and adaptability. Although it is not easy to simultaneously pursue and balance each of these traits within an organisation, studies have demonstrated a positive correlation with performance criteria.

The role of the board

Undoubtedly the cultural health of an organisation is the responsibility of the organisation’s leadership. The board, which sits at the apex of the organisational hierarchy with ultimate authority and accountability for the organisation, is part of the organisation’s leadership along with executive management, and therefore must have a role in forming and monitoring the culture.

Although the duties of a nonexecutive director are critically different to those involved in the dayto-day management, non-executive directors cannot leave the issue of organisational culture entirely to management, because doing so fails to recognise the board’s leadership position. It also fails to recognise that the executive members of the leadership group will be living the culture and be enmeshed in it, and may not easily recognise dysfunction or sub-optimal aspects, or be willing or capable of challenging it.

The question then is how to share the responsibilities for organisational culture between the board and management, because the nature of the accountability has many ramifications, including in relation to the fundamental delegation by the board to the chief executive officer to manage the organisation, legal liability, and the extent to which a part-time non-executive director can meet increasingly formalised and prescriptive responsibilities. Like other areas of governance, such as strategy, understanding the organisation’s culture, and bringing about change to that culture if needed, has to be an ongoing iterative process, a process whereby the board and management work together in a shared responsibility.

How can this shared responsibility work in practice? We can operationalise this approach by identifying those areas that should be the board’s principal matters of concern.

Firstly, the board has a responsibility to understand the culture of the organisation, and whether there is congruence between the more observable indicators of culture (such as the company’s stated mission and values) and the shared underlying assumptions (the shared norms) that really determine how things get done.

This requires the board to access a variety of sources of information, including observing how things work in the organisation. Board members can learn a lot about the cultural norms by observing interactions of executives with each other, and with the CEO and non-executive directors at formal and informal occasions, such as board meetings, site visits, safety walk arounds, training forums, industry events, and informal gatherings. Board members should also have the opportunity to interact with other employees, for example, during site visits, board presentations, and company events.

Boards should also seek input from the senior leadership team, and request information that will help reveal the cultural dimensions of the organisation, such as employee survey results, customer and supplier feedback, internal audit reports, reward and performance management systems, and organisational measurement systems.

Secondly, the board needs to determine, through a process of iterative conversations with management, the shared norms that the company aspires to have and identify the gaps within the existing culture.

From this process the key elements of the desired culture will be identified, such as to act ethically and comply with all laws, treat employees, customers and suppliers fairly, and have a focus on shareholder returns.

Ethical behaviour is a cultural trait that should be evident in the cultures of all our organisations. Studies have shown that our moral compass is lower when we respond to workplace ethical issues compared to those we may face outside work. We are significantly influenced by an organisation’s culture, and our work context often determines how we make decisions.

Factors such as precedent, routinised actions, heavy workloads and stress, organisational norms and peer pressure all influence the decisions we make at work. We are also prone to making decisions based on intuition, rather than decisions based on reasoned and deliberate thinking.

For these reasons a desired cultural trait of ethical conduct must be supported by deliberate actions to raise ethical awareness, provide training on ethical issues and decision making, provide mechanisms to raise ethical issues and seek guidance, and hold people to account for unethical behaviour. Mechanisms to monitor organisational ethics can be developed from these initiatives.

A statement of the elements of the desired culture will guide the board in their governing task, such as informing the metrics against which organisational performance and the performance of the CEO will be monitored and assessed. Is the CEO embedding in the organisation the cultural traits the board has endorsed through the setting of goals, processes, rules, rewards and sanctions, and the distribution of power and status? Is the CEO modelling the desired culture? A statement of the elements of the desired culture will also guide the board in the selection of a new CEO, who may be required to strengthen an existing organisational culture or facilitate its transformation. How can a board select the next CEO if it does not have a shared understanding of the organisation’s culture, or the cultural traits needed to achieve the strategic vision?

The third area of responsibility of the board is the delegation to the CEO of the management of culture and the implementation of cultural change. In making the delegation the board does not “set and forget” as the board has an ongoing role of oversight. The CEO reports to the board on the alignment of systems and processes to support the core cultural elements, and against agreed indicators of cultural health supported by the use of appropriate tools to provide meaningful information. The CEO also reports to the board on areas where behaviours and activities are not aligned with these elements, and provides plans to address.

It is likely that there will already be within the organisation a wealth of data from which to build a dashboard on cultural health. A blend of information from external sources, such as customer and regulator feedback, and internal sources, such as employee ethics training, will provide a good basis for developing metrics relevant to the organisation’s cultural health. The dashboard will assist the CEO and senior executives to monitor culture, and form the basis for oversight by the board and good discussion between the board and the CEO.

Finally, the board has a responsibility to act in accordance with the stated cultural traits, demonstrating a commitment and adherence to the shared norms they determined were appropriate for the organisation to meet its objectives. The board must model the culture when it interacts with management, employees and other stakeholders, and review its own performance as the governing body by reference to the stated cultural dimensions. The board also needs to be open to reviewing the appropriateness of those norms from time to time.

The approach to the board’s role in organisational culture proposed in this article is not about adding another prescriptive element to a board’s already significant oversight obligations. Rather, it recognises the criticality of culture in an organisation’s success, and that cultural change must be driven by, supported by, and modelled by the leadership of the organisation, and therefore accommodated within the board’s overall governance role. The board’s role in culture will, when developed through a shared responsibility approach with management, lead to a more effective organisational culture and improved organisational performance.

Suggested further reading

• Edgar Schein, Organizational Culture and Leadership (5th ed), published by Wiley.
• Daniel Kahneman, Thinking, Fast and Slow, published by Farrar Straus & Giroux.
• David Thodey, Maintaining Australia’s Corporate Competitiveness in a Digital World, speech given to the AIIA.
• Daniel Denison et al, Leading Culture Change in Global Organizations: Aligning Culture and Strategy, published by Jossey-Bass.
• Greg Medcraft, Tone from the Top: Influencing Conduct and Culture, speech to the Law Council of Australia Business Law Section: asic.gov.au/ about-asic/media-centre/speeches/directorsduties-and-culture/.
• Wayne Byres, Six Issues for 2016, remarks at Finsia’s The Regulators Panel: www.apra.gov.au/ Speeches/Pages/Six-issues-for-2016.aspx.