I recently had the chance to visit with Rakhi Kumar, Senior Managing Director, Head of ESG Investments and Asset Stewardship, at State Street Global Advisors (SSGA). We discussed the firm’s recent initiative around corporate culture and Board of Director engagement on this issue.
SSGA recently released a letter (Letter) from its President and Chief Executive Officer (CEO), Cyrus Taraporevala, in which he called upon corporate Boards to place a greater emphasis on corporate culture, which SSGA says is a top asset stewardship engagement priority for the asset manager in 2019. But more than simply laying out the problem around Board’s assessing and monitoring corporate culture, SSGA laid out a framework for Boards to do so. In Part I, I introduce the issue of corporate culture and the Board’s role in oversight. In Part II, I discuss the SSGA framework for doing so.
As an investment advisor SSGA sees the long-term investment value of an entity focusing on its culture. It is this focus on long-term investment values which has driven SSGA to engage the investment community around effective, independent Board leadership; Board quality, including cognitive diversity enhanced by better gender diversity; and environmental sustainability. The firm also values transparency in its asset stewardship practice. All of this has led SSGA to focus on corporate culture as “one of the many, growing intangible value drivers that affect a company’s ability to execute its long-term strategy.”
I find this to be significant because it is a different focus than having Board oversight as a mechanism to prevent negative reputational damage. SSGA sees Board oversight of culture as a way to foster long-term growth and enhance long-term investment. This is similar to my views of compliance, which, when properly operationalized in an effective compliance program, will make businesses run more efficiently and in the long run more profitably.
Obviously, culture is important with the well-worn phrase that culture eats strategy for breakfast. Yet as SSGA notes, a recent Ernst Young (EY) study found that “intangible assets such as culture average 52% of an organization’s market value”. Unfortunately, and even troubling, is that SSGA has found that “few directors can adequately articulate their company’s culture or demonstrate how they assess, monitor and influence change when necessary.” Moreover, many Boards do not even attempt to ensure alignment of corporate culture and corporate strategy.
Kumar defined corporate culture as encompassing “a broad range of shared attitudes shaping the behaviors of individuals as a group across an organization. It allows employees to identify with their organization and differentiates companies from competitors. It is closely associated with human capital management.” To enhance culture there must be effective leadership from, and incentive to, senior management, yet the Board must engage in appropriate oversight.
Obviously, regulators are interested in the involvement of the Board. Kumar noted, “In June 2018, the UK Financial Reporting Council affirmed the importance of culture by formalizing the Board’s role in aligning corporate culture with the company’s purpose, values and strategy in the revised UK Corporate Governance Code. Boards in the UK are now expected to assess and monitor culture and seek assurance that management has taken corrective action to fix any misalignment.” US regulators such as the Securities and Exchange Commission (SEC) and prosecutors at the Department of Justice (DOJ) are also interested in Board oversight (or lack thereof) in matters as diverse as the Wells Fargo fraudulent accounts scandal to corruption under the Foreign Corrupt Practices Act (FCPA).
Based on all of these, Kumar said that SSGA will focus on corporate culture “as a priority engagement in 2019”. SSGA will focus on three key areas: (1) educate Boards on the need for both involvement and oversight of corporate culture; (2) provide a framework for Board’s “to evaluate the alignment of corporate culture with its long-term strategy and for directors to guide senior management in its implementation”; and (3) suggest best practices related to culture that SSGA has identified. By following these three general prescripts a company can have something in place if the regulators come knocking.
From the business perspective, focusing on corporate culture can be important during times of not only crisis but strategic change. These include mergers and acquisitions (MA&) or strategic turnarounds. Kumar noted, “The lack of focus on culture can delay or even derail important strategic objectives and pose unanticipated challenges for management. For example, potential employee turnover and operational impacts associated with changing corporate culture can lead to challenges for management teams trying to implement strategic changes. Even in relatively stable times, culture can shift and fall out of line with strategy undetected if it is not actively monitored.”
Kumar recognized that changing corporate culture does not come easily or quickly. This is why SSGA sees this initiative as a multi-year project. She acknowledged that the results of Board efforts may be “difficult to monitor” but this is why Boards must “proactively consider culture in the context of strategy. SSGA has laid out four areas of inquiry which Boards can use to monitor and assess their progress in aligning their culture with long-term corporate strategy. They include: (1) Can the directors articulate current corporate culture? (2) What does the Board value about the current culture, strengths and weaknesses? (3) How is senior management both influencing and effecting change in the organization’s culture? (4) How is the Board monitoring the progress?”
The Letter ended by stating, “Ultimately, better understanding how businesses across the globe are aligning corporate culture with strategy will improve how we analyze our portfolio companies in the years ahead. We believe that at a time of historic disruption, increased focus on corporate culture and how it supports strategy is essential to sustainable, long-term value creation. That is good for investors, good for the quality of the indices on which so many investment portfolios are based, and good for our shared prosperity.” This view aligns with compliance and ethics being seen as assets to improve corporate culture. When businesses see the value of using the techniques to increase efficiency and enhance profitability and not simply as a legal prophylactic, it will certainly be a step forward.
Part II-the Framework
Based on insights SSGA has gleaned from years of engagement, it has developed a Framework for Assessing and Monitoring Corporate Culture (Framework) which can be used as a starting point to help guide directors and senior management on their role in oversight of corporate culture. Under this Framework, they suggest that senior management, with oversight from the Board, undertake three key exercises. First is comparative analysis, which is performed through a gap analysis or risk assessment. Second is the implementation phase where you move your organization to a place where your culture aligns with your long-term strategic goals. Third is reporting the results, ongoing monitoring and fine tuning. From the SSGA perspective, the Framework is not meant to be prescriptive, rather it is a tool to help Boards develop their own approach to incorporating culture into their long-term strategy.
Kumar emphasized that this is not a one size fits all prescription. Moreover, it is not a ‘tick-the-box’ exercise but one which is an ongoing process. She said, “A culture is very unique to a company. It needs to be unique, just like a strategies. Unique culture needs to be unique.” A Board must not only get the sense of where the corporate culture currently exists but also its long-term strategic goals. SSGA has developed a list of questions that each Board can ask of itself and its organization.
These questions include: (1) Can the directors up articulate current corporate culture? (2) What does the Board value about the current culture? (3) What does it see as its strengths? (4) How can current corporate culture be improved? (4) How is senior management influencing or affecting change in corporate culture? And (5) How is the Board monitoring the progress? Kumar went on to state, “while these may appear to be simple questions, they’re very complicated in the sense that these are conversational questions.” This is why this is not a “check the box kind of a Framework. There’s no right answer, wrong answer. It’s literally open-ended questions to get a sense of how the Board and management is addressing and looking at culture.”
The Framework itself begins with a Gap Analysis by asking the Board to “describe the corporate culture need to achieve the long-term objectives of the organization.” Kumar said you should begin “by describing what is the culture that is needed to achieve the strategic objectives. As you are identifying and laying out strategy, think about it and expand that conversation.” This could mean “what kind of behaviors would I need my employees to have or what kind of culture do I need if I want to achieve the strategy?” Next you should move to “get a sense of what are the existing corporate and employee behaviors.” If there is a gap in this culture and your long-term strategic goals; this will tell you about what you need to change.”
From there you should describe the existing corporate culture and how it is aligned with your long-term strategy. If it is aligned, you should then inquire into how “does the Board and senior management perpetuate the current corporate culture?” If it does not, the Board needs to ask how “does the current culture need to change”, with the identified agents or practices which need to change. Now moving on to remediate, you need to measure your progress towards the desired culture by identifying the indicators you will assess as markers. Finally, what will be your reporting mechanism for continuous improvement towards your goal of aligning corporate culture to long-term strategy?
Kumar said that the next line of inquiry is to find out what is important to your culture that you need to perpetuate, what are its drivers? From there “what needs to change and what is the timeframe in which your organization is going to change it?” Further, “How are you going to evaluate if your corporate culture is actually being changed? And the last phase is the reporting phase. How are you going to communicate how culture fits in with your strategy and support your strategy? And, finally, how is the Board getting a sense of culture?”
SSGA suggests this process be performed in stages. As noted, it all begins with the Gap Analysis and moving forward from there. If your corporate culture is aligned, “identify how to perpetuate the current corporate culture by identifying the key drivers.” If the converse is found and it is “misaligned, determine the desired culture and identify the practices or agents that must change. The analysis should contemplate corporate culture in the context of the company’s long-term strategy, as meaningful changes may take many years to occur.” Kumar cautioned that this phase is not completed quickly and as the entire process should be seen as a multi-year process, with the first phase being at least one year.
The next step should be the implementation phase where “mechanisms to influence and monitor progress can be identified and implemented.” SSGA further notes, “In the context of rewards systems, culture-related indicators could be aligned with incentives, where appropriate. Senior management is the most influential agent for cultivating corporate culture and should take the leadership in its implementation throughout the organization. The Board and senior management should be aligned and implementation expectations should be clearly understood.”
Finally you reach the reporting phase. This can be a continuing challenge and SSGA has noted, “We have found few companies that can effectively communicate their Board’s involvement in influencing culture. However, given growing investor interest in this area, directors should also be prepared to discuss their role in influencing and monitoring culture at the company.”
Boards have been grappling with the difficult task of overseeing corporate culture. As a starting point, the SSGA Framework is a useful guide to help directors and senior management as they tackle this complex issue. Kumar stated, “What we have done through the Framework is to provide a viewpoint which we have shared in a systematic manner with all our Board members ahead of engagement. We have also put it out in the public domain, so other investors who may not have teams can evaluate and understand how we approach corporate culture.” Moreover, it is designed to be adaptable. She concluded, “We’ve had people start using the Framework, start actually understanding the issues involved and engaging on the issue both in internally and externally as well.”
SSGA is to be commended for moving the discussion forward.