The Governance Gap

Over the past few years, there has been a growing focus on Governance and the role it plays in avoiding or contributing to corporate mishap. In November, the UK Government published its Green Paper on governance reinforcing corporate hand-wringing, stoked by almost daily media coverage highlighting a focus on gender, diversity, executive pay, employee representation on boards and board effectiveness in general.

Against this backdrop, organisations are continually tripping up. BT’s announcement last week that it had uncovered “inappropriate behaviour” in its Italian division gives an indication of the potential impact of employees not acting properly. Despite the Italian part of BT accounting for 1% of EBITDA, BT’s share price fell 20% in one day on the news. This reaction reflects the concern that such lapses are a signal of a prevalent culture rather than a one-off event, and such culture will manifest itself again in the future. As the old investment saying goes: ‘there is never just one cockroach in the kitchen.’

A worrying detail of the commentary on BT’s lapse is that the practices in question came to light as a result of a whistle-blower and not from any internal process of oversight or control, of which doubtless there are many.

BT is by no means an isolated example. The list of mature, respected companies with damaging and expensive lapses in behaviour is long: VW (emission test cheating); BP (Deepwater Horizon); Deloitte (Brazil accounting); Wells Fargo (dummy accounts); HSBC (money laundering); and Serco (fraud), to name but a few. All had extensive governance structures, integrity policies and values programmes in place and yet the companies are all paying the price for conduct that was either illegal, lethal or unethical. With the news that Martin Winterkorn (ex-CEO at VW) is being investigated for fraud, it also seems that authorities are increasingly willing to pursue individuals through the courts in the case of wrong doing.

What keeps CEOs awake at night (or should)

The impact of such infringements is not only financial, in the form of penalties, reparations and market restrictions, but also reputational and the organisations involved are seen as untrustworthy and have to work hard over a long period of time to recover a positive reputation.

In the years when Jack Welch was running GE, when asked what kept him up at night, he always responded by saying his biggest worry was someone, in one of GE’s many businesses across the world, doing something illegal and damaging the reputation and credibility of the company.

This reputational risk is amplified by social media and muddied by the increasingly populist political mood music against which organisations need to make decisions.

The response to the occasional scandals and such risks is usually to introduce new rules, regulations and policies (remember the ongoing regulator response to the 2008-9 financial crisis), yet the scandals keep coming …

Mind the Gap

There are two problems with such a rules-based approach. Firstly, in organisations conduct is dealt with as a negative (‘conduct risk’) and policed by the risk, compliance and internal audit functions. The (un-expressed) assumption that this approach rests on is that employees will behave badly unless they are controlled to avoid ‘inappropriate behaviour’.

Secondly, this approach inevitably leads to the need to detail every possible situation and behaviour that is not allowed, resulting in long and tiresome rules that, despite valiant attempts, never cover every possible eventuality.

Such an over-reliance on the structural elements of corporate governance is incomplete, seeking to control behaviours only by policy. In fact, people do what makes sense to them but do not change behaviour just because you tell them to. It is conduct, and its driver culture, that really matters and yet when it comes down to doing something about it, boards and executive teams often revert to governance, rules, policies and changing structures to manage behaviours.

The spirit and the letter

The necessary change in emphasis is best described by GE’s ‘Spirit and Letter’ approach to integrity and compliance, where it was the ‘spirit’ of laws and integrity conflicts was more important that the letter of the law. This emphasises an individual’s responsibility to do the right thing rather than an edit to follow a series of rules.

Industries and companies have to look at themselves to do the right thing and have the right mindset that looks to intent not the letter of the law to guide their actions. This was also a recommendation from the Presidential report into Deepwater Horizon: ‘Because regulatory oversight alone will not be sufficient to ensure adequate safety, the oil and gas industry will need to take its own, unilateral steps to increase dramatically safety throughout the industry, including self-policing mechanisms that supplement governmental enforcement.’

Shaping culture

What is needed is the tools, language and focus to consciously shape the mindset and underlying assumptions at play in an organisation. An organisation’s culture evolves over a number of years, will be deep-rooted and require substantial and ongoing effort to shift. There are no shortcuts. It also starts with the leadership. Too often, leadership teams are too awkward discussing behaviours, too superior or too busy, establishing ‘training’ programmes for their organisations, neglecting the fact it is their behavioural ‘shadow’ that governs how the rest of the organisation behaves.

The good news is that an aligned and effective culture creates personal accountability to automatically do the right thing when faced with difficult decisions and to prioritise the company’s long-term success above their own (believing the two to be the same).

Boards have a role here too, providing active, forward-looking leadership on culture in addition to the more established governance structures. Extending the principle of ‘Leadership Shadow’, they should also be actively talking about the culture of the Boards themselves – how the members behave and the chairman leads.

This is not to say that Governance is the wrong thing to focus on. However, a focus solely on governance is insufficient and potentially even damaging as it focuses management on rules and box-ticking as opposed to what really drives conduct – culture.

Governance reforms are likely to dominate the headlines in 2017, occupying the attention of boards and management teams alike but it is culture that should also be in focus. Different tools and mind sets are needed to get culture right but until this balancing of approach occurs, there will be more BTs and VWs to come.

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