Speech by Stephen Haddrill, CEO, FRC, Airmic Evening Lecture: Corporate Culture and the Role of Boards
06 February 2017
The plain text version of Stephen Haddrill's speech can be found below. Download the formatted version
Chief Executive, Financial Reporting Council
Airmic Evening Lecture: Corporate Culture and the Role of Boards
Tuesday 31 January 2017
I am delighted to be here speaking on three very connected subjects, corporate governance, culture and risk, which over the past year have ignited political discussion and calls for change. Taking risk remains a fundamental driving force in business. When appropriate risk is encouraged, underpinned by a strong corporate culture and governance framework, and entwined with the strategy and business model, the long-term integrity and success of a company is more certain.
The FRC’s guidance ‘Risk Management Internal Control and Related Financial and Business Reporting’ which supports the UK Corporate Governance Code, in fact states that risk management should support better decision-making in line with sustainable financial, business and shareholder value strategies, rather than inhibit sensible risk-taking. It also emphasises that the board’s responsibility for the organisation’s culture is essential to the way in which risk is considered and addressed.
I’d like to consider the relationship between governance, corporate behaviour and culture, and the role of risk and look at some of the current developments in the three areas. Let me begin by giving you some background on the work of the FRC. Our mission is to promote high quality corporate governance and reporting in the public interest. Trustworthy information and trustworthy behaviour support the needs of investors and generate confidence in boards ultimately leading to the long-term success and health of an organisation.
In turn, high standards of corporate governance and reporting are important for the fair and effective functioning of the capital markets - that benefits investors, companies and the wider public. The FRC maintains codes and standards for corporate governance and investor engagement, monitors corporate reporting and auditing standards, and is the competent authority for audit in the UK. We oversee the accountancy and actuarial professional bodies in their regulatory roles; and we operate independent disciplinary schemes for accountants and actuaries. Our Financial Reporting Lab helps companies and investors collaborate on improvements to reporting.
Ultimately it is for boards, preparers, auditors and other professionals to implement the standards we set; our role is to support them as far as possible by reinforcing best practice and providing a regulatory framework that is seen as realistic, helpful and proportionate. We work with our stakeholders to encourage constant improvement to promote growth in UK markets.
Over the years, the FRC has taken many steps to encourage improvements in confidence in the way companies are governed. In 2014, for example, we introduced through the Corporate Governance Code the requirement to disclose the long-term viability of a company, improved risk reporting and greater focus on boardroom diversity.
Reporting a longer-term view of a company’s prospects in the form of a viability statement, requires companies to consider how solvency, liquidity or other risks may impact the long-term viability of the business. In identifying the material risks and uncertainties a company faces, directors should consider a range of factors. These should include operational and financial considerations, and risks in the broader environment in which it operates, such as cyber security and climate change.
2016 was the first full year of reporting against this new Code provision. The FRC assessed the quality of reporting in a sample of viability statements from ten FTSE 350 sectors covering nearly 100 companies. Our analysis suggests that there is little variation in time horizon between the different business sectors, with two thirds of the sample choosing three years and the remainder mainly electing five years. To be of true value to investors and companies, we encourage companies to provide clearer rationale for the time period chosen, some of the assumptions made and better links to principle risks. Indeed in reporting, business model, strategy, and principle risks should align with the viability statement.
Edelman recently released its annual Trust Barometer which shows that globally we are experiencing a total collapse in trust in the institutions that shape our society. Trust in the UK is at a historic low on the Barometer, at 29 per cent. Attitudes towards institutions are no longer defined by left and right, but by a political realignment around those who have “faith in the system” and those who don’t. Business is part of this system and needs to lead if an improvement is to come.
The Prime Minister has a vision of an economy that works for everyone where business fulfils a role in society rather than just rewarding the privileged few. UK businesses need to thrive if all stakeholders, including workers, customers, suppliers and society itself are to benefit through jobs, growth and prosperity. That in turn requires a continued strong flow of investment, much of it from abroad, into UK companies. For the UK economy to prosper, particularly after Brexit, business needs a governance framework which creates trust in business, reduces company failings and serves the needs of wider society. The Prime Minister is leading a review of the governance of private companies, executive pay and stakeholder representation. The outcome of their work could set the tone for the relationship between business, society and the government for the future.
The UK Corporate Governance Code is 25 years old this year. It is respected worldwide and has helped attract global investment into UK companies. Now we have an opportunity to reflect on how the entire framework of UK corporate governance – including Codes and legislation - can contribute to rebuilding public trust in business. In doing so, we must keep an eye on Brexit and the need to balance the need to maintain investment flows with the desire of business to locate in the UK.
We must make sure that the strength of international investor confidence in UK Corporate Governance is recognised. This must not be jeopardised, particularly in times of economic uncertainty. At the same time we must also recognise that wealth creation is disproportionately favouring a few and this damages public trust in business, especially if those who are well rewarded do not uphold high corporate standards and are not held to account.
In addressing these concerns the right balance needs to be struck between the needs of
investment and of
accountability. In terms of accountability greater awareness of stakeholder concerns and better reporting to them as well as to shareholders needs to be achieved.
Some of the key FRC’s recommendations are:
- That Boards should pay more attention to their responsibilities under Section 172 of the Companies Act 2006 to both shareholders and wider stakeholders and should report on how they have discharged these. For example, by showing how they have allocated funds between pensions, dividends, directors’ remuneration, and capital investment.
- That the remuneration committee should have a wider responsibility for scrutinising the pay and conditions of the company’s workforce as a whole and should report on the link between the remuneration structure and strategy.
- That the Government should review the enforcement framework in order to establish an effective mechanism for holding directors and others in senior positions to account if they fail in their responsibilities.
In pursuing such changes, the current strengths of UK governance: the unitary board, strong shareholder rights and the “comply or explain” approach, need to be preserved.
If changes to regulatory frameworks and to the Code are required, the FRC will play its part in ensuring that change to the Code is done carefully and through full consultation.
The effectiveness of regulatory change will depend on the spirit with which companies address the challenge set out by the Prime minister as much as on compliance with regulation.
Codes put forward principles for best practice that make bad behaviour less likely to occur; and public reporting can make it harder to conceal such behaviour. But, by itself, a code does not prevent inappropriate behaviour, strategies or decisions. Only the people, particularly the leaders within a business, can do that. Codes also signal to those in and outside the organisation that the company sees the value in acting with integrity. Behaviours though are key.
For this reason the FRC in 2015 took a closer look at Corporate Culture and the Role of Boards. We worked with a number of other organisations to produce our report last July.
Our report set out seven key observations and shares examples of good practice. In particular, it encourages Boards to:
- Recognise the value of culture: A healthy corporate culture is a valuable asset, a source of competitive advantage and vital to the creation and protection of long-term value. It is the board’s role to determine the purpose of the company and ensure that the company’s values, strategy and business model are aligned to it. Directors should not wait for a crisis before they focus on company culture.
- Demonstrate Leadership: Leaders, in particular the chief executive, must embody the desired culture, embedding this at all levels and in every aspect of the business. Boards have a responsibility to act where leaders do not deliver. Remuneration decisions. Decisions must be consistent with the desired culture. This includes decisions on appointments and remuneration incentives.
- Be Open and Accountable: Openness and accountability matter at every level. Good governance means a focus on how this takes place throughout the company and those who act on its behalf. It should be demonstrated in the way the company conducts business and engages with and reports to stakeholders. This involves respecting a wide range of stakeholder interests.
- Assess and monitor: Measures, indicators or proxies for culture should be tailored to the behaviours and include external as well as internal stakeholder views.
Through our project we gained useful insight into, for example, the extent to which you can and should measure indicators of culture and what sorts of indicators are useful. Much information is already available to do so. Health and safety reports, environmental assessments, customer satisfaction data, employee turnover, exit interviews, whistleblower incidents, conduct self-assessments and engagement surveys are all good examples. It is what you choose to measure and how you analyse and interpret it that is important. At the same time culture is company specific and there is no one–size–fits-all. The indicators selected for assessment should be tailored to each company’s circumstances. Many organisations use a code of ethics or conduct to embed a culture. A code can translate generic values into more specific policies and guidance, which in turn can influence behaviour. Repeated behaviour over time creates a corporate culture. Codes also signal to those in and outside the organisation that the company sees the value in acting with integrity.
In order to establish an appropriate governance structure, a board must define the purpose of the company and what type of behaviours it wishes to promote in order to deliver its business strategy. It involves establishing a company specific corporate culture, asking questions and making choices: how to align values and purpose to the company’s strategy; how to integrate new leaders into that culture, particularly at times of merger or acquisition; how to maintain a healthy governance under pressure; how to decide whether different parts of the business should operate different cultures, and how actively to communicate values, purpose and behaviours in order for shareholders to engage in constructive discussion. Boards as a whole need to be better informed about the link between diversity, strategy and business value.
Once a healthy culture is in place, however, the ongoing success of the company and its culture are rooted in diversity and succession planning. A Board must consider the balance of skills, background and experience the senior executives and non-executive directors will need. Diversity needs to be encouraged, diverse thinking needs to emerge and the dangers of group think avoided. On this, the FRC supports the work and aims of the Hampton/Alexander and Parker reviews. Board effectiveness and succession should be discussed when investors engage with companies. The boardroom must be a place of constant challenge, questioning procedures and reviewing current processes.
In relation to risk the Board must ask if the company is clear on its risk appetite and is it communicated effectively? What risks does the culture create for the organisation? How is risk taking encouraged and rewarded and how are risk events assessed to ensure key lessons are learnt?
Our research and engagement showed that there is an important role and opportunity for risk professionals to play in advising and supporting the board when considering governance, risk and culture in the business. Airmic also provided much valued insight to the project advising that risk culture should be thought of as a way of framing risk and culture in the organisation’s overall culture and management system – acting as a bridge between risk, reward and risk appetite. Risk taking is a fundamental part of growing a successful business and companies must not seek to eliminate risk. They should be ensuring that their approach to risk taking – their risk appetite – is aligned to their values and an intrinsic part of their culture. Companies must also continually question if the culture they have poses any risks to the business.
During the evidence gathering part of the project, one risk professional told us “that risk culture is not given enough prominence because it is not properly understood.” Others suggested that organisations do not engage because they are reluctant to appoint risk managers who ask difficult questions, and want access to sensitive information.”
Airmic’s research Roads to Resilience
which looked at the way leading organisations were building their ability to withstand both expected and unexpected risks also produced some new insights. Among these was that in order to achieve resilience companies should establish a culture based on trust and respect that also avoids risk blindness. The result is a no blame culture which ensures all in the company are committed to a common purpose and values – which should be the two interlinking factors when deciding the cultural route of a company.
To conclude, values, behaviours and corporate culture are central to the way an organisation achieves its objectives and strengthens it corporate governance framework. By encouraging and managing risk, while weaving a healthy corporate culture into your strategy and business model, you are not just contributing to the overall success of your business but, creating an environment on which investors can depend. In that way, importantly, you and we create sustained growth in the UK economy.