Culture – The New Lever For Good Governance
Those who had lived long enough would have observed crises come and go, including those in the financial markets. While some could have forgotten about the global financial crisis triggered by the sub-prime loans in 2008, the side effects from that crisis are still unfolding and some of the mysteries are still being unrevealed.
Last year, the Fair and Effective Market Review Report which was released in the United Kingdom which covers the wholesale fixed income, currency and commodity markets. The value and scale of these markets affect many people globally by influencing borrowing costs, currency exchanges and commodity prices, yet these markets remains mysterious to most people on the streets.
The report, amongst others, recommends that the standards, professionalism and accountability of individuals involved in those industries need to be raised. Obviously, such recommendation is aimed at ensuring their conducts and behaviours remain in check.
Earlier in 2014, the Financial Services Professional Board (FSPB) was established as one of the efforts by Bank Negara Malaysia to ensure high standards of professional conduct including fair business dealings and ethics is maintained in the financial services industry that is consistent with the long-term growth, stability and integrity of the Malaysian financial system.
In April this year, the Securities Commission issued the draft Malaysian Code on Corporate Governance 2016 (Code) for public
feedback. What is interesting it that the Code is adopting an “apply or explain an alternative” by emphasising on the intended outcomes of the respective principles of corporate governance practices instead of just the recommended processes. While this approach provides leeway on how the MGCG 2016 would be implemented, organisations which are required to adopt it would have to show the outcomes as intended by the Code, hence mere box ticking would not be acceptable.
All these efforts, when put together, would provide us with the idea of how regulators are now focusing on conducts and behaviours of institutions under their regulations in ensuring their long term sustainability. Conducts and behaviour cannot be separated from culture, as culture in a simple definition is “how things are done here”. It permeates across organisations, right from the boardrooms, C-suites and the operational floors where the rubber hit the road. Based on the new focus, it could be envisaged that topics about culture would be included in the conversation between regulators and institutions during the supervisory visits by regulators.
This does not suggest that culture was not important before. In fact, as observed by the then governor of Bank Negara Malaysia in her opening speech at the launch of FSPB, “The 2008 financial crisis highlighted how business decisions that were predominantly driven by short-term incentives critically undermined the health of some of the largest global companies. This in turn had enormous consequences on entire economies.” So, culture could also work in the negative ways in influencing conducts and behaviours of institutions and corporations.
When Andrew Fastow, the former Chief Financial Officer of Enron, was asked about the culture of Enron leading towards its demise, Andrew explained that the tone set by the CEO was very clear, results was the only expectation, how they were to be achieved was not addressed at all. Hence, people in Enron were focusing on delivering profits, as expected by Wall Street, and did not care about the consequences.
Fastow also shared that the board knew about the mismatch between Enron’s own assessment of its financial standing which was not assessed as good with the credit rating given by rating agencies which rated Enron to be within the investment grade. Instead of worrying and ensuring their credit position was addressed, Fastow was praised instead for being able to convince the lenders! Such tone influenced management when they dealt with other people across the company, which ultimately set the culture.
Similar kind of behaviour was also observed in the Citigroup leading towards the 2008 financial crisis. The then CEO, Chuck Prince, was clearly in the know of the problems faced by the bank but his explanation was very telling about the culture at Citigroup, “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.”
The above examples of how culture had ruined even long established institutions should trigger the interests of the board of
organisations, for profits or otherwise, on the kind of cultures which they should nurture to compliment other efforts in ensuring organisations under their care continue to create value and remain sustainable. Are those cultures healthy and influencing the people in those organisations to do the right thing?
In attaining good governance and setting corporate culture, we can take guidance from the thoughts of the South African governance icon, Mervyn King, when describing elements of good governance, “You all have heard of ‘the tone at the top.’ I talk about ‘the tone at the top, the tune in the middle, and the beat of the feet at the bottom.’ The board and top management have to make sure that the whole company has bought into the strategy and is facing in the same direction.
I know from my executive days that if you get your strategy right and you get buy‐in, you get ordinary people to achieve the most extraordinary things! But if you don’t get it right and it doesn’t fit in with the milieu of the day, you can have the most extraordinary people, but you won’t even achieve ordinary things.”
King made it very clear that good governance is about people being convinced to do the right thing and this should happen at all layers of governance and management. The board sets the tone, management plays the tune and those at the operation levels have to perform their work at the beat which is in harmony with the tone and the tune.
Perhaps as many organisations are structured as body corporates with legal personas, the human components had been overlooked and instead the focus had always been the ability to display good legal and operating structures. While those features are important, without a healthy culture, the boxes could be ticked but the outcomes could be something which are not necessarily reflective of good governance as provided in the examples above.
If culture is critical to ensure organisations behave in ways which benefit their stakeholders, how would the board ensures the cultures in their organisations are as such? Before we go even further, the first question that needs to be asked is whether culture appears on the agenda of the board at their meetings? If not, perhaps incorporating such discussion in the next board meeting would be a great start.
While management is responsible to ensure corporate objectives are met, the kind of questions asked by the board on the ways those objectives are achieved during board meetings could also set the tone for the right culture. For example, if management of a property development company is challenged on the effects of their operations on the environment and people living within their development areas, such interests from the board would remind management that the ways business are operated also matters, not just the profits which they generate. This strong stand from the board about getting the right results using right ways would certainly influence the “tune in the middle” which in turns would determine the “beats at the bottom”. This
should also be applied to other areas such as anti-corruption and gender equality.
The other factor which influence culture is the reward system. “People will follow the money” said Fastow on the question of what would shape corporate culture. The issue of mis-alignment of incentives has also been the focus of regulators when picking up the pieces after the global financial crisis. The idea is to push for people to have longer perspectives in making business decisions rather than chasing quarterly numbers to make financial analysts happy. New designs such as bonus clawbacks are now becoming the norm for global companies with the intention of aligning long term interests of those corporations with the risks assumed through the executive decisions made by management.
Aligning the right culture and conduct to financial rewards should also be maintained at other levels of organisations. Including culture in performance evaluation alone is not enough. What is required is for those who did the right thing consistently to be rewarded in a transparent manner. Once people could see the benefits of doing the right things in the right ways, “the ways we do things here” would also change. The real battle is winning the hearts and minds of people across the organisation.
Audit committees, internal audit and compliance functions should also consider culture as one of the key risk drivers which require regular attention. Given the ‘soft’ nature of culture and the difficulties in ‘measuring culture’, it would be easy for this topic to be omitted. Unless audit committees are persistent is pushing this agenda, the take off and follow up would receive a lot of push backs.
As a conclusion, while rules and regulations could provide deterrence for misconducts, good culture could be more effective and cost efficient in ensuring value are created in the most beneficiary ways for the corporations and their stakeholders. The board certainly have their hands on the levers of culture and should not abdicate this responsibility in lieu of short term gains and immediate bottom lines results. Otherwise, regulators may come and control the handles of the levers with more expectations, rules and regulations.
The choice is with the members of the board.