Board oversight of culture increasingly prioritized, notes EY report

May 13, 2019
Center for Board Matters sets out culture guidelines, but metrics tough to define, say critics

The oversight of culture is a growing priority in the boardroom and in ‘Five ways to enhance board oversight of culture’ the EY Center for Board Matters tries to establish a guide to improve it.    

The first way is ‘Oversee how culture is defined and aligned to strategy’. The report states: ‘Many leaders struggle with defining and [operating] the culture that is right for their business. A corporate culture that clearly aligns with a company’s purpose and strategy enables and accelerates that strategy. When alignment isn’t there, culture can drag the organization down. It is difficult to accomplish new things with old ways of working. As a first step, leaders should spend the time to define attributes of culture needed to both realize what the strategy calls for and engage their people. 

‘Boards play a pivotal role in overseeing that management teams have defined their corporate culture in the context of their strategy. It should do more than sound good; it should actually fit well with the company’s current ambitions. Management should be able to articulate the organization’s desired culture, gaps that may exist and how the gaps are being closed. The board should oversee how management defines and harmonizes the culture and strategy.’

On the second way, ‘Create accountability for how culture is communicated and lived – internally and to key external stakeholders’, the report states: ‘Everyone in the company contributes to culture. Each person is accountable for how she or he shows up every day. It only takes one event or sometimes one person to disrupt harmony, prompt a wave of employee turnover, damage client relationships or impact share price.’

Here, the board can ‘play a role in supporting this system, including by aligning executive compensation, including senior executive performance metrics, to the behavior/culture the business needs.’

On the third point – ‘Monitor how culture and talent metrics are measured to keep a pulse on how culture is evolving’ – the report notes: ‘Effectively governing culture calls for boards to understand and monitor the metrics that best reflect the health and strength of a company’s culture. Culture is measurable; there are many options to directly and/or indirectly measure it.

‘Through monitoring, it is critical that the board develops a deep understanding of the current culture’s strengths, gaps to close and the path that needs to be driven to close the gaps. Depth of understanding is key for effective culture oversight and is increasingly expected by leading institutional investors that believe directors should be able to articulate where the company is on its culture path.’

On the fourth point, ‘Provide oversight of intentional culture shifts to stay in step with strategy shifts’, the report says: ‘Culture must shift when strategy shifts. Consider a company that has been hyper-focused on efficiency that is shifting to a focus on innovation. That company’s recruitment strategies, operating and incentive structures, its entire DNA, has been built around formal structures and defined roles.

‘As culture shifts are [put into operation], the board should monitor progress toward the desired culture and help management challenge whether changes being made across the organization are superficial – which could feel disingenuous to employees – or truly changing the undertone of how the company works.’

On the fifth point, ‘Challenge the board’s culture’, the report states: ‘The board sets the ultimate tone at the top regarding corporate culture – not just in the way the board prioritizes and oversees the company’s culture but also in the composition, dynamics and culture of the board itself.

‘Boards should challenge whether they are dedicating sufficient time and attention to culture matters and whether any of the committees should have related responsibilities – for example, the compensation committee expanding its purview to incorporate broader talent strategy and culture-related matters.’

Analyzing the report, Marc Hodak, partner at Farient Advisors, the New York and LA-based corporate governance and executive compensation consultancy, tells IR Magazine: ‘Notwithstanding this report’s casual mention of the benefits of directly measuring ‘culture’ and holding management ‘accountable’, such metrics are really hard to define. I am skeptical that a dozen metrics could adequately capture an organization’s culture, and really doubt they could do so well enough to base variable compensation on them without significant problems.

‘The basic problem is the ‘observer effect’, where the mere fact that we are observing something changes it. In other words, paying for ‘culture’ may hamper one’s ability to manage it by introducing an unhealthy bias in how those metrics show up. A well-known example of this effect is the measurement of safety.

‘Safety is critical in heavy industry. Many companies know that paying bonuses to reduce accidents undermines the quality of the metrics used to track them, so much so that safety experts – including the Occupational Safety and Health Administration – strongly discourage companies from including ‘safety’ metrics in formal, financial reward systems, though many companies do it anyway.

‘Measuring culture is much harder. The EY report correctly points out that, Hundreds of little shifts over time is how company culture evolves. The metrics tracking those shifts must be established artfully, viewed holistically and interpreted carefully. This implies a much more subjective evaluation than compensation experts would normally prefer, or that managers and boards might be comfortable with.’

Also analyzing the issues raised by the EY report, Christina Rehnberg, an associate consultant at London-based KKS Advisors, tells IR Magazine: ‘Companies seem to struggle with meaningfully communicating the role of the board for setting corporate strategy to reach long-term goals. Investors have expressed interest in receiving more information about how the skills of the board members are driving long-term value, for example, how they intend to improve their competence on climate change risks and opportunities and how executive compensation is aligned with long-term strategy.

‘It seems as if the discussion around these topics is often vague and conversational, rather than structured around actionable, quantifiable KPIs. In contrast, companies have long assessed and provided metrics about future trends, financial performance and competitive positioning as part of their standard corporate reporting. So it may not be surprising that these are the themes on which companies seem to be disclosing the most forward-looking and specific information.

‘By studying corporate long-term strategies, we have found evidence that intangible assets, such as corporate purpose and human capital, are value-enhancing elements that institutional investors consider in their investment decisions. This means including these elements in a company’s strategy comes with a benefit to both the company and the investor: it can help drive long-term value creation and relieve short-term pressures.’

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