Culture again

It's been a while since I mused on culture here. I've been waiting to see whether policy makers and regulators would come up with any good ideas beyond a lot of handwaving about how important it is. Or even any bad ideas, like trying to measure it or prescribe it.

Today I came across an interesting paper on the subject, the first I've found that attempts to examine culture empirically beyond anecdote.

The authors conclude:

"While economists are increasingly aware of the importance of corporate culture..... limited empirical work exists on the topic, in part because it is difficult to measure. Before we started this project, we thought culture might be too amorphous to quantify. Then in interviews with CEOs and CFOs, we heard loudly and repeatedly, how important culture is, especially from CFOs who are typically the numbers people and among those one might expect to be suspicious of hard-to-quantify aspects of the business environment. We believe that our paper conveys a powerful message that corporate culture does matter, a lot. We are aware that our study is just a first cut at this very difficult but important problem. We also fully realize that causal inference is not possible. Nevertheless, we believe the magnitude of the topic means it deserves substantial research going forward and we hope our paper helps build a bridge to enable such future work."


To my surprise, at first reading there are a number of things that I like about this paper. I like the model in figure 1 which links culture with formal mechanisms. I like the fact that the authors started with some interviews. I like the fact that they have included the survey instrument and I like the penultimate sentence in the paragraph quoted above. I need to read the paper again to see if I find their interpretation of the stats convincing. And I need to ponder a bit on their definition of effective culture. But the paper deserves wide circulation and could prompt some interesting discussion. And it would be good to see it replicated in a UK and European context.

Great Expectations

Recently I have been reflecting on expectations. This was initially prompted by the change in attitude to Aung San Suu Kyi, once highly praised as a beacon of resistance and now reviled and stripped of honours for not condemning the type of behaviour she resisted for so long.  No doubt her apparent power is in fact severely constrained but we expect consistent behaviour, especially from our heroes.  Nearer home, the fate of the Liberal Democrats also hinged on expectations: I suspect that their power in coalition was also severely constrained and unpleasant trade-offs had to be made but expectations were high and perceived inconsistencies eventually punished.

We expect certain standards of behaviour from professionals, to whom we may trust our wealth and our health. Professional bodies exist to uphold these standards but the norms of professional behaviour are rarely framed in the context of expectations.  As far as I know, the accounting profession is the only one which has explicitly addressed the problem of unmet expectations by identifying the expectation gap between public expectations of the audit process and what auditors can actually achieve.  Some of what professionals due is aspirational: your doctor may not be able to cure you. Neither can accounting – a pertinent discussion of this can be found in McSweeney (1997).

As people have become more aware of the huge influence of corporations on our daily lives, expectations about those running such organisations have increased and the panoply of corporate governance regulation and policy has developed to address those expectations. Prescription about board behaviour is now extensive, based on the assumption that we expect board members to direct and control their companies effectively.

But do we expect too much of boards? At the time of the Cadbury Code, independent NEDs were seen as key to meeting expectations of corporate governance best practice. One significant difficulty for NEDs is the tension between the detachment required to maintain independence and the deep knowledge of company activity required to exercise oversight. Since that time, boards have become smaller and predominantly independent.  NEDs no longer meet at the boardroom table with the senior executives who manage the functional areas of the business: their contact with these people is often mediated via the remaining executives on the board who are typically only the CEO and the CFO. I’m not aware of any studies of how the information flows around the board have changed given this evolution in board composition but intuitively one might expect the ability of NEDs  to exercise their oversight role to have been challenged by the emphasis on board independence.

Useful guidance for NEDs in how to approach their role from an ethical perspective is provided by Guy Jubb’s recent paper for the Institute of Business Ethics, originally drawn to my attention by this comment. As well as raising issues for NEDs to address, the paper places financial reporting in its central role in corporate governance, a point made by John Kay as noted in earlier posts on this blog. 

Academic literature questioning the existence of any link between board independence and board performance has been around for quite a while (see for example ) and there is a an equally large literature exploring the effectiveness of NED oversight (see, for example).

But the latest data from Grant Thorntons’ annual corporate governance survey suggests perhaps that boards themselves are sceptical about the value of the UK Corporate Governance code’s current NED prescription:

“The most widespread non-compliance relates to directors’ independence. Twenty-five companies declare non-compliance with provision B.1.2, which requires that at least half of a board is made up of independent non-executive directors. Non-compliance with provision A.3.1, requiring the chair to be independent on appointment, remains the second highest area of non-compliance with 19 companies.”

The accepted wisdom on board composition is now that they should be independent and diverse but the impact of these requirements has not been properly considered. Other expectations are also coming into play: for example, the pressure on boards to engage more closely with a wider range of stakeholders. I have yet to find robust evidence that this engagement will improve board decision-making. It will certainly take up board time, and further increase expectations of what they can achieve.

Maybe it’s time to review the expectations that are being placed on these small groups of part-time directors?

McSweeney, B(1997) The unbearable ambiguity of accounting.  Accounting, Organizations and Society. 22(7) pp 691-712

Some thoughts on stakeholders

I like to start with a dictionary definition. The Oxford English Dictionary is my dictionary of choice because (a) I can reach it in a couple of clicks whereas to reach my copy of Chambers I have to stand up and lift it down from a high shelf and (b) once I start turning the pages of Chambers I’ll soon forget what I was looking for as I wander down the tempting byways of the English language and (c) I can copy and paste from the OED.

So how does the OED define stakeholder?

1. An independent person or organization with whom money is deposited, esp. when a number of people make a bet or other financial transaction.

2. A person, company, etc., with a concern or (esp. financial) interest in ensuring the success of an organization, business, system, etc.

These two types of relationship are rather different but, unless you’re a gambler, you’re probably more aware of current usage matching the second definition. The stakeholder economy, stakeholder pensions.. we’re all stakeholders, aren’t we?

I was prompted to think about this by today’s publication from the Investment Association and ICSA: the Governance Institute entitled “The Stakeholder Voice in Board Decision Making” which urges boards to engage more closely with stakeholders and offers a series of principles to guide them in doing so. It says that:

“Stakeholders are those groups which are likely to be affected by the actions of a company, or whose actions can affect the operation or business model of the company.”

While intuitive, that’s a pretty broad definition. In identifying such groups, boards will have to set some boundaries and consider in some detail the form of their interactions with stakeholders. Future generations may be affected by corporate actions, for example, with regard to environmental sustainability: how can boards take account of this. Decisions by government bodies and regulators will affect the operation of the company: these stakeholders have a very different perspective and relationship with companies from other groups.

Forty two years ago the Accounting Standards Steering Committee published a discussion paper entitled “The Corporate Report” in which it identified the user groups to which corporate reporting was addressed.

“1.9 The groups we identify as having a reasonable right to information and whose information needs should be recognised by corporate reports are:-

(a) The equity investor group including existing and potential shareholders and holders of convertible securities, options or warrants.

(b) The loan creditor group including existing and potential holders of debentures and loan stock, and providers of short term secured and unsecured loans and finance.

(c) The employee group including existing, potential and past employees.

(d) The analyst-advisor group including financial analysts and journalists, economists, statisticians, researchers, trade unions, stockbrokers and other providers of advisory services such as credit rating agencies.

(e) The business contact group including customers, trace creditors and suppliers and in a different sense competitors, business rivals ands those interested in mergers, amalgamations and takeovers.

(f) The government including tax authorities, departments and agencies concerned with the supervision of commerce and industry, and local authorities.

(g) The public including taxpayers, ratepayers, consumers and other community and special interest groups such as political parties, consumer and environmental protection societies and regional pressure groups.”

The paper proposed a series of changes and extensions to corporate reporting to address the information needs of these groups but, in spite of this and subsequent work by the Scottish Institute, the accountancy profession never really managed to make significant changes to corporate reporting to recognise the needs of these groups and, at the time, the more immediate challenge of accounting for inflation diverted everyone’s attention. This list of users has, however, become embedded in thinking about corporate reporting and it seems like a fairly comprehensive list of stakeholders for boards to think about.

But another reason why corporate reporting didn’t change to address this range of information needs was the difficulty in prioritising those needs. Financial reporting developed to address the information requirements of creditors and investors and the model we currently have, which is central to our system of corporate governance, was developed in the nineteenth century. Unsurprisingly it reinforces the view of shareholder primacy because in those days investors provided finance. Are shareholders really investors these days?

Investors are not homogenous. They may be classified in binary fashion - active/passive, owners/traders – but as a group for any company they will include a wide range of different perspectives and concerns. It is not always easy for a company to discover who its shareholders are. They don’t always want to engage with the boards of the companies in which they invest – some company secretaries have told me how difficult it can be to encourage any sort of interaction – so expecting them to exert constraint on boards in, for example, the area of executive pay may be unrealistic.

If engaging with this specific stakeholder group is challenging enough, is it reasonable to expect boards to engage with the much more diffuse group of its other stakeholders? To spend corporate resources on formalising and reporting on relationships which probably already exist in a rather amorphous way? It’s difficult to imagine any moderately successful board which doesn’t already follow the first three “core principles”.

1 Boards should identify, and keep under regular review, who they consider their key stakeholders to be and why.

2 Boards should determine which stakeholders they need to engage with directly, as opposed to relying solely on information from management.

3 When evaluating their composition and effectiveness, boards should identify what stakeholder expertise is needed in the boardroom and decide whether they have, or would benefit from, directors with directly relevant experience or understanding.

And I’m struggling to see the value of the last three.

8 In designing engagement mechanisms, companies should consider what would be most effective and convenient for the stakeholders, not just the company.

9 The board should report to its shareholders on how it has taken the impact on key stakeholders into account when making decisions.

10 The board should provide feedback to those stakeholders with whom it has

engaged, which should be tailored to the different stakeholder groups.

Corporate governance needs to be rethought by first considering the fundamental relationship between the company and its resource providers and designing an accountability system which prioritises them. Boards inevitably consider relationships with other stakeholders in the course of directing company operations but requiring them to report on such relationships broadens the scope of corporate governance in a way that can only impinge unproductively on board activity.

The Diversity Bonus

I have been reading “The Diversity Bonus: how great teams pay off in the knowledge economy” by Scott E Page (Princeton University Press, to be published in Sept 2017). I have read some of Page’s earlier work in this area and wanted to see what he had to say about diversity on boards of directors so I requested an advanced readers’ copy of this book from the excellent Netgalley . 

Page delivers a very readable and well constructed argument for the “bonus” to be derived from organisational diversity, which he characterises as identity and cognitive. The proposal that organisations benefit from diversity is intuitively convincing and thus uncontroversial and he supports it clearly with both anecdotal and more rigorous empirical evidence but also makes it clear that the bonus depends very much on context. An afterword by Katherine W Phillips offers further detailed academic evidence from her own research.

The emphasis in the book is on organisational teams but I think that the board of directors is a very particular form of team, partly because of its status in the organisation hierarchy but also because of the way in which its composition is determined and its prescribed accountability. This is not addressed in discussions about the value of diversity in this context and I was hoping for some insights in this book. How, for example, can diversity assist with oversight and monitoring tasks, an important part of the board’s role?

Page only focuses on boards in discussing gender diversity, a form of identity diversity. He examines the case of Norway, frequently cited as a successful example of mandating quotas. As Page correctly notes, the evidence shows that in some firms increasing the number of women on the board has resulted in a decrease in return on equity. He argues that this supports his diversity bonus logic model by demonstrating the importance of context and his analysis suggests that the Norwegian situation was not one in which such a bonus was likely to occur. He also points out that in the longer term the quota imposition may prove effective in promoting diversity.

I would also have liked to see some more detailed discussion  of the costs of diversity, which Page only mentions tangentially. These may be significant: lack of consensus can stifle productive progress and be difficult to manage. Unanimity is not always a signal of lack of diversity and is not necessarily negative: I suppose that in terms of Page’s logic this again shows that context is very important and there is not always going to be a bonus.

This is an interesting book which should provide food for thought for all involved in managing organisations.

What is a chartered accountant?

@TruenFairview has tweeted this which I really like. I'm parking it here to remember it for future use, although I have some misgivings about the way the verb "curate" is used these days.

Chartered accountants are curators of uncertainty. We can't make the uncertain certain but we can help you analyse it and prepare

Looking at evidence: the dog that didn't bark

The BEIS corporate governance inquiry report was published this week. I haven't yet had a chance to read it in detail but Alex Edmans, who gave both oral and written evidence has usefully summarised it here. He makes the very important point that evidence should be viewed with care and not cherry-picked, an issue that has plagued the debate on board gender diversity since Lord Davies' first report, which relied on a very selective review of the existing literature.

But taking a balanced view of available evidence also requires some thought about gaps. Conan Doyle and more recently Mark Haddon each constructed a plot on such a gap, the dog that didn't bark. While assisting ICAEW in providing a summary of the written consultation evidence to the committee, I noticed a significant absence of any comment from companies. Some reflection on this could be instructive. If corporate governance reform is to be effective, consensus has to be achieved not just among company stakeholders but with companies themselves: the process of building the Cadbury Code clearly demonstrated that. Stronger enforcement may not be the answer.

A fundamental review which addresses more directly the purpose of the corporate form is sorely needed. My letter on this appeared in the FT last Saturday.

Corporate governance: all talk, no action?

Today I attended a roundtable discussion billed as "Cadbury 25 Years On". I'm never sure what the purpose of a round table discussion is - indeed, the chair of this one in his closing remarks said "I'm not sure where we go from here." The panel of experts pontificated and various people offered questions and comments from the floor. The audience and panel were overwhelmingly male and middle-aged edging towards elderly, and the panel members and some of the audience who spoke were well known to each other and chuckled about their past connections in a frightfully British sort of elitist manner. It was in many ways rather old-fashioned which chimed well with the observations made that nothing seemed to have changed much since Cadbury.

Which of course isn't true and the lack of recognition of this is stultifying any sensible discussion of future corporate governance policy. Rehearsing yet again the problems of executive remuneration, shareholder engagement and the governance of the investment intermediary chain is not helpful. Companies are global, shareholders are not a homogenous group and not a major source of corporate finance. Corporate reporting needs to be broken out of its statutory shackles and done differently, in a way that makes it relevant to all those with an interest in company activity.  That can then lead to a proper review of corporate governance.

Not being a grandee or connected in any way with the big cheeses on the panel, I couldn't catch the chairman's eye and had to listen to a number of false statements about Cadbury pass uncorrected.

1. Cadbury failed to prevent corporate scandals. That was never the remit or intention of the Cadbury Committee.

2. The Cadbury Committee discussed and abandoned the financial bit of "the financial aspects of corporate governance". Given that a central recommendation was the establishment of audit committees, this seems a very strange assertion. What is the major concern of the audit committee if not financial? I don't think that the person who said this went on to explain what might follow from the assertion but I may have missed something by being cross.

3. The Cadbury Committee was only concerned with issues internal to the company. The whole point of "comply or explain" was to stimulate conversations about the explanations with those outside the company.

There are a great many of these events taking place at the moment, organised by different groups which don't seem to talk to each other and produce, in my view, very little of substance in the way of contributions to corporate governance policy change. The responses to the BEIS corporate governance inquiry were, with one or two notable exceptions, bland and boring. It will be interesting to see whether the Green Paper responses are any more radical but I'm not expecting anything surprising.

However, I have been very cheered by the publication this week of this from The Purposeful Corporation. I haven't yet had a chance to read the whole paper but it appears to take a holistic view, have some intellectual substance and it does make mention of the role of corporate reporting.

Looking round that room today, it occurred to me that we probably don't need more women on boards nearly as much as we need more women influencing corporate governance policy. I don't think an all female panel would have chuckled so much.

A radical approach to #corpgov?

John Kay’s submission to the BEIS inquiry made the very important point that businesses are financed differently from the way that they were when our legislative and regulatory regime was first constructed. We are locked into a nineteenth century framework of accountability that bears little resemblance to twenty first century business reality.

In the past the accountancy profession has led the way in radical thinking. The profession has struggled for many years with the idea that financial reports are not useful.  “The Corporate Report” was published by ICAEW in 1975, before the accounting standard setting behemoth had submerged corporate reporting and developed into a huge constraint on any form of constructive rethinking.

The new forms of report proposed by this discussion paper were largely ignored, apart from the value added statement, although the statement of future prospects and the statement of corporate objectives have been revisited, with little acknowledgement of their history, in the integrated accounting project. The list of users and the description of their information needs has become received wisdom, repeated in financial accounting textbooks and firmly set in stone.

Thirteen years later ICAS published the discussion paper “Making Corporate Reports Valuable”.

This is much more radical in its approach, starting with a clean sheet and  thinking through accountability issues and how to address them. (It is notable that chapter 2 provides a corporate governance perspective: Scottish accountants had been reflecting on corporate governance for some time and were central to the establishment of the Cadbury Committee.)

MCRV reframed the list of users and directly addressed problematic areas of reporting. A detailed analysis of information needs led to precise suggestions for different reporting forms. This paper was followed in 1990 by a specimen set of accounts for a fictitious company, Melody plc, showing how the ideas could be applied in practice and in 1993 by a further feasibility study.

The two discussion papers bear rereading. While they were very much of their time, prompted by specific concerns such as the problem of accounting at a time of high levels of inflation, they represent a depth of thinking about reporting and accountability that has not been seen during the past twenty five years since the publication of the Cadbury Code. Corporate governance, financial reporting and audit are inextricably linked (yet surprisingly few corporate accounting textbooks – even those written by accountants – fully address this) as they form the framework within which accountability is expressed and achieved.  It would be encouraging to see the accountancy bodies once again grappling with these issues from a radical perspective, rather than offering further ideas for tinkering at the edges.

But the only recent instance of radical thinking on corporate governance that I have found is in this paper by a US legal scholar which argues that boards of directors are no longer essential.

It’s worth a read.

This week the FRC has announced a fundamental review of the UK Corporate Governance Code.

It remains to be seen how fundamental it will really be, in terms of addressing how corporate governance arrangements relate to modern business models and different funding patterns. And whether it will go back to first principles and pose unasked questions – for example, the unintended consequences of mandating board composition, which have not been widely discussed. Since Cadbury, board independence has been viewed as desirable but US evidence questioning this existed even before Cadbury*. Many large companies now have a hybrid form of two tier board: the board and the executive group do not sit around the table together and the link between the two is principally in the hands of the CEO. Which is ironic, given that corporate governance arrangements were largely intended to curb the power of the CEO.

Another useful set of questions might be: how do governance mechanisms operate within the public sector, where accountability structures are very different? Have boards of central government departments and of NHS Trusts simply replicated arrangements from within the private sector or have such arrangements been adapted? Is there anything that the private sector can learn from this?

The discussion paper published this week by ICSA is an interesting attempt to extend the debate, arguing that restoration of trust in business is not only the responsibility of listed companies and they cannot be expected to shoulder alone the task of achieving broad public policy objectives.  ICSA promises further papers and a radical approach. My breath is bated...

---

* Baysinger, B.D and  and Butler, H.N (1985) Corporate Governance and the Board of Directors: Performance Effects of Changes in Board Composition Journal of Law, Economics, & Organization, Vol. 1, No. 1 pp. 101-124;  see also Bhagat, S and Bernard Black, B (1999) The Uncertain Relationship Between Board Composition and Firm Performance The Business Lawyer Vol. 54, No. 3 pp. 921-963