16 April 2018 by Anne Kirkeby
A cohesive approach to culture and strategy can build a competitive advantage
For the past 12 years, Black Sun has conducted an annual research project called the ‘Complete 100’, which identifies and analyses corporate reporting trends and best practice in the annual reports of all FTSE 100 companies.
How companies report on corporate culture forms part of this, with the project finding the FTSE 100 are increasingly discussing culture in their annual reports. However, the research also shows they tend to focus on how to create a culture that protects value, rather than one which supports value creation.
With new reporting requirements relating to the proposed revisions to the Guidance on the Strategic Report and UK Corporate Governance Code on the horizon, a change is needed.
This focus on culture has been high on the corporate agenda for a number of years now, since the FRC kicked off its Culture Coalition project in 2015.
Learning from this project has been implemented into the recently proposed updates to the UK Corporate Governance Code and Guidance on the Strategic Report, with a focus on value creation as well as value protection.
As the FRC’s chairman, Sir Win Bischoff, emphasised in the report ‘Corporate culture and the role of boards’: ‘A healthy culture both protects and generates value. It is therefore important to have a continuous focus on culture, rather than wait for a crisis.’
Companies are increasingly being scrutinised by both internal and external stakeholders, who expect them to rise to the challenge through improved procedures, governance and reporting.
Despite this, we continue to see high-profile cases of corporate misconduct, which erode public confidence and create a sense that companies serve the interests of a few.
Recent parliamentary and government inquiries have explored how the UK’s governance regime can be strengthened to restore public trust in business. However, governance reform on its own is not enough to prevent inappropriate behaviour.
A unifying corporate purpose that takes the company’s impact on stakeholders into account and a healthy corporate culture driven from the top are further vital ingredients. Supporting this, clear cultural norms that define the behaviours that are encouraged and discouraged within the organisation are also paramount.
The debate around corporate culture has substantially affected reporting, with most companies in the FTSE 100 now reporting on their culture to a greater or lesser extent.
Our ‘Complete 100’ research suggests companies are generally happy to describe their values (66% do so), while 46% make commitments to a desirable corporate culture in their leadership statements.
38% also discuss some of the initiatives they undertake in support of this commitment, 23% include culture or values as part of their employee training programmes and 21%, up from 12%, report that culture or values form part of their staff appraisal process.
“There is much less focus on how corporate culture contributes to value creation”
Although these numbers are still somewhat low, they have crept up over the past five years as understanding of culture matures and more data is generated as a result of programmes put in place.
Companies are most likely to discuss culture in relation to risk, with 52% doing so. This is symptomatic of the ‘value protection’ approach most companies take to culture – or at least the approach they take to reporting on culture.
The emphasis still tends to be on compliance and ensuring that employees adhere to a set of ethical behaviours. There is much less focus on how corporate culture contributes to value creation.
Most companies still struggle to provide evidence of a coherent strategy for shaping and implementing culture and are hesitant when discussing measurement and tangible results.
In fact, companies often do not articulate what they are trying to achieve with their values and most fail to explain how the desired corporate culture will support achievement of strategic objectives.
Depending on the nature of these goals, this may require the organisation to be flexible and receptive to change, focused on results and solutions, or innovative, with a focus on learning.
Alternatively, the desired culture may be something entirely different, as long as it is aligned with the strategy and will encourage employees to develop and hone specific capabilities.
Not only can corporate culture be harnessed to support the achievement of strategic objectives, but strategic change without consideration for the existing corporate culture can have disastrous consequences.
Anecdotally, we know that corporate culture when properly aligned with values, drivers and needs can unleash tremendous amounts of energy towards a shared purpose and enlarge an organisation’s capacity for success. It can become a substantial competitive advantage.
When companies miss the opportunity to tell this story in their annual report they are missing out on presenting their full investment proposition, one which takes into account their full range of value drivers.
Corporate culture is difficult to define and harder to manage. Most importantly, cultural change takes time. Maybe that is why our research shows relatively little year-on-year change.
It is clear that by 2019 there will need to be a change in reporting, with companies having to comply with the many new requirements coming out of the proposed revisions to the UK Corporate Governance Code and Guidance on the Strategic Report.
Increased responsibilities and reporting in relation to corporate culture is a key part of this agenda.
The 2016 edition of the UK Corporate Governance Code emphasised that it was the role of the board to establish the company’s culture, values and ethics.
However, the proposed code goes further than this by explaining that the board should establish the company’s purpose, strategy and values and satisfy itself that these are aligned with culture.
The focus is on alignment and the inclusion of strategy in this context suggests that the FRC is challenging companies to consider culture in the context of value creation, as well as value protection.
The proposed code goes on to say that the board should monitor and assess the culture to satisfy itself that behaviour throughout the business is aligned with the company’s values. The board should also take corrective action where it finds misalignment and explain its activities and any action taken in the annual report.
“The board should establish the company’s purpose, strategy and values, and satisfy itself that these are aligned with culture”
Finally, the board should satisfy itself that remuneration and workforce policies and practices promote long-term success and drive behaviours consistent with strategy and values. Again the focus is on alignment but also on tackling drivers of behaviour that may encourage excessive risk taking.
The suggestion that companies should report on the board’s activities and actions taken when it finds misalignment is interesting, as misalignment is often a gradual development. So the question is at what threshold should companies start reporting.
We suspect most boards will want to report on culture on an ongoing basis and not just when they find misalignment, as this will show them to be proactive and accountable.
What is more, if they are already reporting on culture on an ongoing basis, it will attract less attention if misalignment is detected and they are required to report on it.
Together with the proposed code, the FRC also published revised Guidance on Board Effectiveness.
The guidance reiterates the board’s responsibilities in relation to culture and provides more practical assistance in how to undertake these responsibilities, including questions the board should be asking itself, potential indicators of culture and tell-tale signs of a culture problem.
This document also serves as a good guide for some of the factors you could be reporting on.
When writing narrative on culture it is important to remember that the proposed Guidance on the Strategic Report also addresses culture and what companies should disclose on this topic.
The convergence of the governance and strategic report is something that we have noticed with certain topics, such as having regard for stakeholders. This is emphasised by the FRC, which encourages linkages between the two reports.
The guidance proposes that companies disclose their desired values, behaviours and culture and how their financial and non-financial objectives are drivers of these.
If you are tasked with writing part of the annual report, you may want to consider liaising with the rest of the reporting team to set a strategy for how you cover culture consistently in relevant places throughout the report, in order to emphasise the central nature of culture.
Currently, the typical place companies discuss culture is in the leadership and people section.
However, you may want to discuss culture in relation to the business model, to illustrate that you do not have a culture that could inadvertently compromise the business model in the long-term.
You may also want to discuss culture in relation to your strategy, underlining how it supports you in achieving your strategic goals. Finally, the risk sections provide an opportunity to describe risk culture.
It is also important to consider that annual reports give many indicators of culture without specifically addressing culture. These indicators include the level of transparency, accountability and report connectivity.
Whichever approach you take, you should aim to build a consistent and chronological story. A story that clearly sets out how your culture is aligned with strategy and drivers of behaviour while contributing to value creation can, if authentic, articulate a clear competitive advantage.