The Financial Reporting Council’s (FRC) 2014 revision of the UK Corporate Governance Code requires the board to set the appropriate “tone from the top”. This means establishing the “culture” – the values and principles that direct how the company behaves – and ensuring that this culture is followed throughout. During 2015, the FRC will work with a wide range of stakeholders to gather practical insight into this area.
Culture is not an easy concept. It’s the sum of knowledge, beliefs, values and experiences acquired by a group of people over a period of time through living or working together. Relating that to a corporate setting, where every company is different and cultures might need to be established or changed within a specific timetable, brings added complexity. This is one reason why the UK corporate governance framework offers important flexibility in terms of developing sound company culture.
Good corporate governance is an essential part of a healthy corporate culture. The FRC’s latest report “Developments in Corporate Governance and Stewardship”, which will be published this week, shows how far the UK has come in terms of compliance with standards of behaviour expected of boards, including the quality of their reporting work.
Strict adherence to the Principles and Provisions of the Code is not, on its own, necessarily an indication that company culture is completely healthy. The UK Corporate Governance Code is not a set of hard rules. Its “comply or explain” approach gives companies flexibility in how they govern themselves. Boards should give extensive thought to how they apply the Principles of the Code and consider carefully when they wish to depart from the Code’s Provisions, providing a clear rationale when this is the case.
Culture is closely linked to risk and risk appetite. The 2014 Code asks boards to look at the risks which might affect the company and its long-term viability. To support this, there is a separate longer-term viability assessment which asks boards to give investors a broader and integrated assessment of viability. Any governance framework, however, cannot totally eliminate risk and should not seek to do so. The difficult question of what represents an acceptable level of failure will always be with us, but that does not mean that we should be complacent.
To establish sound culture, the board must define the company’s purpose and the behaviours it wishes to promote in order to deliver its business strategy. This involves asking questions and making choices about the correct balance between constructive innovation and disproportionate risk-taking; deciding whether different parts of the business should operate differently; maintaining culture under pressure and through change; and encouraging constructive discussion among shareholders on culture.
The governance of individual companies depends crucially on culture. The FRC’s recent guidance on risk management highlighted the need for boards to think hard about assessing whether the culture practised within the company is in line with what they espouse. Companies should consider what assurance they have around culture. Are performance drivers and values consistent? Are company values and reward packages integrated? How effectively does the company’s culture relate to its business model?
The FRC guidance also reinforced the need for boards to be frank on whether they have the capabilities to understand and address the threats to the long-term success of the company, including threats arising from behaviour in the company.
The Code recommends that boards be a place of constructive challenge. This “tone from the top” must flow right through the company and be observable through the values, attitudes and behaviours displayed.
Unfortunately, as 2014 showed, we continue to see examples of governance and cultural failings. Boards have responsibility for shaping the culture within the boardroom and across the organisation as a whole, and this requires constant vigilance. It is particularly challenging when the board is seeking cultural change, but ultimately worthwhile.
The FRC knows that this is not an easy task. We are ready to help by continuing to seek new ways to promote and improve governance practice. In an attempt to do so, during 2015 we will initiate market-led work to gain insight into how effective boards establish and embed company culture and promote better practice.