Boards must prioritise and assess culture as a strategic asset, and develop an appreciation for how it may lead to behaviour with material consequences, says Siew Kai Choy, Starling Advisory Board member and former GIC Managing Director.
“Better Business” was one of the main themes of Davos 2020 this past January, amidst calls for a new kind of capitalism entailing a better balance between government, markets, and civil society. Business leaders resolved to better serve the interests of those identified in the 1973 Davos Manifesto: customers and clients, workers and employees, shareholders, societies, and other stakeholders.
A focus on Governance, Stewardship, and Engagement principles appears set to stay for the long term, and even the world’s largest passive investors will likely struggle to be passive owners in the days ahead. Institutional investors have a stewardship interest in promoting the long-term health of the companies in their portfolios. By acting to ensure that boards pursue effective corporate governance objectives, institutional investors align company interests with the investors’ own. This engagement between stewards (investors) and trustees (boards) is healthy. Boards should recognise that they benefit by such engagement; institutional investors are often well placed to contribute necessary expertise and experience in the discharge of their stewardship responsibility.
It is obvious to state that it pays to invest in better-run companies. Oddly, it appears less obvious to some that good governance usually leads to better returns. However, in my 20-years’ experience with GIC, Singapore’s sovereign wealth fund, we saw that companies with superior governance practices, at both the board and management levels, were better run and tended to deliver greater returns.
We also found that boards which had opted for constructive engagement with investors fared better with building broad investor support—and were usually more effective in warding off activists when they faced inevitable difficulties. All businesses will go through periods of difficulty. Consistent engagement with long-term oriented investors fosters shareholder support so that it is in the offing when most needed. Collaboration around corporate governance builds such investor trust.
In the last five years, many institutional investors have come together to state the shared expectation that firms must work to raise their governance standards. For instance, the International Business Council of the World Economic Forum published “The New Paradigm: A Roadmap for an Implicit Corporate Governance Partnership Between Corporations and Investors to Achieve Sustainable Long-Term Investment and Growth,” whilst the Investor Stewardship Group implemented the “Framework for Stewardship and Governance.” And a business-led effort by the Business Roundtable saw dozens of CEOs at America’s largest companies sign up to a new set of “Principles of Corporate Governance,” emphasising stakeholder capitalism to a greater degree than ever seen before in the United States.
Prominent global investors have also been individually vocal in emphasising a desire for enhanced governance and sustainability efforts in service of stakeholders. For instance, BlackRock and State Street have made repeated and strong statements indicating that the companies in which they invest must be managed with a long-term mindset if they are to deliver desired returns over time. Along with this long-term focus, they have made clear their conviction that corporate “purpose,” a concern for sustainability, and governance mindfulness must be integrated across their portfolios if they are to enjoy better risk-adjusted returns. They are thus looking to incorporate environmental, social, and governance (ESG) factors into their investment analysis and decision-making.
Going forward, we should expect that culture and conduct concerns will be seen as a critical component of any reliable governance assessments in this institutional investment context.
Regrettably, however, when it comes to culture and conduct related risks, we have not yet developed easily usable and consistently applicable frameworks to support investors in the exercise of their stewardship interests or boards in their discharge of oversight responsibilities. As a consequence, management of such matters has not been terribly successful in recent years; there are countless unfortunate examples of failure coming from across the globe and in just about every industry. Where culture and conduct risks have been ignored and allowed to be perpetuated, we have seen downside hits to reputation and brand-value, in addition to ruinous regulatory penalties.
This harms the interests of institutional investors, who will look to boards in the first instance when assigning accountability.
Sticking to the letter of the law or internal compliance rules is not enough. Employees can operate within the boundaries of such rules while still behaving in ways that do not reflect the values of the organisation, resulting in behaviours that generate unacceptable risk. Allowed to fester, such behaviours multiply, further harming all stakeholders. This is unacceptable.
Boards are responsible for safeguarding the interests of stakeholders and assuring that management has adequately addressed the potential violations of public trust that such behaviour may entail. Assuring effective culture and conduct risk management is thus a board level responsibility. Boards must prioritise culture as a strategic asset, endeavour to assess the culture of the organisations they oversee, and develop an appreciation for how that culture may lead to behaviour with material consequences. Investors will increasingly insist upon this and hold boards—and individual board members—accountable for repeated culture and conduct risk management failures.
In the words of Lord Cadbury, writing in 1992, “Governance is the system of rules, procedures and processes by which a company is directed and controlled. Specifically, it is a framework by which various stakeholder interests are balanced and efficiently and professionally managed.” This lies at the heart of directors’ responsibilities and should serve as their guide-star.
Concern for the environmental impact of business activity has been increasing in recent years. More recently, the current global health crisis has made all of us more sensitive to the social impact of business. As we rebuild our economies following this crisis, our attention will shift to place a greater emphasis on corporate purpose, practice, and governance. Boards should realise that this will inevitably entail consideration of corporate culture and the behavioural propensities it sustains.
We need new governance tools; ideally tools that provide leading indicators of trouble rather than systems that merely record problematic events for subsequent forensic inquiry. To achieve effective governance, management must blend qualitative measures of risk with quantitative measures, and report results up to their boards, enabling them to engage more effectively with investors around governance concerns – as they appear in real-time. Ideally, we may strike upon a set of standard metrics for such ‘soft risks’ which will serve to facilitate ESG-minded investment decision-making.
In times of unprecedented change, such as we are currently experiencing, mindsets are more open to alternative solutions and new ideas. As the current pandemic forces us to reset our business practices and to revisit our expectations of firms, investors and boards should give thought to how we might better serve a shared interest in assessing the effectiveness of firms’ governance practices. Firms that lead in this regard will warrant greater support from institutional investors.
Starling’s 2020 Compendium will be published soon. Use this link to reserve a copy.
Siew Kay Choy is a member of the Risk & Governance Advisory Board at Starling, an applied behavioural sciences technology company. Previously he was a Managing Director at Singapore’s sovereign wealth fund (GIC) where he was Director of the Data & Analytics Department, Head of Governance and IT in the Public Markets Group, and founder of GIC Innovation Labs.