A Question For Our Times

Andrew Grove

Thirty-five years ago, Andrew Grove found himself “wandering in the valley of death”, leading Intel’s huge but floundering memory chip business.  Eventually he asked his chairman, Gordon Moore (of Moore’s Law) an empowering question. “If we got kicked out and the board brought in a new CEO, what would he do?”


Moore replied without hesitation: “He would get us out of [memory chips].[1]” They did just that, overcoming pain to transform Intel into the world’s leading micro-processor company.

Intel succeeded because Grove’s question tapped into deep knowledge. It helped to overcome groupthink, status quo bias, loss aversion and a host of other well-understood social and psychological behaviours that usually leave us unable even to discuss big problems especially when change is needed. And he was blessed with an environment in which his question could be asked and answered in safety.


Most businesses face an existential crisis framed by Covid-19 and the Climate Emergency.  Moore's  deep knowledge was of the IT world and that was enough to see the new opportunity within it.  Had the opportunity been outside his experience, he would not have found a solution even though he was asked an excellent question. 

To use words I dislike, he had deep knowledge of the IT 'paradigm' and was able to move Intel within it.  But had the problem needed a paradigm shift, he might well have lacked the experience and perspectives to see it.

Some will solve the current crisis within the current paradigm.  But many will need to shift outside their current paradigms, for example the travel, leisure and energy sectors.  To achieve this, leaderships will need people who think and know things that current leaders do not know and may never have thought about - or even openly despised.

So to my question.  What if leaders were to create the conditions to empower their boards and other internal fora to answer Grove's question safely, before listening - with care and respect - to no-holds-barred answers and discussing their implications?

Or can you devise a more penetrating question for our times?

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Humility and Self-confidence in Leaders

One wet, windy winter’s day, I took refuge in the 11^th Century fortified Basilica of Valère, high above the city of Sion in Switzerland.  It’s a national treasure.  The visit revealed a gem in its Treasury.  A long-forgotten cleric from the Middle-Ages had left a Latin graffito on the wall: translated it means: “Humility is the pinnacle of wisdom and the mother of virtue”.

Humility has been out of fashion for a while.  It’s partly the cult of celebrity, with superficial appearances - assertiveness, drive, social graces and apparent success - eclipsing evaluation of skills, experience, character and the role of luck in track records.  It doesn’t help that those who choose leaders often lack self-awareness of their psychological biases, and an understanding of the pivotal role of character in decision-making, let alone the analytical skills and the experience needed to make good leadership choices. 

When I first praised humility in leaders, my audience’s initial reaction was gently mocking.  ‘Leaders need self-confidence’, they said, implying that humility and self-confidence are incompatible.

The truth is that leaders do need self-confidence, but self-confidence comes in different flavours.

One that seems widespread among high profile leaders in business and especially in politics is the robust, even hubristic leader whose self-confidence is like a lobster’s carapace: tough armour that protects a vulnerable interior.  These often egotistical, hubristic and insecure individuals see high pay as an endorsement of their fragile self-worth.

They can feel their very identity is at risk if their thinking is questioned, let alone if they are given news that things are not going according to plan.  It isn’t that they lack intelligence but rather that to accept they may have made an error undermines their self-esteem. So they attack.  They sack dissenters and surround themselves with sycophantic acolytes. This drives unwelcome news and insights underground so they don’t learn about problems until it is too late.  They and their organisations, whether commercial or political, become brittle, vulnerable to failure for reasons that subordinates and outsiders can often see coming years ahead. 

But there is a deeper kind of self-confidence. There are equally bright and ambitious leaders who know and accept that they will sometimes get things wrong.  They understand and credit the role of luck in their successes. Echoing the Tao Te Ching's telling of Lao Tzu's wisdom from 600BC, they “consider those who point out [their] faults as [their] most benevolent teachers.”  More recently Jim Collins observed that these often self-effacing yet successful individuals deflect adulation and channel any egotistical needs away from themselves and into making their organisations great.

Their self-confidence is not a mask to camouflage insecurity but a strong edifice built on acceptance of their strengths, their limits and their weaknesses. While few welcome being wrong, these leaders are receptive of contradiction and keen to use the insights of others to remedy weaknesses and correct errors before harm is caused.  They thank their ‘teachers’ before analysing whether things are on a good track. They surround themselves with people who have different perspectives and encourage all around them to say what they really think.  The result is colleagues and subordinates who promptly pass on unwelcome news and are both competent and willing to challenge what may be errors. 

Their organisations are intrinsically resilient because, through their openness to different perspectives, challenge and bad news, they gain early warning of things that may be going wrong in time to avoid or mitigate bad consequences.

The reason that graffito grabbed my attention was a recent Financial Times job advertisement by Russel Reynolds.  It described the successful candidate as one who exemplifies, amongst other traits, humility and integrity.  One swallow does not make a summer, but this is a powerful pair of character traits in a leader.  Boards - and investment managers’ governance teams - would do well to develop that line of thinking.

Anthony Fitzsimmons

Author of "Rethinking Reputational Risk: How to Manage the Risks that can Ruin Your Business, Your Reputation and You"
Reputability 

London

www.reputability.co.uk

'Why We Get the Wrong Politicians' - Book Review

When the UK Parliament's select committees dig to discover why a large organisation has failed, they regularly find systemic weaknesses that have been there for years, widely recognised but not by leaders, a time-bomb ticking ’til luck runs out. These canny committees expose leaders who, unchallenged, managed those systems whilst lacking the skill, knowledge and experience required, often pin-pointing character weaknesses, culture and incentives as deeper causes of failure.

When the bomb explodes, most leaders are stunned to discover what outsiders had long been expecting. They don’t miss the warning signs because they are bad but because we humans are wired that way. Cognitive biases lead us to believe that we are better than we really are and cognitive dissonance leaves us unreceptive to news that contradicts our world view.

The UK's politicians seem stuck in that cognitive limbo. We are experiencing the worst failure of government and opposition in living memory. This is not like the departmental disasters described by the Public Accounts Committee. It is far worse. It is the failure of our political system.

In Why We Get the Wrong Politicians, political journalist Isabel Hardman corrals evidence of what is going wrong in a book that should be compulsory reading for every aspiring and elected politician and civil servant. It is eerie to find so many parallels with my own research into corporate failures. But this is no surprise because all organisational systems are ultimately run by humans. 

Analysing MPs’ backgrounds, Hardman finds that few have the knowledge or expertise they need to be effective: “The place is weirdly full of career politicians”. Far fewer have been educated in law, a bizarre weakness in a legislature. Fewer still are well educated in the science and technology that drives the modern world. MPs receive no training on how to navigate the byzantine parliamentary system and its processes. The huge cost of becoming an MP must also reduce diversity of background and perspective.

Hardman describes parliament as “unprofessional”; one MP she interviewed called it “dysfunctional”. She quotes a 2004 pamphlet by Andrew Tyrie: “The executive has succeeded in frustrating parliament… Executive obstructionism and parliamentary weakness threaten to erode trust in politics and politicians, leaving our system of government the biggest casualty.”These traits ensure a blinkered world view and functional incompetence even before the mind-warping Westminster bubble.

Everyone knows that MPs bawl at each other across the floor of the Commons but I was surprised to learn how actively this hubbub is orchestrated. MPs who do not demonstrate unquestioning support for their party find paths towards prestige and power blocked. As to “troublemakers”, the whips reportedly “seek dirt on backbenchers in order to compile as weighty a dossier as possible” against them.

Keeping MPs ignorant, powerless and afraid suits ministers because it shields them from effective challenge. But it is disastrous for democracy and the country.

Just as banks became attractive to people who were driven by the love of money, a culture like this is likely to attract and advance arrogant, amoral egotists with a primal thirst for power more than those with an ethos of diligent public service. 

Competence determines what we can do, but character determines what we will do. With MPs selected and rewarded for character traits and behaviour that make them slippery, sycophantic and self-centred, it is no surprise that the public trusts politicians’ truthfulness less than anyone else bar advertising executives. Tyrie’s prediction is now the electorate’s perception.

There is no select committee to force politicians to see their competence, culture, behaviour and mores as others do. The question is: do politicians have the self-awareness to reform themselves before reform is thrust upon them?

Anthony Fitzsimmons is Chairman of Reputability LLP and author of “Rethinking Reputational Risk: How to Manage the Risks that can Ruin Your Business, Your Reputation and You”

This piece was first published in Civil Service World

Ben Graham's Insights into Audit

The first edition of Benjamin Graham’s ‘The Intelligent Investor’ devoted 30 pages to “The Investor as Business Owner”.  Two insights remain relevant today.

Graham contrasted the theory of shareholder rights with reality.   Shareholders are notionally “king”, he wrote, with the power to “hire and fire managements and bend them completely to their will”.  In practice Graham saw them as “a complete washout”.   “As a class they show neither intelligence nor alertness.  They vote in sheep-like fashion for whatever management recommends and no matter how poor the management’s record of accomplishment may be. ”

The ability of ultimate shareholders to influence management has diminished.  Most individually owned shares are held through nominee accounts that, in practice, disenfranchise shareholders.  Managers of collective investments provide patchy stewardship.

Private shareholders could easily be re-enfranchised by legislation and technology.  A resurgence of individual shareholders at AGMs would help boards to focus on public perceptions and the penetrating questions that astute shareholders ask.

As to collective investments, the UK Stewardship Code is inadequate because it is voluntary and has limited scope.  The Financial Conduct Authority should develop robust rules that force institutional investors’ incentives and behaviour into alignment with the interests of their ultimate clients, such as retail investors and future pensioners most of whom seek steady long-term growth.  To support this, legislation, not just the UK Corporate Governance Code, should make it the unambiguous primary duty of directors to promote long term sustainable success.  With this as a national policy, there is logic in aligning voting power with duration of shareholding, giving full voting power only to long term investors.

But that leaves a fundamental question: how can good stewards get the information they need to do their job properly?

The answer ought to be informative company reports.  The FRC has made good progress on company reporting requirements but the scope and quality of information provided in Annual Reports depends on management openness.  These often seem to be in proportion to management competence.

Extending the scope of audit to the whole annual report will help ensure the accuracy of information provided.  But it will not solve the problem of inadequate or absent information.

For those who can see through corporate spin and market groupthink, it is not difficult to identify companies from which more information is needed.  Graham suggested investigating those whose return or profit margin has persistently lagged their peers and those who have lost market share.  He also highlighted the importance of management competence.  This is a crucial tell-tale of future failure, along with leadership characteristics such as CEO arrogance, hubris and dominance and boards that are inadequate to appoint and manage a CEO. 

Graham’s second insight is relevant here.  He proposed that shareholders of “underperforming” companies should be able to “call in outside business engineers to pass upon the policies and competence of the management”.  These outside experts would be “selected by an independent committee of stockholders” with the report “submitted directly to stockholders” and the cost borne by the company. 

Auditors could fill much of this role.  The Big Four’s move away  from calling the firms they audit 'clients' is a start but cosmetic because their appointment and tenure depend on the auditee’s board.  They have powerful incentives not to rock the board’s boat.  The parallel move, away from providing other services to audit clients, is helpful but too modest.  We should follow the direction recommended by Graham.

The auditor’s relationship with larger and quoted companies should become arm’s length.  Legislation should create independent Shareholders’ Committees to appoint the auditor, to direct the audit and the investigation of any murky corners (including leadership competence), and to receive reports on behalf of shareholders.  Boards will still prepare the accounts and annual report but they will be audited by an entity that owes allegiance only to shareholders.

This will remove the perverse incentives under which the audit profession has laboured for too long, allowing auditors to use their professional skills and judgement to the full.  It should also help stem the steady stream of predictable, avoidable corporate failures.


Anthony Fitzsimmons is Chairman of Reputability LLP and author of “Rethinking Reputational Risk: How to Manage the Risks that can Ruin Your Business, Your Reputation and You”

Why great leaders seek uncomfortable truths

TSB’s leaders did not expect their IT upgrade to become a reputational disaster.  No-one was more surprised than the trustees of the Presidents Club when it imploded.  Philip Green was preparing an upbeat message to markets only five days before announcing Carillion’s £845m profit warning.  Bell Pottinger’s leaders seemed blind to their firm's impending disintegration.    

The pattern repeats endlessly.  In ‘Deconstructing failure’, we found that in over 80% of the crises we analysed, the board seemed to be taken by surprise.  What is going on?

Anthropologists have observed that social groups develop shared mental maps.  These aren’t just a common world view.  They define who is a group ‘insider’ and who is not.  They influence how the outside world is perceived, what is discussed and what is not - leaving what group ‘outsiders’ see as crucial subjects undiscussed.  As Gillian Tett, a Financial Times commentator and trained social anthropologist, put it, these topics “become labelled as dull, taboo, obvious or impolite”.  The result is that a social group - such as a board or leadership team - can’t or won’t see, let alone discuss, things that well-informed outsiders - such as their subordinates - know are important.

If we feel we know little, we can learn easily.  But when we are presented with information that contradicts our world view, we face what psychologists call ‘cognitive dissonance’.  This is stressful.  I have pinned to my wall words from the Tao Te Ching: “A [leader] considers those who point out his faults/ as his most benevolent teachers.”  Yet I still feel discomfort when someone is considerate enough to tell me I may be wrong.

Most people become defensive when faced with cognitive dissonance.  They turn over the page.  They hear but do not listen.  They bully the bearer of bad news.  So doing, leaders lose the opportunity to discover that something is not as they hoped or believed.  In failing to assimilate dissonant information, we deprive ourselves of the opportunity to fix incubating, often systemic, weaknesses before they cause crises. 

Shutting our eyes, blocking our ears and shouting are not our only responses to uncomfortable truths.  We tend to seek information to confirm our world view, rather than to challenge it, because of our confirmation bias.  Faced with information that a particular weakness probably affects ‘us’, overconfidence and our egocentric bias lead us to believe we are immune.  Optimistic bias leaves us believing that bad things are less likely to afflict us.  The Ikea Effect makes us disproportionately proud of what we have produced.  

Biases like these and more make it harder to accept the idea that even ubiquitous weaknesses, such as leaders’ blindness to important information - which obviously apply to ‘them’ - also apply to ‘us’.  As Daniel Kahneman put it, “We’re blind to our blindness.  We have very little idea of how little we know.  We're not designed to know how little we know.”

Behaviours and biases such as these leave us predictably vulnerable. The phenomenon is so widespread that we named it the “unknown knowns” problem:  There are things leaders need to know, that are widely known to others in the organisation, that they cannot discover until it is too late.  Many can be seen by analytical outsiders, including investors, who are able to see through corporate PR, market groupthink and their own psychological biases.

Zen philosophy has an answer to the problem: the cultivation of ‘Beginner’s Mind’.  Shunryu Suzuki summarised it as “Wisdom which is seeking for wisdom”.  The challenge for a leader is to be as open-minded and inquisitive as a novice with no vested interest in the way things are.  Few achieve this state of mind. 

Most of us need outsiders to our group with access to corporate knowledge to uncover these uncomfortable truths.  Once found, bringing truth to power needs courage and social skills: courage because powerful leaders forced to confront dissonant information can be aggressive; social skills because unwelcome news needs to be presented in a way that helps leaders to change their world view, overcoming dissonance and their cognitive biases. 

Research shows that leaders should expect to face a major crisis during a period as short as five years.  By overcoming social and behavioural tendencies that affect everyone, including themselves, leaders can search for and fix unknown knowns before they cause trouble.  Prevention comfortably beats having to deal with a reputational crisis and face public vilification.

Anthony Fitzsimmons is Chairman of Reputability LLP and, with the late Derek Atkins, author of “Rethinking Reputational Risk: How to Manage the Risks that can Ruin YourBusiness, Your Reputation and You”

This article was first published in Management Today in September 2018.

New FRC Code and Guidance: The Headlines

The Financial Reporting Council has delivered radical revisions of the UK Corporate Governance Code and of the Guidance on Board Effectiveness.  The purpose of this note is to bring you the most important headlines. 

NED Teams

One of the lessons of the Banking Crisis was that companies that failed frequently had non-executive teams that lacked sufficient know-how, curiosity or character to ask penetrating questions of the executives who were leading them towards a cliff.  As Andrew Bailey, now Chief Executive of the Financial Conduct Authority once put it, “Healthy scepticism channelled into intelligent and forceful questioning of the self-confident can be a good thing.” 

The FRC has given a strong, systematic emphasis to NED teams having the skills knowledge and experience to understand everything of importance that is going on in their company. It has focused on the importance of so-called 'soft' skills. Crucially it has put ‘Courage’ at the top of a list of desirable personal attributes of NEDs and steered boards towards actively seeking good candidates who are outside the (social) circles of classical head-hunters.

Short-termism

There has been growing political criticism of short-termism and covert asset stripping by those who lead and invest in UK companies.  This has been supported by criticism from economists and long term investors.  This behaviour is in part a result of Milton Friedman’s ‘Shareholder Value’ philosophy, which has put anything other than shareholder perspectives into ‘second class’ category.

Encouraged by a strong political steer, and despite seemingly coordinated resistance from large corporates, the FRC has now brought “long term sustainable success” to the core of the Code.  This philosophy has been reinforced throughout the Code and the Guidance, in which “long term” appears no less than 40 times.

Workforces

Friedman-ism has been dealt a second blow by forcing boards to listen to the workforce.  Political pressure arising from the increasing disparity between C-suite and worker pay is one driver.  The second is the recognition that workers often won’t give leaders unwelcome news because they fear the consequences – what we call the ‘Unknown known’ problem.

As regards the unknown known’ problem, the FRC has given renewed emphasis on going beyond ‘whistleblowing’ programmes towards systematising a culture which makes it both routine and safe for the workforce to ‘speak up’ if they feel anything is amiss. 

The pay disparity issue has been tackled by a variety of measures.  One is to force boards to institutionalise an ‘employee voice’ whether via an employee director, a director designated to listen to and bring workforce views to the board; or a formal workforce advisory panel.   Boards are expected to explain to the workforce the relationship between executive pay and wider company pay policies and corporate culture.

Bonuses and other incentives

Finally, the FRC made a promising and well-thought-through attempt to de-risk bonuses and other incentives. Among other measures, the FRC is encouraging simplicity and clarity in their structure and the thinking through of potential unintended consequences.    

But they have also taken a stand against the risk of a CEO burnishing present profits (and thus bonuses) by increasing risks ‘after I have gone’.  It is often easy, and given the wrong bonus architecture can be tempting, to boost profits (and bonuses) today by cutting back on, for example, maintenance or innovation.  Cut maintenance regularly causes costly disasters.  And many suspect that investment foregone is an important cause of lacklustre performance at UK companies. 

The FRC has tackled this through the best method of which we are aware: by encouraging boards to require executive bonus share awards to be held for “two or three years after leaving the company”.  That way retiring CEOs have a huge incentive to leave their company in excellent shape.  For if one thing is certain, it is that their successor will have a thorough look for skeletons left by their predecessor before setting the starting point for their own bonus scheme.

You will find the rationale behind most of the FRC's main changes fully explained in "Rethinking Reputational Risk - How to Manage the Risks that can Ruin Your Business, Your Reputation and You" by Anthony Fitzsimmons and the late Derek Atkins.

We have written a more detailed note on this, which you will find here.

Anthony Fitzsimmons

Reputability LLP

London

www.reputability.co.uk

Radical Revisions to FRC Corporate Governance Code and Guidance on Board Effectiveness

The Financial Reporting Council has delivered radical revisions of the UK Corporate Governance Code and of the Guidance on Board Effectiveness (the Code and the Guidance respectively).

The Code and Guidance have been substantially recast, with a focus on making 'tick-box' approaches and boilerplate reporting much more difficult.  To this end the Guidance is laced with over eighty penetrating open-ended questions for boards to consider. The new rules come into force as regards accounting periods beginning on or after 1 January 2019.

Our note concentrates on four important themes involving change:

• Long term sustainable success
• Board skills knowledge and experience
• Interacting with the workforce and
• Remuneration issues

Long Term Sustainable  Success

For years there has been trenchant criticism of short-termism and opportunism among UK company leaders and their shareholders at the expense of sustainable growth.  Recent examples include utilities accused of asset stripping that will leave their companies vulnerable when interest rates rise.  But examples go back many years.

The Code now begins:

"A successful company is led by an effective and entrepreneurial board, whose role is to promote the long-term sustainable success of the company, generating value for shareholders and contributing to wider society." (Code Principle A)

"The board should ensure that workforce policies and practices are consistent with the company’s values and support its long-term sustainable success."  (Code Principle E)

Boards have to report on this. The Provisions that elaborate Code Principles A to E provide:

The board should assess the basis on which the company generates and preserves value over the long-term. It should describe in the annual report how opportunities and risks to the future success of the business have been considered and addressed, the sustainability of the company’s business model and how its governance contributes to the delivery of its strategy."  (Code Provision 1)

This approach is underpinned by the Guidance, which begins by describing an effective board.

"An effective board defines the company’s purpose and then sets a strategy to deliver it, underpinned by the values and behaviours that shape its culture and the way it conducts its business. It will be able to explain the main trends and factors affecting the long-term success and future viability of the company – for example technological change or environmental impacts – and how these and the company’s principal risks and uncertainties have been addressed."  (Guidance 1) 

Whilst this respects the formal wording of s172 of the Companies Act 2006 with all its ambiguities, boards subject to the FRC will either have to comply with the Code on this or explain that, and why, they will not.

What remains is the potential for major shareholders to drive undesirable short-termism in the board.  The FRC intends to consult on revisions on the Stewardship Code.  In our view this problem cannot be resolved without drawing in the FCA to regulate issues between investment professionals and their ultimate clients, particularly as regards the disparity between the often short bonus-driven time horizons of investment professionals and the far longer horizons of retail investors saving for the long term to retirement.  Some have suggested more draconian measures such as the Loi Florange.

Board Skills Knowledge and Experience

The history of corporate disasters, including the 2007/8 Banking Crisis, is littered with boards that lacked key skills, knowledge or experience, a pattern that persists.   In an attempt to stem this steady flow, the FRC has tackled board composition.  They have three aims: to encourage NED teams that have an adequate combined skill-set; to encourage diversity of perspective; and to increase strength of NED character. The Code now provides:

"...Both appointments and succession plans should be based on merit and objective criteria and, within this context, should promote diversity of gender, social and ethnic backgrounds, cognitive and personal strengths." (Code Principle J)

"The board and its committees should have a combination of skills, experience and knowledge. ... " (Code Principle K)

These dry anodyne principles are reinforced in the Guidance, which includes a new emphasis on character - with courage heading the list.

The boardroom is not supposed to be a comfortable place:

"The boardroom should be a place for robust debate where challenge, support, diversity of thought and teamwork are essential features. Diversity of skills, background and personal strengths is an important driver of a board’s effectiveness, creating different perspectives among directors, and breaking down a tendency towards ‘group think’." (Guidance 16). 

Directors should be chosen to add value and effectiveness:

"Appointing directors who are able to make a positive contribution is one of the key elements of board effectiveness. Directors will be more likely to make good decisions and maximise the opportunities for the company’s success if the right skillsets and a breadth of perspectives are present in the boardroom. Non-executive directors should possess a range of critical skills of value to the board and relevant to the challenges and opportunities facing the company." (Guidance 87)

 Diversity, soft skills and character matter:

"Diversity of personal attributes is equally important. The nomination committee will want to ensure the board is comprised of individuals who display a range of softer skills, such as [sources of intellect, critical assessment and judgement, courage, openness, honesty, tact, ability to listen, ability to forge relationships, ability to develop trust and strength of character]" (Guidance, 91 combined with Figure 7)

 The Nomination Committee should be systematic in working out what the board needs, then set out to find them.  Competent boards will also create a person description setting out the personal attributes they seek.

"... The nomination committee should evaluate the skills, experience and knowledge on the board, and the future challenges affecting the business, and, in the light of this evaluation, prepare a description of the role and capabilities required for a particular appointment. .... It is important to build a proper assessment of values and expected behaviours into the recruitment process." (Guidance, 92)

"Skills matrices that map the existing skill-set against that required to execute strategy and meet future challenges can be an effective way of identifying skills gaps. They are a useful tool for role evaluation and succession planning." (Guidance 93)

 Boards should make efforts to attract recruits beyond the 'usual suspects':

"Publicly advertising board appointments and working with recruitment consultants who have made a commitment to promote diversity are examples of ways in which the nomination committee can access a more diverse pool of candidates from which to appoint. Attention also needs to be paid to how the interview process is conducted so that candidates with diverse backgrounds are not disadvantaged." (Guidance 94)

The Nomination Committee is asked four questions

• "Have we assessed what skillset is required for the board and its committees?
• Do we reassess the make-up of the board as a result of emerging trends?
• Do we take account of the technical skills and knowledge required by the committees when recruiting members?
• How often is a skills audit undertaken and are we keeping up with the pace of change?"  (Guidance before 92)

Interacting with the Workforce

The back story to these reforms includes public and political debate around how boards take account of relationships with stakeholders other than shareholders, and the workforce in particular.  Separately we have long raised the 'unknown known' problem - the all too common situation where the workforce knows important things that, for a variety of reasons, they will not, or dare not, tell their leaders.  The FRC has tackled both issues.  

The Code provides:

"The board should ensure that workforce policies and practices are consistent with the company’s values and support its long-term sustainable success. The workforce should be able to raise any matters of concern."  (Code Principle E)

"... The annual report should explain ... the company’s approach to investing in and rewarding its workforce." (Code Provision 2)

The board's engagement with the workforce is expected to include one or more of a director appointed from the workforce; a formal workforce advisory panel and/or a designated non-executive director (Code Provision 5).

"There should be a means for the workforce to raise concerns in confidence and – if they wish – anonymously. The board should routinely review this and the reports arising from its operation. It should ensure that arrangements are in place for the proportionate and independent investigation of such matters and for follow-up action." (Code Provision 6)

Boards are encouraged to draw the workforce into a collaboration when setting values because "Ownership of the values will be stronger if a collaborative approach is taken and both the leadership and the workforce are involved in a two-way process to define the company’s values (Guidance 18).  Similarly the Guidance advocates using "multiple qualitative and quantitative sources" to avoid gaining an incomplete picture of culture. "The workforce will be a vital source of insight into the culture of the company" (Guidance 23).

The FRC echoes our longstanding concern that boards are commonly in the dark about important things that the workforce knows but will not tell them - what we call the 'Unknown known' problem.  The FRC exhorts boards to make both whistle-blowing and more routine 'speaking up' safe for those with information to impart.

"Having policies in place that encourage individuals to raise concerns is a core part of an ethical and supportive business culture.  Whistleblowing policies that offer effective protection from retaliation ... are essential components of this. ..." (Guidance 57)

"Companies need to create an environment in which the workforce feels it is safe to raise concerns. Common fears include being negatively labelled, sidelined for promotion or bonuses, and even loss of employment. Leaders need to ensure there are no negative repercussions as a result of doing so." (Guidance 58)

"It is equally important to encourage individuals to speak up. Speak-up arrangements help build trust, act as an early warning system and help to manage risk. It is critical for success that leaders actively listen and feedback how the matter raised has been considered, including any action taken. Companies may want to consider the benefits of extending such arrangements beyond the workforce to external parties, like customers and suppliers. (Guidance 59)

One of the questions for boards to consider in this area is:

"What evidence do we have that the chief executive is willing to listen, take criticism and let others make decisions?" (Guidance below 26)

Remuneration issues

A crucial issue for behavioural risk specialists such as ourselves is the risk that executive reward systems to create incentives that encourage behaviour that is against organisation's best interests and that encourage treating the organisation's interests as pawns in a bigger game: the gaming of incentive schemes.  A long-running sore with the public and with politicians is the divergence between C-suite pay and workforce pay.  The FRC has tackled both.

As usual the FRC's approach begins with the Code.

"Remuneration policies and practices should be designed to support strategy and promote long-term sustainable success. Executive remuneration should be aligned to company purpose and values, and be clearly linked to the successful delivery of the company’s long-term strategy." (Code Principle P)

Remuneration Committee chairs are required to have had at least 12 months' service on a Remuneration Committee. (Code Provision 32).  The Committee should "review workforce remuneration and related policies and the alignment of incentives and rewards with culture, taking these into account when setting the policy for executive director remuneration." (Code Provision 22)

FRC Guidance on executive pay is now robust, encouraging rules that require the holding of shares awarded for long periods.  Foreshadowing the holding of shares well into retirement:

"Remuneration schemes should promote long-term shareholdings by executive directors that support alignment with long-term shareholder interests. Share awards granted for this purpose should be released for sale on a phased basis and be subject to a total vesting and holding period of five years or more. The remuneration committee should develop a formal policy for post-employment  shareholding requirements encompassing both unvested and vested shares." (Code Provision 36)

 The Code steers Remco towards clarity, simplicity, risk awareness and alignment with culture:

"When determining executive director remuneration policy and practices, the remuneration committee should address the following:

• clarity – remuneration arrangements should be transparent and promote effective engagement with shareholders and the workforce;
• simplicity – remuneration structures should avoid complexity and their rationale and operation should be easy to understand;
• risk – remuneration arrangements should ensure reputational and other risks from excessive rewards, and behavioural risks that can arise from target-based incentive plans, are identified and mitigated; 
• alignment to culture – incentive schemes should drive behaviours consistent with company purpose, values and strategy.  ..."  (Code Provisions 40)

Remco is expected to supervise all aspects of reward, including the relationshiop between workforce pay and executive pay.

"The remuneration committee is also tasked with reviewing workforce remuneration and related policies. The purpose of this review is to:

• ensure the reward, incentives and conditions available to the company’s workforce are taken into account when deciding the pay of executive directors and senior management;
• enable the remuneration committee to explain to the workforce each year how decisions on executive pay reflect wider company pay policy; and
• enable the remuneration committee to feedback to the board on workforce reward, incentives and conditions, and support the latter’s monitoring of whether company policies and practices support culture and strategy." (Guidance 130)

In setting executive pay, Remcos are expected to "focus on the strategic rationale for executive pay and the links between remuneration, strategy and long-term sustainable success",  avoiding "pay structures based solely on benchmarking to the market, or the advice of remuneration consultants, as there is a risk this could encourage an upward ratcheting effect on executive pay."  (Guidance 133 and 134)

Once again, the theme of long term success reappears, with what is probably the most effective way of ending the gaming of incentives: forcing executives to hold shares until well after they leave.  New leaders tend to search for time bombs bequeathed by their predecessors.

"It is important that the remuneration committee takes steps to counteract the risk of incentives that are detrimental to the long-term success of the company. Packages that are structured to ensure exposure to the long-term share value, including for two to three years after leaving the company, can support alignment with shareholders and encourage executive directors to focus on the impact of their decisions over the long-term." (Guidance 135)

The FRC has asked Remcos to consider a suite of questions that probe:

• alignment of executive pay with wider company pay policy
• the extent to which workforce incentives support culture and encourage desirable behaviour?
• How Remco has explained to the workforce the relationship between executive pay and wider company pay policies 
• whether their pay policy strengthens long-term thinking
• how they have addressed Provision 40 of the Code 
• how performance measures support long-term thinking 
• whether the choice of any measure may encourage negative behaviour and if so, what steps have been taken to manage the risks (Guidance after 132, 136 and 37) 

If you wish to understand the rationale behind most of these changes, you will find it explained in "Rethinking Reputational Risk - How to Manage the Risks that can Ruin Your Business, Your Reputation and You" by Anthony Fitzsimmons and the late Derek Atkins. 

Should you wish for an external board evaluation focused on helping your board to avoid the pitfalls that bring down companies and their boards time after time, please get in touch.

Anthony Fitzsimmons
Reputablity LLP
London

www.reputability.co.uk
www.reputabilityblog.com