The board’s role in promoting an ethical culture

Boards that prioritize corporate culture, watch for red flags, and set clear expectations will encourage ethical behavior throughout the company.
By Sabine Vollmer

The board’s role in promoting an ethical culture
Photo by imaginima/iStock

Research over the past 20 years has continued to underscore that integrity drives performance. Corporate culture and tone at the top are considered key drivers of ethical behavior, but boards of directors often devote little time to the topic.

Board members generally recognize their responsibility to oversee ethics and compliance, said Pat Harned, CEO of the Ethics and Compliance Initiative, a U.S. think tank. What they struggle with, she said, "[is] to know what questions to ask and what information to look for. I don't think directors are particularly well-versed in recognizing red flags."

Serving on a board is a big job, Harned said. Business strategy and expansion, risks, and enforcement frequently take priority. Board members are aware of the importance of an ethical corporate culture and that it is driven from the top down, but 87% considered culture and engagement a top challenge, according to a Deloitte survey published in 2015. A separate Deloitte study published in 2016 found that just 28% of executives said they understand their organizational culture and 12% thought their company was driving the "right culture."

The problem often starts right in the boardroom. Research from a 2016 survey by the Rock Center for Corporate Governance at Stanford University and The Miles Group suggested that only 46% of board members strongly believe their board tolerates dissent. The same percentage believes that a few directors have an outsize influence on board decisions.

A 2017 Blue Ribbon Commission of the ­National Association of Corporate Directors (NACD) suggested that boards can tackle the challenges. What they need to do is become as disciplined in overseeing corporate culture as they are in overseeing risk management, commission members said.

LOOKING FOR RED FLAGS

Many businesses have codes of ethics that employees are supposed to follow and mission statements that promote values such as ethical behavior.

It is important that these statements and codes exist, but what really counts is having the board and senior management know and buy into them, said Christy Pickering, CPA, a sole proprietor in Ocean Springs, Miss., who focuses on tax and litigation support. She has been a member of the board of directors at Hancock Holding Co., one of the largest banks in the Southeast, since 2000 and has served on the board's audit, compensation, corporate governance, and executive committees.

"Corporate culture defines why a company exists and what it believes in," Pickering said. "Business strategy and operating methodology may change over the years, but corporate culture should remain constant. Tone at the top means that the board truly believes in the corporate culture and assures that the entire team adheres to the cultural values, starting with the directors and executive officers of the company."

For example, once a year the audit committee of the Hancock Holding board schedules a meeting with each of the top 10 or so executive officers. These are confidential sessions where executives are encouraged to speak about concerns, problems, and other potential warning signs, she said. The sessions typically last between 30 and 45 minutes. This occurs either during an all-day meeting, or in sessions that are split into two or three dates, depending on availability.

It's important that during the annual executive session, audit committee members ask broad questions. The AICPA Audit Committee Toolkit for Public Companies advises asking questions such as:

  • Are you aware of any issues that could cause embarrassment to the company? Have you ever been told anything in confidence or otherwise that would embarrass the company if it were known publicly?
  • Are there any items that you have discussed with the CEO, CFO, other officers, or outside counsel of which the audit committee is not already aware?
  • Is there any activity in the organization with which you are uncomfortable, consider unusual, or that you believe warrants further investigation?
  • Are you aware of any current or past fraud occurrence or any kind of fraud in the organization? Do you know of any situations in which fraud could occur?
  • Do you feel comfortable raising issues without fear of retribution?
  • Are there any questions we have not asked that we should have asked? If so, what are those questions?

10 RECOMMENDATIONS THAT DRIVE ORGANIZATIONAL CULTURE

To establish clarity on the fundamental elements of a strong organizational culture, as well as promote and enforce it, boards may follow these 10 recommendations from the NACD's Blue ­Ribbon Commission:

  • The board, the CEO, and senior management need to establish clarity on the behavior they expect across the organization regardless of geography or operating unit, and they should develop concrete incentives, policies, and controls to support the desired culture.
  • Directors and company leaders should take a forward-looking, proactive approach to culture oversight to achieve a level of discipline that is comparable to leading practices in the management and oversight of risk.
  • The board's nominating and governance committee should ensure that board policy documents and committee charters clearly delineate the allocation of culture oversight responsibilities and explain how culture oversight is embedded into the board's ongoing work.
  • Directors should regularly review the culture of the whole board and its key committees, both formally in the evaluation process and informally by allowing conversation in executive sessions. Results of these reviews should inform board composition, succession planning, and continuous improvement efforts.
  • Directors should assess whether the chief legal officer/general counsel and other officers in key risk management, compliance, and internal control roles are well-positioned within management and in relationship to the board to support an appropriate culture.
  • Integrate culture into the board's ongoing discussions with management about strategy, risk, and performance, emphasizing that the way results are achieved is as important as whether a given goal is met.
  • Boards should set the expectation with management that regular assessments of culture will include qualitative and quantitative information and incorporate data from sources outside the organization.
  • Directors should make culture an explicit criterion in the selection and evaluation of the CEO, and set the expectation that the CEO and senior leaders do the same in their own leadership development and succession-planning activities.
  • Boards and compensation committees should review the company's recognition and reward system to ensure that they reinforce the desired culture and avoid unintended outcomes that could undermine it.
  • Shareholder communication should include a description of how the board carries out its responsibility for overseeing and actively monitoring the company's culture.

The importance of ethics

Employees in high-integrity cultures are 67% less likely to observe significant instances of business misconduct compared with employees at companies with low-integrity cultures, according to a 2010 Corporate Executive Board report. And businesses with the best organizational culture earned an average return on assets that was 40% higher than those with the lowest-rated organizational culture, according to a study by Denison Consulting.


About the author

Sabine Vollmer is a JofA senior editor. To comment on this article or to suggest an idea for another article, contact her at Sabine.Vollmer@aicpa-cima.com or 919-402-2304.


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