Event: Good Governance driving Corporate Performance
Looking back on an inspiring program
On Thursday afternoon 2 February 2017 the event ‘Good Governance driving Corporate Performance’ took place, a joint initiative of Nyenrode Business Universiteit and Deloitte Risk Advisory. Over 100 executives and non-executives attended the inspiring program. The high turn up demonstrates that the theme is an area of importance to many. We are looking back at a successful day, with lively discussions and new insights. Below you can read a report on the day, including a summary of the break-out sessions.
‘Governance is never a ‘one size fits all’ recipe’
The meta-analysis that was conducted by a joint research team of Nyenrode and Deloitte shows that governance is never a ‘one size fits all’ recipe. But there are elements of governance that can enhance corporate performance:
- Board independence: research shows that having more independent board members improves objectivity and brings in multiple points of view into the decision-making process. The size of the board matters: above 7 members the effectiveness decreases. It can be an advantage to be the ‘new kid on the block’, especially when you have escalation competence and dare to be challenging.
- Board diversity: this is more than just the male – female ratio: regulation is not preferred and does not deliver the desired effects. However, having women on board is certainly a good idea (the winning team is consisting of a little over half of women). Demographic diversity has a positive impact on corporate performance. Family owned companies should consider bringing in non-family members, especially a non-family member as CEO has a positive effect on performance.
- CEO characteristics: more powerful CEOs drive performance, however, one should be aware of narcissism. Combining the CEO role and that of the Chairman may lead to a weakened monitoring of the board. Separating the two consistently outperforms those that do not.
- Oversight is weakened when all is going well. Board meetings tend to get a repetitive character. An increase in board meeting frequency may lead to more volatile results.
- Ownership structure matters: large – active – institutional shareholders may help to enhance diversity and the quality of the decision-making process. Depending on their horizon, the engagement might differ.
Expert Panel discussion
An expert panel consisting of Harvey Christophers, Sandra Heuts (both partner at Deloitte), Daniëlle Melis (former Chair of the Nyenrode Corporate Governance Institute) and André Nijhof (professor in the fields of Corporate Social Responsibility and Business Ethics, Nyenrode Business University) shared their practical experiences regarding governance and long-term value creation.
‘Include side-effects in your strategy development’
According to Nijhof, in our current transparent society it might be possible to hide irresponsible practices for the short-term, on the long-term we have to ensure that the whole story linked to our products and services is valuable. All companies have negative side effects on society that might undermine the long-term value of these companies. These effects can no longer be disregarded as ‘externalities’ and boards will have to include them in their strategy development and show integrated thinking about long-term value creation.
Multiple points of view
‘Diversity is a quality of the mind’
Melis states that active ownership can enhance value creation. But is this financial value creation, customer value creation or even sustainable value creation? We need to consider multiple points of view. Human beings, however, can basically not chase after more than one objective at the same time. If that is a fact, having a diverse board is even more important. That is the sweet spot for value creation. How can we start with hiring the right people? It is not about counting the right amount of a group of people. We should take this a step further to focus on how to include all these different perspectives. Diversity is a quality of the mind rather than of hiring people.
‘Governance is about aligning the objectives’
In the opinion of Heuts good governance is about aligning the objectives of the company. Is the objective long-term or short-term, financial, societal or sustainable? Team cohesion in finding each other in a common goal should be balanced in bringing different points of view to the table. In general, diversity is about inclusion. How do we include our Chinese colleagues in decision-making? How do we include new technology thinking in our board? Diversity from a board perspective is to think about capabilities and personalities and on how to manage the board so that diversity can optimally enhance performance. It is about how you can make all the voices heard.
‘Principle based regulation is harmonizing around the globe’
Christophers experiences principle based regulation is harmonizing around the globe. Adding the perspective of long-term value creation is going to help companies to survive. Inherently Risk Management is one of the principals for long-term value creation. We should have a conversation with the management board on their risk appetite for certain risks. The risk appetite of a company should fit in with the company’s culture and values. Otherwise management might lose touch. On the question whether one-tier board or two-tier boards are better, Christophers answers that there is no black and white to it. It is about the quality of the chair people and the quality of engagement.
Break out sessions
During small interactive sessions a couple of themes from the Corporate Governance Code 2016 was discussed more in depth. If you wish to read more on how to apply the rivised Dutch Corporate Governance Code, please follow the button on the right.
If you wish to read more on the topics that were discussed in the break out sessions, please scroll down to one of the themes:
- Culture & Leadership
- Risk Management
- Internal Audit
- External Audit
- Board Diversity
- Balanced Remuneration
Long term value creation
Keynote Maurits Hendriks
‘Everything we do goes back to a framework of values’
According to the Chef de Mission for NOC NSF, sport brings out some very knowledgeable aspects of society. “We do not have a commitment to treat everyone equal, which is probably important in your environment. Sports are about winning. Our ambition in the Netherlands is that we want to be the tenth best country in the world. To reach this we built a framework of values and everything we do goes back to that framework.” The other framework comes from the international community.
Long- versus short-term
The long-term goal for Hendriks is to convince a young generation to strive for excellence. But: “I will only be allowed in this team as long as the short-term performance is okay. As a coach you are not allowed a lot of errors, neither are you allowed a lot of efforts in long-term perspective. I can illustrate this with swimming. Let us say the podium was missed by 0.12 seconds. For me this delivers a dilemma: to help close the 0.12 seconds gap to the podium is far more expensive than to fund a young group of 5 athletes for 4 years. Do I focus on the short-term or on the long-term by funding the young athletes? I will only be able to continue the long-term goals if I have a backing by the board.”
“A crisis develops in such a lightning speed these days that you won’t have time to check the plan. In today’s society you have an automatic reaction in a crisis that if the victim is a person, you as an organization are accountable and the head of the organization is publicly responsible. This is a personal dilemma, because your decision will affect the personal environment. This makes decision-making very difficult. If you want to handle a crisis and want to stick to the framework, then, as I have learned the hard way, your only chance is to have personal credibility as a leader. You also need to get very good in back-to-front planning: that means brainstorming about a dilemma and trying to think of the reaction of our country ahead of time.”
Recap break out sessions
Leadership & Culture
‘Include cultural differences and listen to employees’
How can non-executives effectively encourage and supervise the development of a transparent culture? One of the participants in this session stated that in order to engage and make this actionable, it should be on the board’s agenda. Awareness is key. Also, according to another participant, cultural differences need to be aligned in order to create long-term value internationally.
The question was raised how long-term value creation can be linked to culture, and in what form (monetary, structural, sustainable). One of the participants claimed that: “culture can be best described in terms of what board members will do in case of stress. Whenever a firm is in distress, the true colors of the board can be identified.” Someone else added that: “there needs to be a basis between the two-tier boards of trust before we can achieve added-value for the firm. This needs to be closely linked to Risk Management, not from a ‘police officer perspective’ but to attribute to a common goal, thereby focusing on transparent dialogue.”
Atmosphere of openness
How can the board create an atmosphere of openness, where employees can engage in honest discussions on the impact of their decisions and behavior? The participants in this session state that the board should make clear how it defines ‘transparent culture’ and should define the cultural differences within the company. For instance: a Chinese ‘honest’ discussion can have a different meaning than a Dutch ‘honest’ discussion by means of showing potential disrespect. A tip shared with the group regarding transforming the code of conduct was to include cultural differences, listen to employees and their preferences and, from a supervisory board function, align your views with the board of directors of the firm.
Tone at the top
What could help is making team-members fill out an independent questionnaire that gives insight in their perception of how they act towards each other. Trust should be the basis of this. Overall tone at the top is considered the best way to implement the local cultural aspects. The discussion on leadership & culture ended with a reflection on how non-executives can be both challengers and guardians at the same time.
‘How to frame a risk strategy is difficult’
In this session the participants discussed what 'risks associated to the strategy' mean for their organization and how they intend to deal with these risks. Risks associated to the strategy are defined as risks linked to fulfilling the company’s strategy. The revised Code more explicitly mentions these risks, however, they were already mentioned in the previous Code.
The participants state that dealing with these risks depends on the quality of the ‘breaks’ the organization has; ‘high quality breaks’ allow for more risk taking. E.g. the better the controls you have in place the more risk can be taken. To the participants it is important, however, that the company stays flexible, despite the controls in place. Therefore risk thresholds should not be zero: having two or three3 incidents a year is fine. The participants indicate to be afraid of causing too much red tape instead of raising a discussion on possible risks.
One of the participants says that boards tend to take quite a long time to formulate a strategy including strategic risks and even then the result is often highly abstract. Another participant shares that in his experience it depends on the type of business how risks are being dealt with. Either a board meeting starts with risk management, or it is of minor interest to the board. Family owned companies tend to have a more strict risk management policy than other types of business. In general they share their strategy with their clients and therefore risk management is important to the company, because it enables guaranteeing a certain quality.
Another question is to what extent the risk appetite is defined in the organization. Do you feel that there is strong alignment between supervisory board and management board on what risk appetite is? How to frame a risk appetite is difficult. Many companies struggle with how to report on their risk appetite. When you are too open about it the competitive advantage is gone, you don’t want your competitors to know everything about your company. 90% of risk management is about handling opportunities; only 10% is a real threat. We should however be prepared: the ‘black swan’ is out there.
’The position of IA is strengthened by the revised Code’
The position of the Internal Audit function is strengthened by the revised Corporate Governance Code that states explicitly what should be monitored, who to report to and what obligations the supervisory board has towards the management board. The relation with Risk Management and the role of Internal Audit within the governance system is clarified, with the purpose of making an impact that matters.
According to the participants in this session the Internal Audit function should above all be familiar with the operational management within the company. To ensure the knowledge of operations the Internal Audit committee could be put together as a multidisciplinary team. In addition to this it is not uncommon to rotate the function (within a group). This enables a more flexible way of organizing the Internal Audit function.
The participants are interested in how to ensure the independence of such a rotating Internal Audit function. In the end this comes down to a state of mind: formalizing the function is possible, but eventually it should be part of the corporate culture. The CFO could take a leading role in this. One of the preconditions in making this work is that you can tell your boss’s boss that he does not have the right processes in place. It comes down to approachability. If you can manage to organize this in an effective way you are half way there.
Culture is an important aspect of an effective Internal Audit function. Try to create the willingness to improve the company amongst your colleagues, let them think along with Internal Audit. In practice this turns out to be rather difficult to achieve. One of the participants suggests using case discussion of companies with comparable commercial circumstances in order to enable a discussion on dilemmas. For Internal Audit it is important to take up an equal position, to avoid resistance from the other functions. Continuously engaging in the dialogue is important.
The discussion moved to the relation between the Internal Audit function, the management board and the regular audit committee. The Internal Audit function now reports directly to the management board where as in the old Corporate Governance Code it reported to the audit committee. In practice this is still the case for many companies. Finding the right balance in dividing responsibilities is important.
‘Adding more rules is not the solution’
The participants discussed how to link annual financial reporting with long-term value creation. Most participants agreed that External Audit is mainly backward looking and, in general, focuses on a twelve-month period. Therefore long-term value creation is beyond the formal role of External Audit and the auditor will need to focus on new techniques, like data analytics.
In linking the financial reporting to long-term value creation we should be critical about what should be included in the annual report. What information is really relevant and what information do shareholders really need?
The participants state that the current set of rules is too complex and that adding more rules is not the solution. Because the supervisor (AFM) has become stricter the external auditor is more afraid to make mistakes, however the external auditor should perform more than just a tick the box exercise. It is suggested that de auditor should focus on a few specific topics as proved by the management of the company. Eventually it is the management that is responsible for the processes and controls. Someone else states that the external auditor should step up in determining the effectiveness of controls, in that way the auditor can truly add value. On the other hand, when the Internal Audit function is of high quality a reviewing role of the external auditor will do.
The second question raised was how Internal and External Audit can interact and increase each other’s effectiveness. Most participants agree that Internal Audit can increase effectiveness of the External Auditor, given that the internal function has an independent mind set and that the corporate culture supports proper monitoring. However, IA and EA should be better aligned in focus and expertise. In general EA has a better expertise on IT audit. Some participants state that EA is a burden for IA.
Focus on big data
The last topic that was discussed was the role of the external auditor in monitoring the effectiveness of the system of internal controls. Participants state that the business should take responsibility of internal controls. The EA could have added value if they would judge the culture and check & balances in place. Some participants question whether EA should be the one to judge the culture of a company. The most important enabler for effective internal control still is the tone at the top within the company. The EA and supervisor (DNB) have the tendency to look to closely at a company; the EA should focus on big data instead.
‘Safeguard different views being taken into account’
One of the participants in this session shared its experience with gender diversity in its own board. Apparently, in The Netherlands it is harder to find women for the board then it is in, for instance, in the US, UK or Scandinavian countries. Another participant stated that if the population in the lowest echelons is not 50-50, it is harder to achieve that in the top echelons.
Another important aspect that was discussed is that one woman does not make a difference. It is more difficult for women to speak out and make decisions if they are the only female director in the board. Therefore, they need other women to speak out. Furthermore, in line with that, it was discussed that it is important to have more than one female director for the appointment of other female directors in the future, because if a company does not have any female directors, it is hard to determine what makes a woman perfect for the job.
Looking for the right person
One of the pitfalls of the discussion was that diversity was mostly addressed as gender. However, it is also about skills and looking for the right person for the job instead. One of the reasons mentioned is that it is easier to address diversity in terms of gender than in terms of other aspects. One of the participants shared that if the board is more masculine than feminine, the board has a need for input from women. However, the more masculine the board is, the more difficult it is for the board to give women an arena to share their views. Therefore, we need to take one step back and start with the question how the board could be composed in such a way that women will also get the chance to share their views and thoughts. The role of the chairman was discussed in this regard. The chairman has to supervise and safeguard different views being taken into account in decision-making.
‘Executives should have a vision on their own remuneration’
The Code asks for a remuneration policy that is linked to long-term value creation. How do you translate this into KPIs? How many KPIs do we need? Which KPIs should this be? Should there only be financial KPIs or should there be a focus on for instance sustainability goals?
One of the participants of the session shared that in theory this idea sounds good, but in his experience “when financial KPIs are not met, you can forget about the other KPIs.” Another participant suggested that KPIs should be ‘sustainable adjusted’, so that financial KPIs are combined with sustainable KPIs. In that way the bonus is not only dependent on financial KPIs but will always be linked to sustainability goals.
Two things are important in this part of the Code: a focus on accountability, and translating the remuneration focus in long-term value creation. In doing this, the Code asks for an indication of the ratio between the remuneration of the (non-) executives and a representative group within the company. The participants discussed what a representative group would be. Is this the group with the lowest wages? Or should we look at the median wage? Someone even suggests that focusing on the lowest wages could lead to more work being outsourced in order to raise the wages of the referral group. They agree that it is essential that executives have a vision on their own remuneration. The participants state that this rule is a typical Dutch phenomenon. Raising the discussion is good, but forcing it by legislation is not necessarily the right way to go.
One of the participants suggested that long-term value creation is not only about shareholders and therefore the KPIs should also not only be about financial value creation. Why not include customer satisfaction and employee satisfaction as KPIs? If a CEO is more oriented towards the stakeholders it will translate into the financial performance of the company. In addition, giving employees a sense of ownership of the company is also a very important driver for performance. However, this always depends on the life cycle of the company. For a young company the experience of the CEO will be very important and the focus would naturally be on financial performance. But as the company evolves sustainability becomes more important. Embedding sustainability goals will ultimately enhance financial performance. The participants concluded that the feeling of ownership would probably have a bigger effect on performance than earning a bonus.
Boardroom dilemmas & good-practice interventions
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