Corporate directors monitor the tone at the top. Since I began serving on corporate boards 10 years ago, I have repeatedly heard the corporate pundits and gurus emphasize that monitoring the tone at the top is among the corporate director’s primary fiduciary responsibilities. It is taught in virtually every corporate governance seminar and conference. Clearly, monitoring the tone of the C-suite is paramount to effective board performance.
Dr. Larry Taylor
But what about the tone at the bottom?
Boards have long accepted as fact that if the tone at the top is good, then the culture throughout the organization is good as well. That is, corporate directors have assumed that the tone at the bottom mirrors the tone at the top. Corporate directors—especially nonexecutive directors—also frequently believe that they have no prudent way to monitor the tone at the bottom. Further, many directors believe that it is not the director’s responsibility to monitor the tone at the bottom because it infringes on the CEO’s responsibilities.
Many strategic and operational risks germinate from the bottom of the organization. Corporate directors are responsible for assessing the feasibility of management’s strategic plans, which entails challenging the risk assumptions. Risks related to product liability, employee loyalty, whistleblowers, shareholder activism and union relations are often related to activities at the bottom of the organization. For example, most experts have concluded that the catastrophic BP oil spill in April 2010 resulted in large part from inadequate monitoring of the tone at the bottom: lower-level supervisors and employees knew about the operational risks but did not adequately communicate that information up to the C-suite and the board.
Tone at the bottom seldom mirrors the tone at the top. Hourly employees, their supervisors and perhaps even middle managers too often have different views on incentives, fairness, values and success than the C-suite executives do. The number of employees at these organizational levels could be thousands of times more than the C-suite executives, which makes homogenous viewpoints even more problematic. The culture at the top is not necessarily the culture at the bottom. I realize that this may be a controversial statement, but it is based on personal observations from conducting hundreds of management audits and serving on boards as the financial expert. Too often senior management, let alone the board, was surprised and caught off guard by the final presentations from management and operational audits.
Upward communication through the management chain is inefficient. The more layers of management, the less likely the true tone at the bottom will reach the boardroom. Communication up the management chain is not efficient, especially with many layers. Thus, monitoring the tone at the top alone is inadequate. To quote my former mentor and dissertation advisor, the late, great management guru Peter Drucker, “Most discussions of decision making assume that only senior executives make decisions or that only senior executives’ decisions matter. This is a dangerous mistake.” Decisions made at the bottom levels of an organization create risks and opportunities. Further, it is an undeniable span of control characteristics that lower employees are more likely to avoid reporting bad news to their superiors. Thus, too often, information is distorted as it moves up the management chain.
The Board’s Role
Why is monitoring the tone at the bottom the director’s responsibility? It is inherently part of NACD’s fifth and seventh corporate governance principles: Independent Board Leadership and Attention to Information, Agenda and Strategy. These are two critical tenets of good corporate governance. Yet many believe that non-executive corporate directors are too dependent on management for information about the company’s operations.
All directors get independent financial assessment information, but few get independent operations and tone-assessment information. Many directors shy away from challenging management’s plans because they believe it will alienate the CEO; others shy away because they do not have enough information to challenge. Independent sources of information must be nurtured. A vehicle for directors to independently monitor the tone at the bottom is needed.
In 2010, more than 40 percent of corporations reported that the chairman position was separate from the CEO posi- tion—up from 24 percent in 2009. This trend clearly indicates the preference for more independence, but the independent information flow must be enhanced to make this paradigm effective.
Shareholders expect directors to monitor the tone at the bottom. An April 2011 survey of 150 institutional investors conducted by The Creighton Group Foundation found that 50 percent strongly agreed and 50 percent agreed that tone at the bottom was worth monitoring.
When interviewed by NACD Directorship (“Investors vs. Directors,” February/March 2011), Stanley D. Bernstein, a prominent litigator for shareholders, noted, “Challenging management’s presentation seems to be the weakest aspect of board meetings.” It is not enough to just monitor the C-suite. Outside directors and CEOs should receive independent assessments of the tone at the bottom in order to minimize the potential liabilities associated with litigation, regulatory fines and whistleblower actions.
So how can non-executive directors and the CEO best monitor tone at the bottom? Corporate boards should obtain independent operational tone assessments similar to the independent financial assessments that Certified Public Accountants provide. Such an engagement is not as daunting as one might expect. Many directors are unaware that independent operational assessments are already being conducted throughout their company’s operations. Management routinely engages ISO registrars to conduct independent operational assessments in accordance with international management standards. Much of the objective evidence collected can provide a clear picture of the tone at the bottom. Unfortunately, the ISO auditors and assessors are not trained to evaluate such evidence for board-level oversight purposes. Instead, the data are exclusively used to determine conformance to the ISO management standards, and the results are delivered to managers that are several levels below the board of directors.
The results of ISO-based audits and reviews, if properly aggregated and synthesized by professionals with the appropriate expertise, can provide pertinent information to the non-executive directors and the CEO. Thus, an independent, board-level, corporate-wide assessment of the tone at the bottom is primarily an aggregation and interpretation engagement. Again, only a seasoned, multidisciplinary professional with board experience can properly design and implement such an engagement. The results will help ensure that all non-executive directors and board chairs are truly independent, and are on par with the CEO in terms of tone-at-the-bottom information. This will allow them to be more effective in evaluating management’s strategic risk assumptions, and will help them to better meet their oversight responsibilities.
Dr. Larry Taylor is a professional non-executive corporate director and the chairman of The Creighton Group, a corporate governance advisory firm based in Los Angeles. He currently serves on the board of directors for OBN Holdings as a financial expert. In 2011, he earned the designation NACD Corporate Governance Fellow.