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Devastating Reputation Failures: Paper summary

Devastating Reputation Failures: Paper summary

1.1 Background

Our firm has been working on this paper for the past five months, sparked by the revelations from a variety of significant investigations recently, including the Financial Services Royal Commission.

We seek to understand why these catastrophic reputation-damaging events have happened to major companies over many years, and what boards can do to ensure they do not happen in the future to the same extent.

We have read all the relevant material on these topics from experts around the world, and spoken to a large number of influential Chairs, directors and other knowledgeable people on these topics.

We have also drawn from the extensive research our firm has undertaken over the past five years on the topic of how the best boards in the world go about their work.

We wrote a paper based on this previous research several years ago titled “Board Focus for Long-term Success” which you can find on our website.

The work we have done over the past five months reinforces what we have learned over the past five years about what boards need to do to build the ingredients of long-term success into their organisations.

This summary is an extract from our full report which you can read here.

The full paper covers the following topics:

  • What is reputation and how important is it?
  • What are the major reputational risks?
  • The impact of the next generation and social media on reputation
  • Examples of the impact of reputational crises
  • Why are these risks not managed effectively?
  • Key areas that boards can focus on to build and maintain a strong reputation
  • The benefits of creating a new, overarching role – the Chief Reputation Officer – that oversees all matters relating to reputation.

This summary focuses on the last three points. But first – what do the best boards in the world focus on.

1.2 What Leading Boards Focus on Globally to Deliver Long-term Sustainable Success

In summary, our previous paper outlined that the companies which have thrived over the long term have the following in common:

  • A very strong purpose
  • A long-term perspective
  • A balanced view of who the key stakeholders are
  • Leaders at board and executive levels with the appropriate experience, knowledge, character, values and mindset
  • Leadership that is obsessed with delivering customer value
  • Driving a very strong innovation culture which focuses on customer needs and improving internal systems and processes
  • Leadership that is focused on developing a new generation of leaders
  • An “always on” strategy mindset and process
  • Active management of a very strong culture, underpinned by aligned remuneration and measurement systems.

Boards have a major role to play in all of these points.

It is clear from the recent major investigations, and reinforced by our work, that many major companies do not have all, or in some cases, some, of these ingredients in place today.

One of the reasons for this is that many boards have a narrow view of what their role is.

The conventional view of the role of a board as described on the AICD website is:

  • Overall organisational performance: ensuring the organisation develops and implements strategies and supporting policies to enable it to fulfil its objectives
  • Overall compliance/conformance: ensuring the organisation develops and implements systems, processes, and procedures to enable it to comply with its legal, regulatory and industry obligations – and ensure that the organisation’s assets and operations are not exposed to undue risks.

Boards need to do all of this, but we would add one important additional role for a board based on our research of leading boards:

  • Build and sustain the conditions for long-term success.

This additional area of focus highlights the importance of a board:

  • Establishing a powerful purpose
  • Developing and applying a long-term perspective
  • Balancing the needs of all stakeholders
  • Recruiting and/or developing directors, CEOs and C-Suite executives who have the necessary experience, character and values to build and sustain strong performance levels and cultures, and
  • Injecting a strong input into the strategic direction of the business.

The leading boards in the world do this difficult work in addition to dealing with all the usual day to day activities of most boards.

The balance of this summary focuses on why reputational risks are not managed effectively and highlights the importance of:

  • Long-term focus
  • Considering the needs of all stakeholders
  • Culture, and
  • What boards can do to build and sustain strong reputations.

We will also discuss the benefits of creating a new, overarching role – the Chief Reputation Officer – that oversees all matters relating to reputation.

1.3 Why are these reputational risks not managed effectively?

For decades we’ve trusted the current organisational and reporting structures to ensure that risks are identified, acted upon and communicated to the highest levels of an organisation so that crises are averted.  There are risk divisions, executive-level risk roles and risk committees at board level through which risks are identified and managed. 

The current landscape, which has seen numerous institutions, be they banking, religious, welfare, aged-care, brought to account for unethical practices, is evidence that these systems are not failsafe, and that often a so-called ‘fire’ has got out of control before anyone at board level has noticed or initiated remedial action. 

What is it about the current structures that have prevented boards and executive levels from ‘smelling the smoke’ sooner?

Considerable research has determined that the highest impact issues leading to reputational crises can be classified into the following categories:

  • The singular focus on delivering profit for the shareholder: the focus on profit for shareholders to the detriment of other key stakeholders (customers, regulators, staff, etc.) and the company’s freedom (social licence) to operate
  • Measurement & Reward Systems: measurement and reward systems that focus on short-term profit, or rewards that are out of the direct control of employees and therefore lead to slack behaviour
  • Culture: the withholding of ‘bad’ news for reasons of fear of retribution, or an expectation that the problem and the solution will be presented concurrently (thus, where no solution has been found, the problem is not reported); institutional conformity; a culture of denial or wilful blindness towards risk
  • Siloed organisational structures: lack of communication and information sharing across divisions or business units which prevents identification of complex risks, particularly where there is competition between divisions
  • Lack of capability, knowledge and, experience: boards and executives who lack the qualifications, personal attributes, and experience to carry out the tasks required of their role.
  • The above list goes some way to explaining how organisations, executive teams, and boards can develop a culture of denial or unwillingness to ‘think the unthinkable.’

1.4 Long-term versus Short-term

As noted above, one of the key reasons for these major reputational damaging events is a corporate focus on short-term profitability. One of the ironies of this is that this short-term focus actually damages the financial performance of the business in the longer-term.

McKinsey analysis suggests that the difference in economic profit generated is 81% over 15 years – between those companies who focus long-term and those that don’t.  

Other factors amplify many boards’ short-term focus:

  • CEO tenure is short – around four years globally – and many CEOs tend to focus short-term, often with the aim of maximising their personal remuneration, through:
    • Cost cutting
    • M&A deals – where a minority of deals add value to shareholders
  • The overall system – the market and the media, measurement and remuneration systems typically drive a short-term view as well – more often than not focused on short-term profitability.

This short-term focus colours everything in the organisation and filters through every level of the business.

Businesses live in the short-term and need to drive results tomorrow, next month and the end of the next reporting period – but they must do all of these in the context of a long-term plan.  Balance is important.

The data as outlined in our previous paper supports the view that boards that focus on the long-term produce a higher level of both profit and wealth creation than those that don’t.

1.5 Focus on all Stakeholders and not just Shareholders

Focusing solely on the shareholder is a corrosive force, and has been identified as one of the key reasons causing major reputation damaging events.  This focus is usually combined with a short-term focus on profitability.

This primary focus on the shareholder, and on profit, was popularised nearly 50 years ago by influential thinkers like Milton Friedman who argued that a board’s primary responsibility is to the shareholder. Milton Friedman outlined his views in a paper titled “The Social Responsibility of Business is to Increase its Profits” printed in the New York Times on September 13, 1970.

That may have been an appropriate view 50 years ago – but it doesn’t cut it today.

There is now a mountain of evidence of damage done in a pursuit of profit that neglects or damages other key stakeholders – examples of these are set out in Section 6 of our full paper.

There needs to be a balanced focus on all key stakeholders for the following simple reasons:

  • You can only create shareholder value in the long-term by creating value for customers
  • Since most businesses today are service businesses, you can only create long-term customer value through your people
  • You can only create long-term shareholder value if you sustain your right to operate – and minimise regulatory burdens – if you treat the regulators as an important stakeholder in the business
  • You can only survive in the long-term if you behave socially in a manner that people:
    • Want to buy your products and services
    • Want to work for you
    • Want to buy your shares and
    • Are happy for you to be part of the broader community.

The evidence is clear that doing all of these things well delivers significantly more profit in the longer-term.

1.6 The Importance of Culture and Leadership Capability

There is a vast mass of data available that shows that cultures are formed by the values and behaviours of the leaders – including the board, and especially the CEO and senior management – of the organisation and reinforced down throughout the entire business by its organisation structures, measurement and reward systems.

I have much experience in assessing CEO and other senior candidates.  An observation I would make from doing this work for 15 years is that many boards are very focused on the person’s track record and historical performance, and less focused on their character.

The lessons in recent years are that boards need to have much more focus on the character and values of the key people in the business.

This is very important since culture flows directly from:

  • The tone set by the board’s focus – purpose, long-term, all stakeholders, what they spend their time on, measurement and reward systems they build and so on
  • The character and capability of the board – and specifically the Chair
  • The character and capabilities of the senior executives chosen by the board
  • The measurement and reward systems agreed by the board

The turbocharging effect of a weak (or purely profit-based) purpose, short-term focus mainly on profitability, ineffective or self-centred leaders, both at the board and executive levels, and a weak culture reinforced by misaligned or poorly aligned measurement and reward systems, are the root causes of the catastrophic reputation failures we have witnessed in recent times.

1.7 What can Boards do to Build and Sustain Strong Reputations

A key requirement for change is that boards need to refine their role to include board-level responsibility and accountability for building the conditions necessary to deliver long-term sustainable success and a strong reputation. These conditions include:

  • A very strong purpose
  • A long-term perspective
  • A balanced view of who the key stakeholders are (this includes not paying undue attention to the few but large, noisy, short-term investors who perennially push management and the Board for short term gains)
  • Leaders at board and executive levels with the appropriate experience, character, values and mindset
  • Leadership that is obsessed with delivering customer value through driving a very strong innovation culture
  • Leadership that is focused on developing a new generation of leaders
  • An “always on” strategy mindset and process
  • A very strong customer-focussed culture underpinned by aligned remuneration and measurement systems.

Boards need to assess all of these attributes that deliver long-term success, and put in place work programmes that deal with any identified shortfalls.

We have identified that some major companies globally have created a new role – Chief Reputation Officer – who can work directly with the board and C-Suite to implement the changes required to underpin a strong reputation.

Imagine a role that carries the explicit expectation that the incumbent will ask the difficult questions and will put in place systems that reward others for highlighting unpalatable truths – and who has the direct link to both the CEO and the Board.

In short, if we imagine a role that carries the responsibility for building and protecting the culture and reputation of the organisation – would that go some way to ameliorating the structural problems that have prevented many boards from ‘smelling the smoke’ until now?

1.8 Conclusion

Our hope is that this work can stimulate thinking at some of Australia’s major boards, which leads to changes being implemented that reduces the risks of further reputational damaging events.

The full paper has a great deal of background information for those interested in reading more on these topics.

This full report can be accessed here.

Author(s)

John Colvin, Elizabeth MacGregor

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