Boards Should Monitor the Tone at the Bottom

Corporate directors monitor the “tone-at-the-top”.  Since I first began serving on corporate boards ten 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 responsibility.  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.   However, what about the tone-at-the-bottom?

Boards have long accepted as fact that if the “tone-at-the-top” is good, the culture throughout the organization will be good.  That is, corporate directors have assumed that the “tone-at-the- bottom” mirrors the “tone-at-the-top”.  Further, corporate directors – especially non-executive directors – believe that they have no prudent way to monitor the “tone-at-the-bottom”.  Finally, 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.  Hopefully, after reading this article some of these assumptions will be seriously questioned, and possibly dispelled.

Why is the “Tone-at-the-Bottom” worth monitoring?

Because 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, whistle blowers, shareholder activism and union relations are often related to activities at the bottom of the organization.  For example, most experts have concluded that the BP Oil Spill, was in large part, due to inadequate monitoring of the “tone-at-the-bottom”.  Lower level supervisors and employees knew about the operational risks but did not adequately communicate the information up to the C-Suite and Board.

Because the “Tone-at-the-Bottom” seldom mirrors the “Tone-at-the-Top”.  Hourly employees, their supervisors and perhaps even middle management too often have different views on incentives, fairness, values and success than the C-suite executives.  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.

Because 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 characteristic 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.

Why is Monitoring the”Tone-at-the-Bottom” the Director’s Responsibility?

Because 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 over 40% of corporations reported that the Chairman position was separate from the CEO position.  This is up from 24% in 2009.  This trend clearly indicates the preference for more independence, but the independent information flow must be enhanced to make this paradigm effective.

Because Shareholders expect Directors to Monitor the “Tone-at-the-Bottom”. An April 2011 survey of 150 institutional investors conducted by The Creighton Group Foundation produced the following response to a “tone-at-the-bottom” question.

Boards monitor the “tone at the top”, but the independent assessments of the “tone in the middle” and “tone at the bottom” are worth monitoring as well.

When interviewed by the National Association of Corporate Directors (NACD) in February 2011 Stanley D. Bernstein, a prominent litigate for shareholders, said “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 CEO’s should receive independent assessments of the “tone-at-the-bottom” in order to minimize potential liabilities associated with litigation, regulatory fines and whistle blower actions.

How can Non-executive Directors and the CEO best monitor the Tone-at-the-Bottom?

Corporate boards should obtain independent operational “Tone-at-the-Bottom” 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[1] to conduct independent operational assessments in accordance with international management standards.  Much of the objective evidence collected during these audit interviews, observations, records reviews can provide a clear picture of the “tone-at-the-bottom”.  Unfortunately, the ISO auditors and assessors are not trained to evaluate the evidence for Board-level oversight purposes.  Instead the data is 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 “tone-at-the-bottom” assessment is primarily an aggregation and interpretation engagement.  Again, only a seasoned multi-disciplinary 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 risks assumptions and will help them to better meet their oversight responsibilities.