Top five issues for directors in 2019

Felicity Caird, GM Governance Leadership Centre, looks at five issues that should be top of mind for directors in 2019.

Directors are organisations’ stewards for the future and long-term value creation. The boards of today and tomorrow need to be adaptive to be able to lead in a complex and dynamic environment and oversee disruptive risks. These are risks that are often interconnected and generally have high speed impact and occur at scale. Geo-political volatility, cyber, disruption to business models and climate change, can all have significant economic, operational, and/or reputation impact. Adaptive governance is dependent on boards getting the right information for decision-making, and on balancing compliance with strategy and stewardship.

1. Culture and conduct

Ethical behaviour and a healthy organisational culture should be a priority for all boards.

Unethical behaviour, poor conduct, people behaving badly – whatever you call it there have been numerous cases recently, globally and in New Zealand, causing significant harm to employees, customers and investors. Corporate governance has come under intense scrutiny and been found wanting.

To show the breadth of cases, think about the Volkswagen emissions scandal, the Facebook/Cambridge Analytica data scandal, the #MeToo movement exposing widespread sexual harassment in the workplace, and the exposure of a bullying culture in the NZ Football Ferns.

In the Australian Royal Commission into misconduct in the financial sector, Commissioner Hayne found there were financial motivations at the expense of basic standards of honesty and misconduct that fell below community standards and expectations. Questions were raised about core governance issues such as remuneration, culture, accountability and risk management.

The recent report on bank culture and conduct by the Financial Markets Authority and Reserve Bank of New Zealand didn’t find widespread misconduct but did identify weaknesses that needed to be addressed immediately.

The FMA/RBNZ recommendations are good reminders for all boards to:

take ownership and accountability for conduct and culture and drive changes
be proactive and prioritise the identification and remediation of issues
strengthen processes and controls to prevent, detect and manage conduct and culture issues
ensure employees know what good conduct and culture looks like and that there are effective mechanisms for employees to report issues

ensure incentive and remuneration policies and practices support good conduct.

Boards are ultimately accountable for what goes on in their organisations. They have a core role in overseeing corporate culture, conduct risk and setting high standards of ethical behaviour. It means thinking beyond compliance, taking the lead, being committed and responsible and setting the tone and standards for the organisation.

Proactive engagement with the community and stakeholders helps build (or rebuild) trust and business legitimacy and licence to operate.

A good indicator of an effective culture and systems that are working is when the board hears about incidents, including bad news. Decisive leadership in following up on incidents and potential risks is critical.

We have seen a steady increase through the Director Sentiment Survey (since 2016) in the number of boards receiving comprehensive reporting from management about ethical matters and conduct incidents. But in 2018 more than half of the boards still aren’t getting this information. This poses a significant risk for those boards and their organisations.

Again, despite an increase, from 32% in 2017 to 44% in 2018, in the number of boards discussing whistleblowing and how the organisation can make speak-up provisions effective, there is still a way to go in embedding this regularly into boardroom discussions.

Pointers for 2019:

Set the tone – promote, inspire and embody organisational values and expected behaviours.
Embed oversight of culture and integrate into discussions on performance, strategy and risk. Probe how success is being achieved and challenge assumptions.

Ensure the board is getting comprehensive and timely reporting (good and bad news) from management (and other sources), with good measurements covering organisational culture, conduct risks and incidences. Use internal audit and board-only time to support robust scrutiny.

2. Climate change

Understand business risks relating to climate change and how to adapt to a low-emissions economy.

The increasing occurrence of extreme weather events, monster storms, severe temperatures, floods and wildfires across the world are reminders of the impact of climate change.

The UN Intergovernmental Panel on Climate Change’s (IPCC) 2018 report demands greater urgency and highlights the disastrous effects of failing to limit global warming to 1.5°C, rather than 2°C, above pre-industrial levels. The next 15 to 20 years are critical. The world’s infrastructure is predicted to double in size over the next 15 years, and the world economy to double over the next 20 years.

At the Global Climate Action Summit (September 2018) Lord Stern strengthened his 2006 position "that the costs of inaction exceed the costs of action" and described the transition to the zero-carbon economy as the inclusive growth story of the 21st century – with direct economic benefits.

The Productivity Commission’s Low-emissions Economy report (August 2018) recommended immediate action to ensure an effective transition, in relation to stronger emissions pricing, establishing stable laws and institutions and increasing investment in innovation. Following consultation on policy development earlier this year, the introduction of a Zero Carbon Bill is imminent. We can also expect the establishment of an independent Climate Change Commission and a revamp of the Emissions Trading Scheme.

Businesses have already taken a lead with the launch of the Climate Leaders Coalition to drive the reduction of emissions and help lead New Zealand’s transition to a low-emissions economy. Seventy CEOs have joined the coalition, representing around 50% of New Zealand’s emissions.

However, in the 2018 Director Sentiment Survey, although 66% of boards considered environmental and social issues to be very important to their organisation, only 29% said they were engaged and proactive on climate change issues.

Directors have fiduciary obligations in respect of climate-related risks including physical risks (eg to assets), economic transition risks and liability risks if boards fail to mitigate, adapt or disclose. Legal action is already being taken against companies and directors in the US, Europe and Australia. It is important that New Zealand directors and leaders prioritise consideration of climate change risks through mitigation and adaptation, and pursue opportunities while transitioning to a low-emissions economy.

Pointers for 2019:

Identify the material risks relating to climate change that can impact your organisation. Run scenarios with management about how things may change.
Think about the risks and opportunities in how your business can adapt to a low-emissions economy.

Focus on meaningful reporting and disclosures (eg what’s material and impactful) for stakeholders, including investors, consumers and regulators.

3. Future of work

Labour shortages, changing ways of working and the impact of technology require adaptive talent strategies.

Labour quality and capability has again rated as the top risk for businesses, and a major impediment to economic performance, in the Director Sentiment Survey. Boards need to ensure that management have appropriate talent strategies in place to ensure they have the capability to deliver their organisation's future strategy in a tight labour market, but also that they are thinking about the potential opportunity that automation can offer to combat labour shortages and productivity challenges.

Often called the Fourth Industrial Revolution, our times are characterised by a pace of change that is faster than ever, and it will only get faster. The board’s role in scanning the horizon for potential opportunities and risks has never been more important. One change that will impact almost all businesses is the changing world of work.

The "future of work" incudes consideration of the impact of technology, demographics and other factors on work, workers and the workplace. Whole jobs are disappearing and jobs are being reshaped, which is also leading to real concerns about increased income inequity and poverty.

Key areas of focus in the Government’s Future of Work forum (August 2018) were:

"just transitions" in industries undergoing structural shifts
introducing a lifelong learning approach to allow for swift training
understanding what new technology will do to work practices

lifting labour productivity.

Boards need to think about their own organisations. They need strategies to excel in these changing times, including assessing their organisation's stance on talent matters including retraining/upskilling workers, replacing workers' tasks with technology alternatives (eg automation and algorithms) and future capital expenditure as the gig economy continues to grow.

The challenge for boards is ensuring that management is looking ahead, keeping an eye on how to maximise the potential of changing ways of working and the impact of technology, while looking after their workers through the change, and assessing the potential risks that disruption will bring to organisational culture.

Questions for directors to consider as we enter the New Year:

What type of work will our organisation’s employees be doing?
What kind of workforce do we need to successfully do this work?
Can automation of some tasks help us remedy some of our productivity and labour shortage challenges?

What type of environment and culture does our organisation need to thrive in a digital and disruptive world?

Pointers for 2019:

Think about work (eg tasks subject to automation), workers (changing skills and expectations) and the workplace (locations and work anywhere) to help develop your strategic approach to investment and future needs.

Understand organisational and worker needs, and how adaptive workplace practices can enhance employee engagement, organisational performance and productivity.

Lead and monitor organisational culture to retain, retrain and grow employee talent.

4. Mental health and wellbeing in the workplace

Protecting and supporting the mental health and wellbeing of workers is not just the legal and right thing to do, it also has positive impacts on business performance and productivity.

Nearly three years since the Health and Safety at Work Act 2015 came into effect, there is an increasing focus on mental health and wellbeing in the workplace. The Act requires organisations to manage risks to workers and that includes risks to their health – including mental health.

According to WorkSafe NZ, 600-900 people die from work-related diseases every year, and 30,000 people suffer from work-related health conditions.

A 2017 Wellness in the Workplace Survey by Southern Cross and Business NZ showed wellness had a sizeable impact on the productivity of most enterprises, including the loss in 2016 of 6.6 million working days and $1.5 billion due to absence.

Risks to physical and mental health and worker wellbeing come in a range of forms, from dangerous substances such as asbestos to workplace cultures and behaviours that cause harm, eg sexual harassment or bullying. Three high-profile cases in New Zealand this year with independent reviews (into Russell McVeagh, the Human Rights Commission and the NZ Football Ferns) all found governance failings.

Our nation has deplorable suicide statistics: 606 New Zealanders took their lives in 2016/17. The Mental Health Commissioner reported in 2018 that one in five New Zealanders lives with mental illness and/or addiction.

The 2018 Director Sentiment Survey results show that during the past 12 months 63% of boards had discussed workplace mental health issues.

This year we’ve seen the launch of a Government Mental Health and Addiction Inquiry and the release of a Mental Health Guide for New Zealand Leaders, which aims to help organisational leaders enhance and protect mental health in the workplace.

It’s not just about doing the right thing so that everyone goes home safe and healthy from work every day. Poor mental health causes significant human and economic costs, eg increased absenteeism, sick leave, injuries and workplace conflict. Improved workplace wellbeing also leads to improvements in productivity, financial performance, risk management, employee retention and recruitment.

Pointers for 2019:

Lead awareness and understanding of mental health in the workplace. Reduce the stigma by normalising conversations about mental health.
Ensure management report on mental health and wellbeing, and that there are measures in place to track organisational culture (including risks, incidences and progress).

Foster more resilient workplaces where mental health and wellbeing are a priority.

5. Compliance that matters

Beware of compliance overload and ensure sufficient time and focus on strategic and performance issues.

Each year since the Director Sentiment Survey began in 2014, between 70% and 80% of directors have said that they had spent more time on compliance-related activities in the previous 12 months than in the preceding year.

The Directors’ Fees Report 2018 found a significant increase in time spent by directors on board matters, up from 106 hours a year in 2017 to 127 hours in 2018. This is up from 88 hours in 2014.

There have been increases in legislative and regulatory requirements, eg the Health and Safety at Work Act 2015, and directors also need to keep on top of complex risks such as cybersecurity and climate change.

The 2018 Sentiment Survey also shows regulatory red tape as a key concern (after labour capability) of respondents in relation to both the economy and business performance and an increased concern since 2017. Sixteen percent of directors (compared to 11% in 2017) citied regulatory red tape as the biggest risk facing their organisation. In addition 41% (up from 30% in 2017) rated it as one of the biggest impediments to national economic performance.

Organisations have mandatory compliance activities that have to be fulfilled. There are also other compliance activities that, although not legally required, are important. The challenge is to manage time and effort on compliance to ensure it adds value and is not undertaken for the sake of it. For example, the 2017 NZX Corporate Governance Code requires disclosures on a "comply or explain" basis. The value of compliance is in providing meaningful disclosures to inform investors and other stakeholders. If you can’t comply then explain why. It’s the "why" that matters rather than ticking the box for the sake of it.

Directors have a wide range of legal, ethical and commercial duties. And there can be significant penalties for breaches or failures. The Directors’ Fees Report 2018 found that only 76% of organisations provided directors with liability insurance.

Additions to that liability burden can have unintended consequences, such as deterring experienced and skilled directors from putting themselves forward to serve. For example, a current proposal by the Tax Working Group to introduce personal liability for company PAYE and GST debts is particularly concerning as it is likely to drive additional (internal) compliance and may also deter experienced directors.

Disclosure and reporting requirements for financial and non-financial information are evolving (and increasing) to meet stakeholder and investor expectations. Telling a performance story, including in relation to governance, social and environmental impacts and risk, is important to accountability and building trust and confidence. But reporting needs to have a purpose and be meaningful to the organisation, and tick-box compliance can add little value.

Pointers for 2019:

Assess the time spent on compliance compared to performance and strategy and rebalance if needed.
Ensure the board is getting the right information from management for effective decision making. Assess board papers as a whole, eg to ensure information is timely, accurate, complete and includes forward looking projections as well as trend data.
Check insurance policies and indemnities provide adequate cover for potential liabilities.

Published in Boardroom Dec Jan 2019 issue