Adapted from Cyrus Taraporevala’s 2019 letter to the Board
Dear Board Member,
As one of the world’s largest investment managers, we engage with companies in our investment portfolios as part of our fiduciary responsibility to maximize the probability of attractive long-term returns for our clients. Unlike our active investment strategies where we can sell a company’s stock when we disagree with management, in our index-based strategies we own the company’s stock for as long as it is included in the index. Therefore we engage as long-term investors through our asset stewardship practice on those issues that impact long-term value.
Our focus in recent years has been on good governance and other practices that affect a company’s ability to generate positive returns for investors over the long run. Those issues span a variety of environmental, social and governance (ESG) topics material to sustainable performance. We approach these issues from the perspective of long-term investment value, not from a political or social agenda (aka ‘values’). This distinction is especially important to understand in light of growing concerns about the influence of large index managers. It is the focus on long-term value that drives our engagement around effective, independent board leadership; board quality, including cognitive diversity enhanced by better gender diversity; and environmental sustainability.
We also believe in the importance of full transparency in terms of the issues we choose to highlight in our asset stewardship practice, why we consider them important for investors and how we suggest companies address them. We regularly publish our views on important stewardship issues, join forces with other institutional investors to document best practices, and summarize our engagements and voting actions in our annual stewardship report. We also take the opportunity each year ahead of proxy season to communicate our stewardship focus for the coming months, which is why I am writing to you today.
This year we will be focusing on corporate culture as one of the many, growing intangible value drivers that affect a company’s ability to execute its long-term strategy. We acknowledge that corporate culture, like many other intangible assets, is difficult to measure and manage. However, we also recognize that at a time of unprecedented business disruptions, whether in the form of technology, climate or other exogenous shocks, a company’s ability to promote the attitudes and behaviors needed to navigate a much more challenging business terrain will be increasingly important. We all know the old chestnut that culture eats strategy for breakfast, but studies show that intangibles such as corporate culture are driving a greater share of corporate value, precisely because the challenges of change and innovation are growing more acute.
The Importance of Corporate Culture
The global accounting firm EY recently found that “intangible assets” such as culture average 52% of an organization’s market value (and in some sectors as much as 90%). Researchers have documented that in the US and UK now, more value is driven by intangible, rather than tangible, assets. However, through engagement we have found that few directors can adequately articulate their company’s culture or demonstrate how they assess, monitor and influence change when necessary.
Investors and regulators are paying attention as well, as flawed corporate culture has resulted in high-profile cases of excessive risk-taking or unethical behaviors that negatively impact long-term performance. The Embankment Project for Inclusive Capitalism, which we participated in, found that key issues aligned to corporate culture, such as human capital management; represent important areas for value creation going forward. However, it also found that the relationship between financials and human capital issues such as retention rates, employee satisfaction, and pay differences is “not yet widely understood” and “much harder to communicate to investors than quarterly earnings.”
Indeed, we have found that boards sometimes fail to adequately ensure that the current corporate culture aligns with corporate strategy. This is especially important in times of crisis or strategic change, such as the transition of a CEO or during mergers and acquisitions or strategic turnarounds. These are critical inflection points during which a lack of focus on culture can delay, or even derail important strategic objectives and pose existential challenges for management.
Helping Boards Align Culture and Strategy
Since we recognize both the importance and difficulty of aligning culture and strategy, we have created the attached framework to help companies begin to address the issue by 1) conducting an analysis to determine whether culture and strategy are aligned; 2) implementing mechanisms to influence and assess progress; and 3) improving reporting that can help directors discuss their role in influencing and monitoring corporate culture.
To be clear, we do not believe it is the responsibility of the corporate board to manage a company’s culture – that is the responsibility of senior management. Nor do we believe changing corporate culture is easy or that there is a one-size-fits-all answer for all companies. Clearly different companies, sectors and business strategies will require different approaches. Further, sometimes indicators such as high employee turnover can actually be a sign that a much-needed cultural change is afoot.
However, we do believe that this is a material issue that must be addressed by companies and investors. By engaging on this topic in a more rigorous and structured way and by elevating these issues to boards, we believe we can help improve the overall governance quality of listed companies over the long term. As such, you should expect to discuss this issue with our asset stewardship team during their engagements over the next year. 1 Jonathan Haskel and Stian Westlake, Capitalism Without Capital: The Risk of the Intangible Economy, (Princeton University Press, 2017).
Focused on the Long Term
Ultimately, better understanding how businesses across the globe are aligning corporate culture with strategy will improve how we analyze our portfolio companies in the years ahead. We believe that at a time of historic disruption, increased focus on corporate culture and how it supports strategy is essential to sustainable, long-term value creation. That is good for investors, good for the quality of the indices on which so many investment portfolios are based, and good for our shared prosperity. Sincerely, Cyrus Taraporevala President and CEO of State Street Global Advisors
Sincerely,
Cyrus Taraporevala
President and CEO of State Street Global Advisors