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Corporate Culture and the CFO

September 3, 2015

 

The intangible enigma

Much has been written about the role intellectual capital plays in the long term value creating capabilities of companies, and the weakness of traditional accounting and reporting practices in describing and measuring the intangible assets of the organisation.

For example, it is widely accepted that the book value of the company does little to illustrate the true value of the human capital, customer (relationship) capital, and infrastructure capital that can define the success of a company. These three asset classes are considered by many as explaining the missing value between market value, or stock prices, and the book value of the company.

Facebook provides a good example of the unrecorded value of the intangible assets of the firm. As of May 27, 2015 Facebook’s market value was over six times its tangible asset value. This “missing value”, to a large degree, represented the market’s estimation of Facebook’s stock of intellectual capital that is not captured in its financial statements. This is not the exception but rather the rule in financial reporting and illustrates one of the major limitations of the current financial accounting model. While new frameworks like the Integrated Reporting Framework of the International Integrated Reporting Council (IIRC) are emerging to help companies understand and communicate their value creating capabilities, many of the intangibles unpinning the productive capacity of companies remain enigmatic and often not considered as falling under the management purview of the finance function.

Once such example, which is now the subject of increasing interest among accounting bodies and accounting practitioners alike, is  the concept of “organizational culture”. More specifically, the role that organisational culture plays in achieving strategic and financial goals;   the impact of a mismatch between organisational culture and achieving corporate objectives; the challenge of cultural change; the impact on the bottom line of getting the culture wrong;   and ultimately, the role of the senior finance executive can play in ensuring that the corporate culture aligns with the overall company strategy.

 

Why organizational culture matters....not only self evident

While many have recognized that the organisational culture of a company is the intangible ingredient that can make or break its ability to achieve its goals,  (A 2015 CFO Alliance survey shows that 95% of US senior finance executives believe that getting the organisational culture wrong will impact the bottom line),  the concept of “organisational culture” itself remains difficult to define.

Researchers have identified  over 100 dimensions associated with organizational culture, such as “rituals” and “structures” to abstract ideas such as “warmth and employee satisfaction” explaining why organisational culture as a whole is often un-measured and consequently, un-managed. In their 2013 global survey of 2,219 corporate respondents, Strategy& (formerly Booz & Co.) found that 60% of executives felt that the culture of their companies was more important than their strategy or operation model, 45% indicated that their culture was not being effectively managed,  and 51% saw a need for a major cultural overhaul in their organisations. (Culture’s Role in Enabling Organisational Change. Strategy& 2013)

According to Dr. Ajit Kambil, global research director for Deloitte’s CFO Program, the role of the CFO in defining organisational culture is broad.  “First,  culture is ultimately an aggregate of the number of different beliefs that are tacit in an organization, he explains, so the CFO needs to understand the shared beliefs between the finance function and the organization.  Naming the beliefs, he notes, is especially critical for CFOs who are in the process of managing change. If those behaviours are leading to outcomes that are undesirable, the CFO needs to ask, “What is not working, what are the behaviours that lead to the undesirable outcomes, and what can be done to change behaviours?”

At the company level, says Kambil, the CEO and the CFO have to work together on this. “ Hopefully, the CFO will have a strong enough relationship with the CEO to have a deeper conversation about beliefs that lead to behaviours that are hindering the company’s growth or performance. “ Second, “I think CFOs have a huge role to play in providing the hard data that allows the leadership team to build the case for culture change.  By that, I mean they can identify the measures of why existing beliefs no longer serve a company well, for example, showing how the costs of having four ERP systems instead of one are impacting the quality and sharing of information, salaries, bonuses, motivation and other drivers of business performance. And the CFO can help the organization imagine what it could do with the resources or funds freed up by changing beliefs that are not serving it well and may, in fact, be hindering performance.”

It is therefore not unlikely that the task of measuring organisational culture in quantitative terms may also wind up under the purview of the finance executive - falling under the often quoted golden rule “you can’t manage what you can’t measure”. To this end, there are a wide variety of suggested tools and frameworks that can be applied to help understand the effectiveness of organisational culture and its impact on the bottom line. For example, the ACCA identifies six separate cultural scenarios to help define a company’s internal operating climate, namely the degree to which the company would fall into the categories of :  Innovation vs Control; Loose Rules vs Tight Rules; Challenge vs Conformity; Open to mistakes vs Zero Tolerance; Qualitative Measures vs Quantitative Measures and Risk Seeking vs Risk Avoiding. In contrast, noted expert in the field James L. Heskett, identifies four sources of competitive advantage underlying the culture of a company that can be systematically measured,  namely the “Four R’s: referrals and retention of employees measured by recruitment of new employees through referrals,  returns to labour measured by revenue per unit of compensation or labour productivity,  and relationships with customers measured by customer loyalty and referrals of new customers by existing ones. (Heskett, James L. Manage the Culture.  The World Financial Review. Sept-Oct 2011).

 

Jung, Tobias, Tim Scott, Huw Davies, Peter Bower,  Diane Whalley, Rosalind McNally, and Russell Mannion, Nov/Dec 2009.  Instruments for Exploring Organizational Culture:  A Review of the Literature.  Public Administration Review.  1087-1096

 

 

 

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