Leadership and Risk Culture

In an increasingly volatile world there is arguably no more important role for senior leaders than to prepare their organizations for risk – taking it, avoiding it and managing it.  This was apparent before, during and after the 2008 financial crisis. Some organizations were ill prepared to manage the risks they had built up over the previous decade of dramatically expanded leverage. They either failed or were badly damaged by the financial markets meltdown and subsequent recession. Others had recognized the risks and had either avoided them or developed robust coping structures, systems, processes and cultures that allowed them to survive or even prosper when the immediate crisis was over.

There were many differences between those organizations that collapsed or were badly hurt – the “failures” – and those that survived and prospered – the “successes.”  We conducted an exploratory study of leadership during this time and concluded that the differentiating factors could be found in those organizations’ risk prediction and management competencies; character of their leaders; commitment to hands-on leadership, especially with respect to the risk management function; their management cultures, and other factors.

In the years following our work, we looked at what organizations are doing to manage risk, taking into account that certain types of risk are Black Swans whereas others are — more or less — predictable. Organizations face different types of risks:  strategic, operational, market, liquidity and credit risk, as well as reputational risk from the non-fulfillment of a brand promise.  The only defense against such Black Swan risks is to build organizational structures, systems, processes and cultures that can allow the particular company to weather such storms.  

Since we are case-writers and teachers, we have the opportunity to develop teaching materials that address risk management as well as discuss them with many audiences: executives, lower-level managers and MBA/EMBA students, both in Canada and elsewhere.  Two extensive case studies in particular have given us some deeper insights into what leaders can do to establish and maintain effective risk-management cultures:  Risk leadership at TD Bank Group, and Maple Leaf Foods Inc.: The Listeriosis Crisis.  We discuss these cases briefly in this article, along with their implications for leadership, especially the development of comprehensive and robust risk management cultures.
 

 Figure 1:  Case Studies in Risk Leadership
In both of these cases the senior leadership, led by the CEOs and fully supported by their management teams and boards of directors, created and sustained strategic risk cultures that have had a powerful influence on risk-related behaviors at all levels in the companies.  These new risk cultures were built on existing risk practices, processes and systems that had proved wanting under severe stress.  In both cases these new cultures represented significant organizational changes, led from the top but reinforced through new structures, processes and systems, and congruent behaviors that cascaded throughout the leadership ranks.

Under CEO Ed Clark’s leadership, TD Bank:

• Pursued profitable long-term, institution building consistent with his views about stewardship, leaving an organization in better shape when he left it than when he had found it, and not pursuing fads and short-term opportunities at the expense of long-term growth
• Developed and promulgated a risk appetite that had three fundamental pillars:  not taking risks you don’t understand and can’t control; not taking long-tail risks with low probabilities but very severe consequences; and not taking risks that could result in serious reputational damage to the bank, its brands and its franchises
• Explicitly targeted a mix of 70 percent retail/30 percent corporate and capital markets banking.  In pursuit of this goal the bank intensified activity in Canadian retail through extended hours and convenience banking, and started to acquire banks in the Northeastern U.S. (Banknorth), then the tri-state area around New York (Commerce Bank of New Jersey), and then with selective acquisitions in the Carolinas and Florida (South Financial Group).  These were careful acquisitions, made over time and based on sequential learning where the acquisitions could benefit from superior TD Canada Trust management, systems, processes, etc., as well as a stronger balance sheet
• Made major investments in TD Ameritrade, a business that he knew well through TD’s experience with Internet banking (TD Greenline). TD also bought Chrysler Financial, again a business (automobile financing) that they knew well and with which they were very comfortable
• Avoided sub-prime lending either in Canada (where it was, in any case, highly unusual because of the structure of the Canadian mortgage market, government insured mortgages, etc.) or the United States, in which it was becoming very common and which turned out to be the epicenter of the 2008 financial crisis
• Avoided investment in or trading of third-party, asset-backed commercial paper other than a very limited amount for its internal, treasury needs
• Exited the profitable but very high-risk structured-products field
• Talked constantly about the bank’s risk appetite, what they were doing to ensure that they complied with it, what successes they were having
• Instituted formal executive- and management-development programs, in which risk strategy, management and the role of senior managers and executives as risk leaders were addressed and discussed with more than 800 senior leaders, and which formally cascaded down to lower-level managers and non-managerial employees. The CEO personally participated in the vast majority of these programs        
• Avoided strategic drift or muddying the message by not pursuing high-risk strategies in emerging markets or unfamiliar geographies
• Instituted formalized risk governance and risk management systems, starting in 2002 but evolving to very highly sophisticated levels by 2011
• Understood and appreciated the value of regulation and worked proactively and effectively with regulators, thereby extending his influence within the financial community
• Built up the bank’s Tier 1 capital reserves in anticipation of tighter Basel regulations.  This meant restricting dividend growth at a time when some of his competitors were increasing their dividend payouts
  

• Defined its risk appetite – zero tolerance for pathogens in products – while nevertheless recognizing the ubiquity of certain pathogens in plant environments
• Established control systems with strong management oversight, locally and corporately, as well as good governance through the Environment, Health and Safety Committee of the board of directors
• Created a new position, Senior Vice-President, Food Safety, and hired a high-profile, dedicated leader with a direct reporting relationship to the CEO. It incorporated a matrix of the food safety role into the plants’ operations and provided the leader with adequate resources, even during hiring freezes when it had imposed very tight expense controls on all other functions
• Spoke about, wrote about, and blogged about food safety leadership as a strategy not just in the immediate, post-recall phase but for years afterward.  The CEO and senior leaders became very visible in video messages, meetings, conferences, leadership development programs, press briefings and other venues
• Mobilized an increased industry focus on food safety by organizing conferences and other events that were attended by customers, suppliers, competitors and regulators
• Took appropriate disciplinary actions in those very rare situations where employees, at any level in the organization, breached food-safety protocols
• Worked with regulators, proactively, to improve the national food-safety system
• Beefed up centralized oversight of food safety while keeping responsibility at the local plant levels.  The plants clearly understand that they “own” the risks but that they are now centrally controlled, tracked and reported
• Showed integrity when it came to executive compensation.  The consequences of the 2008 Listeriosis incident were reflected in significantly reduced leadership pay, bonuses and stock price; there was no re-pricing of share units or options or adjustment of short-term bonuses because of this incident
  
  

  
  

Establishing and Maintaining Risk Cultures
By these actions, the leaders at both TD Bank Group and Maple Leaf Foods were re-engineering the cultures of their organizations with respect to risk.  By culture, we refer to the shared assumptions, values, beliefs, and behavioral norms as they relate to risk management or, in a more colloquial way, “how things are to be done around here” when it comes to managing risk. The culture of an organization manifests itself in various artifacts that can be seen, felt or heard, including but not limited to behaviors or patterns of interaction, language, emotion, stories, structures and systems, rituals or ceremonies, and so forth.  In Figure 2 we represent the establishment and maintenance of a strategically driven culture as a set of five activities:

Think it
Cultures are dynamic.  They develop “because of the way things have been and are done.” The culture that exists at time ‘t’ has been shaped by what was done at time ‘t-1,’ and influences what will be done at time  ‘t+1.’  This is why strong cultures that bind people together can also blind them to realities and possibilities as well as hinder organizational change, in particular when the organization has a track record of success or has to deal with a crisis. For example, success, greed and malpractice eventually pushed organizations such as Enron, Global Crossing and WorldCom into bankruptcy.  

But cultures can be deliberately created by leaders who recognize the strategic necessity of cultural change.  The new cultures conceived and implemented at TD Bank Group and Maple Leaf Foods were soundly based on strategic thinking and recognized the advantages of strong risk identification and management cultures.   Such purposive cultural changes, of different types, have taken place in other organizations such as IBM under Gerstner, GE under Welch and Immelt, Google under founders Brin and Page, Southwest Airlines under Herb Kelleher, and Apple under Jobs – at least the second time around.   Leaders indeed set the tone for culture and the entire organization’s behavior.

The deliberately thought-through culture, as contrasted with one that is merely emergent, addresses several things: why the particular culture is being established, who is expected to lead and promulgate the culture and whom it is intended to embrace, what it will mean in terms of congruent behaviors by both leaders and followers, when cultural change efforts should be made and how the cultural changes will be introduced, enabled, enforced, monitored and celebrated.

Talk it
In an incredibly noisy world, any message has to be clearly articulated and forcefully communicated, repetitively, in multiple media – speeches, presentations, social media, webinars, articles, interviews, on-campus appearances, published case studies, broadcasts and narrowcasts.  Leaders must recognize that they will be bored with their own voices before most people have even heard their messages.  An analysis of the speeches and interviews done by long-serving leaders who have changed their organizations’ cultures will demonstrate an incredible consistency of messaging with constant reinforcement of key themes.  

But communication has to go beyond mere message repetition.  If a statement of a desired or targeted culture is to be effectively heard, understood and then applied, the targeted recipients of the message must be able to “make meaning” of it in the contexts within which they work.  For example, there must be complete clarity on the required behaviors that support the espoused culture and therefore the organization’s strategy.  Or, if “transparency” is a desired component of a risk culture, then an executive in the audit function would need to do some specific things to truly live that value, as would a human resources manager and an operations manager. 

Communication has not really taken place until everyone understands what the implications are for them and just how they will do things differently in the future.  So, the management structure and processes must be used to ensure that training and development, department meetings, performance management, coaching and mentoring are all used to ensure that people “get it.”  Directions must be clear enough to provide guidance in decision-making and behavior.

Walk it
The desired culture, however, can be undermined unless supervisors, managers, executives and especially the CEO are seen to be “walking the talk.”  It’s axiomatic that the more specific the message about the desired culture and the higher the bar with respect to expected conformity, the greater the cost for a leader who deviates from the message.  

Culture can be extraordinarily fragile in the face of unsupportive leadership words or actions.  If a CEO decides to create a culture of constructive dissent then he or she must be prepared to invite and welcome such dissent, listen to it and recognize the value of the parties who are dissenting, even if their dissent does not carry the day.  They must deal with those leaders below them who do not adopt similar behaviors, even if they get great results from a more autocratic behavior.  In short, the senior leader must not only walk-the-talk but ensure that others do so as well.  

Critical to this task is the responsibility to ensure that there are organizational rewards for culturally congruent behaviors and sanctions for those that are not aligned.  This is a tall order.  As part of our research on the financial crisis, we heard numerous stories about managers and employees being let go from the organization because they asked their leaders and managers difficult questions, believing that the essence of risk management is asking an appropriate question.  Risk management will suffer if there is not an espoused culture of constructive dissent.   Most important, in our experience, is the hiring and promotion of certain people into leadership roles, because they send potent signals to others about what senior leaders really value.  

Reinforce it
Everything that is good is usually better when it’s reinforced.  Leaders would like to create a strong culture so that employees understand what is expected of them and other stakeholders understand what to expect from the organization. When we talk about strong cultures we suggest that values are widely shared across individuals and departments and deeply held. 

Leaders of strong-culture organizations never miss an opportunity to talk about the success of their organizations and constantly associate that success with their cultures.  They positively celebrate this relationship. WestJet, with its twice-yearly profit-sharing parties, is an appropriate example.  The company is reluctant to use direct deposit for profit-sharing payments, despite its efficiency, because it eliminates the physicality of a celebration and the opportunity for senior executives to express a sincere “Thank You” to employees.   

Both TD Bank Group and Maple Leaf Foods continually reinforce their cultures at every conceivable opportunity through very high-intensity and frequent communications.

Organizations must be careful to ensure that such celebrations do not engender a sense of hubris or invulnerability.  While cultures can bind people together in common cause, they can also work those people up into a frenzy of self-congratulation or even a smugness that blunts the sensors and exposes the organization to future threats. Too often, strong organizational results act as a camouflage.  In the heady years before the 2008 financial meltdown, as long as people were making money, few were questioning organizational structure and oversight, compensation practices, and the use of quantitative models.  Good leaders are never complacent and always act with a sense of curiosity through asking questions, even uncomfortable ones.  As one bank executive told us, recently, “I get paid to be paranoid.”    

Check It
Cultures that enable strategies contribute to organizational performance whereas those that disable them diminish performance.  And, because the culture that exists today is based on yesterday’s successful reinforcement of yesterday’s strategies, it’s easy to see how culture can blind people to the need for change and prevent its effective execution.  Further, because organizations tend to hire and promote people who appear to be a cultural fit, there is the possibility of hiring or promoting people into leadership roles today who are absolutely perfect for yesterday’s challenges.

Managements, leadership development professionals and boards of directors must be thinking about how to straddle today’s actual culture with the culture that the organization needs to execute its future-focused strategies, including those that are incipient or being mooted. Unless there is some degree of fit with the present, a leader’s efforts to lead will be frustrated by potential followers’ resistance to their leadership.  But unless the leadership candidates’ competencies, character and commitment can extend to achieving success in evolving cultures, they will have limited runway.  More generally, we increasingly look for leaders with the broad bandwidth that allows them to adapt to uncertain futures and those as-yet unborn strategies that organizations may adopt.

In a complex and ever-changing organizational environment, almost every strategy ends up with some unintended consequences; not surprisingly, not all cultures are free from undesirable consequences.  Part of the “check to proceed” element of cultural management is to ensure that these unplanned, undesired manifestations of culture are not emerging.  For example, GE implemented the practice of stretch goals. But if employees felt unsupported, feelings of burnout and resentment would likely have occurred.  So, they were careful to ensure that the “stretch” did not resemble a medieval torture instrument but, rather, became a challenge that would motivate people to achieve.  

Competitive Advantage through Culture
It has long been accepted that a culture that is aligned with strategy can be a source of competitive advantage, assuming that the strategy itself is the right one.  Conversely, a perfectly good strategy may be undermined by a misaligned culture.

In the case studies above we see companies that systematically engineered new cultures with respect to the way they handled risk.  Both have emerged as leaders in their fields, with strong brands and improving performances.  They will still be buffeted by risks in their respective environments.  If financial markets collapse again, TD Bank Group will experience some pain. 

Listeria is omnipresent in the environment in which a food processing company such as Maple Leaf Foods operates, so there can be no guarantee that a future incident could not happen. But both are immensely stronger as a result of the leadership of their respective CEOs and their management teams in developing strong, risk-focused cultures with aligned structures, systems, processes and people at all levels.  They are therefore more robust and capable in the face of both predictable and unpredictable risks.  

We suggest that there is a lesson for all leaders in these experiences, and a reminder that they should not be passive in the face of the opportunity that exists to design and implement cultures that serve the strategies they develop and execute.

Reprint from Ivey Business Journal
 

Reprint from Ivey Business Journal
[© Reprinted and used by permission of the Ivey Business School]