Culture Guardians: Culture is central to long-term performance

The recent dismissal of James Hardie CEO Jack Truong highlights the importance of organisational culture and the responsibility of company directors. While an unplanned exit of key executives is a risk to company performance, company culture is the most critical enabler of successful strategy implementation. Ensuring a respectful and healthy working environment is essential for long-term performance. This article discusses the importance of the ‘culture guardians’ and long-term investment performance.

In January 2022, James Hardie (ASX: JHX) dismissed CEO Jack Truong due to “intimidating” and “disrespectful” behaviour, which created a hostile work environment and prompted complaints from staff.

Chairman Mike Hammes said the company encouraged Truong to change his management style, but this did not occur, and that his actions were a material breach of James Hardie’s code of conduct.

Employees raised concerns about his work-related interactions. The Board undertook extensive due diligence, which included retaining outside counsel and a third-party consultant and provided opportunities and support for sincere change in Truong’s behaviour.

The conduct, while not discriminatory, extensively and materially breached the code of conduct. Truong’s termination meant he exited with nothing more than his statutory entitlements.

Two surveys of ~40 people working under Truong found that his behaviour was intimidating, threatening and not respectful of the individual. 80% of those surveyed conveyed those concerns, while several executives told the board they were preparing to or considering resigning due to Truong’s behaviour.

Executives at risk of leaving have now indicated they will stay given the leadership changes — reducing the risk of a mass exodus from its leadership ranks. At the very least, this decision marks a clear position on poor behaviour and that the board values every employee.

In direct contradiction, the November issue of CEO Magazine placed the spotlight on Truong, highlighting the former CEOs achievements and management style. While Truong suggested that the key to his success was to “lead by example” and that managers must “empower employees to take ownership and accountability [to] foster a collaborative and engaged team environment”, the internal environment appears less promising.

It is reassuring that the Board’s actions align with their public statements that their culture is “a collective belief that we are ‘our brothers/sisters keeper”. In holding Truong accountable to his words, “value creation means nothing without a safe working environment for ALL employees”.

In this single decision, the board has upheld their commitment to their employees to “purposely choose to prioritise inclusion to promote a workplace in which our people feel they belong’’ (James Hardie Sustainability Report, 2021).

No individual is above the wellbeing of others; the company and its successes are the collective actions of all employees. While we generally view the removal of a CEO negatively and can expect some transitory disruptions, we applaud the board’s approach and transparency with the market.

Hasty Departures

Over the past ten years, investors have witnessed several boards taking steps to remove leaders that have demonstrated poor or unethical behaviour. The examples below highlight the intolerance of boards toward behaviour that are inconsistent with their code of conduct.

• David Jones (2010) fired Mark McInnes for harassment of a female colleague.
• Orica (2015) announced their leadership transition following reported accusations of the bad behaviour of Ian Smith.
• QBE Insurance (2020) fired Pat Regan for “workplace communications” that breached the code of conduct after a complaint from a female employee.
• Oil Search (2021) saw Peter Botten resign after 25 years due to health reasons; however, the ASX announcement also noted “complaints about his behaviour” and that his behaviour was “inconsistent with the standards expected by the board”.
• PolyNovo (2021) saw Paul Brennan, the head of PolyNovo, resign suddenly after concerns about his “interaction with the company’s senior management team and management style”.
• Cleanaway (2021) executed a mutual agreement with Vik Bansal to step down following complaints alleging bullying conduct.

For investors, a change in executive leadership (generally) holds more downside risk than upside risk. For public companies preparing succession plans, bringing the market along the journey while grooming the next-in-line brings stability and continuity of long-term strategic objectives.

However, when there is an unplanned departure of a CEO, one can only fear underlying structural or cultural issues. Generally, this is a reasonable assumption for investors.

In the case of James Hardie, we believe the structural integrity of the company remains intact, with the Executive Leadership Team (ELT) proving effective at providing the necessary voice for the broader employee base. This event is a cultural issue, and James Hardie has taken a stand and upheld its core values.

Typically where issues stem from ‘hard’ elements of the organisation (sales execution, lawsuits, safety violations, inadequate structures or procedures), the company is required to inform shareholders. However, in ‘soft’ areas such as culture, values, and leadership styles, these typically have been brushed aside as ‘health’ or ‘family commitments.

Since time immemorial, finding leaders with tough and uncompromising demeanours, focused on delivering and executing strategic objectives, were keenly sought. Today, companies are subject to increasing scrutiny over these softer business areas, and the modern CEO needs to manage the contemporary operating environment.

Custodians of Culture

The Australian Institute for Company Directors (AICD) and the Australian Council of Superannuation Investors (ACSI) presented findings regarding the role of the board and the importance of governing company culture. Organisational culture is the responsibility of directors, not just senior management.

Culture has a direct link with long-term sustainable operating performance. Culture is central to a company’s long-term performance, and because of this, it requires an ‘active’ and ‘curious’ board to deliver on this critical strategic lever.

Directors who are active and curious become aware of cultural problems. Too often, behind the corporate veil, bad corporate cultures and misconduct can go unnoticed. Boards that take proactive steps to respond to complaints send strong signals about their expectations for handling future incidents.

In the case of James Hardie, the board’s procedural approach to these complaints demonstrated they were active and curious as to what was going on within the company. Given adequate time to Truong, the swift and heavy hand exemplified effective board oversight and good corporate governance.

Despite this issue, James Hardie holds a strong market position with a sustainable competitive advantage, supported by favourable tailwinds within the US housing market. They have demonstrated a relentless focus on Fiber Cement, with R&D continuously improving their manufacturing process while bringing new and innovative products to market.

Covid Consequences

Businesses faced many challenges in varying parts of their organisations through the pandemic. Companies that responded effectively to the pandemic and demonstrated resilience had solid processes and procedures well before Covid-19 struck.

Operating with a clear purpose, upheld by shared corporate values, has proven vital for sustainable operating performance. Organisations that have built trusting and ethical behaviours were generally those companies that have witnessed engaged, loyal employees who understand the importance of supporting corporate integrity.

While some view values and vision statements as something posted on the wall next to the water cooler, the companies that embrace these while embedding good behaviour across all levels of the organisation benefit from better decision-making and improved business performance.

The Board and senior management are responsible for strategy and compliance oversight. The board’s role remains vital in determining best practices, and that compensation reflects the behaviours by the organisation are in line with their corporate values.

Importance for Investors

At ECP, we watch several indicators intensely to ensure that organisational disruptions do not impact the predictability of operating performance over time. These indicators include a material change in business strategy, major acquisitions, and unplanned exits of key management personnel.

The crux of these rules relates to our investment philosophy, where we seek to identify companies that have predictable earnings streams through time. These events generally result in significant disruption for the business, which elevates the risk surrounding the continuity of their operating performance, lowering the predictability of business earnings.

Our research places a keen focus on the trustworthiness of management. For us, ensuring that the company has capable, experienced, and trustworthy leadership means we can expect that they will deliver their business strategy.

For us, we must trust company executives — they are the decision-makers at the coal face. By finding management that we trust, we find greater predictability of the company’s behaviour, which reduces the risk to the firm of management’s conduct or failure of business execution.

The ability to trust allows us to accept the level of risk (investing in the company) and become vulnerable as minority shareholders (i.e., we back management). We seek executives who have long tenure and a reputation of being honest, transparent and have been integral to the company’s performance to date.

ECP believes that businesses that demonstrate inadequate corporate governance will deliver poor investment outcomes. Strong corporate governance is a prerequisite to long-term strategic plans. The board plays a central role in ensuring that all elements are considered, with culture central to any long-term strategic success.

Culture Guardians

Boards are the Culture Guardians that hold executives accountable. Culture is the most critical enabler of successful strategy implementation.

The steps taken by the board of directors of James Hardie indicated a clear shift in the tolerance and appetite of Boards to accept poor behaviour in the face of solid investment performance. The board’s acknowledgement that the recent performance is more than the result of one man, but rather that of the entire workforce — a powerful message.

The disruption to the leadership of James Hardie has meant we have made appropriate risk adjustments to our portfolio to deal with this transition; the board has demonstrated industry-leading practices which uphold the integrity of the company. One can only be comfortable knowing that the company’s core values are maintained.

For any investor, identifying quality franchises requires strong corporate governance. Within this, a culture that ensures no executive is above a firm’s core values and that a code of conduct is non-negotiable positions an organisation well for future successes. We watch with anticipation for the next CEO as the company positions itself for the next leg of growth.