Importance of Tone in the Middle

Driven by new standards and regulatory requirements, companies have focused much attention on promoting the Tone at the Top with the expectation that strong ethical leadership by senior management would trickle down to all employees and reinforce their commitment to company values. Most audit plans now include a thorough review of this Tone at the Top. Yet, while a strong Tone at the Top certainly matters, recent research suggests that middle management may be the more crucial conduit for compliant and ethical behaviour across the enterprise.

Further, many business leaders recognise that trust in their businesses and themselves has been lost as a result of the many recent well publicised events. They understand the need to restore the confidence of consumers, employees and citizens as well as investors and commentators both in their leadership and their corporate culture. Leading companies are taking action to more clearly operate in an ethical manner throughout the extended organisation, thereby leading to longer term, sustainable company performance.

Through a recent survey of more than 1,500 senior executives, CEB identified 10 important trends that fall into three broad, but distinct, categories concerning organisation change and which are all impacting middle managers:

• Frequent organizational change – Change and ambiguity will derail productivity unless managers help employees better anticipate, contextualise, prioritise, and respond to frequent change at all levels—ultimately making them more agile and accepting of change.
• More interdependent work – Collaboration will not occur unless organisations enable and encourage broader employee networks—connecting employees as needed and providing clear direction, aligned incentives, integrated workflow, and better technology.
• An increase in knowledge work – Since knowledge work requires both ready access to the right information and effective decision making with that information, organisations need to ensure that employees have the right skills and abilities to use advanced information technology effectively in their jobs.

Relevant and specific trends that can help internal audit understand the importance of the Tone at the Middle include the following:

Middle Managers receive most reports of alleged misconduct – While most companies have set up whistleblower helplines, most employee concerns about observed misconduct never reach this formal reporting channel. A CEB survey indicates that 66% of misconduct allegations are received by frontline managers, yet only 57% of these managers feel comfortable addressing employee concerns.

Middle Managers disproportionately affect employees - Recent CEB analysis confirms that managers strongly affect local culture. Middle managers positively influence integrity levels of local teams, resulting in a stronger control environment. Their behaviour, when aligned with corporate culture, reduces the likelihood of misconduct. It also increases the likelihood of their team members being prepared to debate potential ethical dilemmas and speaking up about observed misconduct. Their demonstration of high ethical standards is also strongly correlated with increased employee discretionary effort.

The Tone at the Top does not always trickle down – CEB research indicates that while employees have slightly improved their perceptions about the Tone at the Top since the financial crisis, they remain much more sceptical about the ethical leadership of their direct managers. It turns out that a strong ethical leadership at the top does not always spread to the middle, and therefore may be an inadequate indicator of a strong control environment. This is intuitively right as most employees see their managers regularly and the top executives very rarely – so their department manager is the real embodiment of corporate values. This is further reinforced by the fact that the Tone at the Top is somewhat unstable, with the average tenure of CEOs being fewer than four years.

In a recent CEB survey, 85% of Chief Audit Executives indicate that Tone at the Middle is an important risk area. To provide assurance over this important conduit of an ethical corporate culture, they must evaluate whether middle managers receive effective training on their responsibilities, create the required working environment, are formally measured on their ethical leadership, properly respond to employee concerns and escalate employee reports of alleged misconduct appropriately.

ADR Recommend 2013 Audit Plan Additions

Tone at the Middle review: Expand the Tone at the Top review by evaluating the strength of middle management in understanding, demonstrating and embedding ethical leadership. Review whether the current ethics and compliance program properly targets the manager role and their responsibilities.

Manager training audit: Evaluate whether HR, in collaboration with Compliance, effectively integrates ethical leadership development in both first time management training and ongoing leadership development programs.

Measurement and Reward check: Review whether ethical leadership and associated roles and responsibilities are an integral part of current performance management systems, including promotion decisions and variable compensation awards.

Whistleblower Program audit: Review awareness and education initiatives on the reporting of alleged misconduct to ensure employee awareness of, and (more importantly) comfort with, their use of these channels. Assess whether the current whistleblower and case management system properly collects information from all channels that employees can report into, including frontline managers.

What is ADR doing for members?

ADR webinars:

2013 Audit Plan Hot Spots webinar replay reviews the emerging risk areas (including Tone at the Middle) that Internal Audit departments will focus on across 2013. Hot Spots are typically “top-of-mind” issues for boards, audit committees, and executives. ADR members use this information to benchmark audit plan coverage, as well as to educate key stakeholders on emerging risks.

ADR research:

National Australia Bank conducts formal culture audits to ensure the creation of local, risk addressing cultures across the organization. To create a testable control objective, NAB deconstructs and measures, across a maturity scale, the eight distinct dimensions of culture. View the case study here.

Mitigating the drivers of misconduct. View the 34-page study here. Based on a statistical analysis of thousands of compliance and ethics survey responses, Audit Committees can short-circuit the primary drivers of misconduct at their organisations by focusing their Management teams’ energies on three key areas:
- Tone at the Top
- Middle Management Tone
- Organizational justice

The important links between Culture, Risk Management, and Business Performance

This study (click here) details the links between corporate culture, risk management, and business performance. Using the rich database on employee misconduct and perception, the study identifies the specific employee behaviours that impact and improve both compliance risk management and business decision-making

For further details on the Audit Director Roundtable resources, please visit our website.