Don’t Underestimate The Value Of An Internal Audit
Most business leaders know corporate culture is important. It can affect recruiting efforts, employee satisfaction and the public perception of your firm. But it may be even more important that you think. Culture can make or break a firm, and in the case of M&A, it can make or break a deal.
A company’s tone, operating style, standard of behavior and shared values that guide employee decisions are all part of culture. And you don’t have to look far to find examples of what can happen when it goes wrong. From Toshiba to Volkswagen, FIFA, Baylor University and most recently, Wells Fargo, organizations in a wide range of industries have seen the detrimental effects of mismanaged or toxic cultures.
Law firms are no exception.
The leaders of Mossack Fonseca, the firm at the heart of the infamous Panama Papers leak, have been under fire over the past year for fostering a culture that led to secrecy, money-laundering, corruption and other unethical practices. In 2009, Scott Rothstein’s firm, Rothstein Rosenfeldt Adler, spectacularly collapsed after Rothstein’s long-running Ponzi scheme and misappropriation of hundreds of millions of dollars from investor trust accounts was discovered. A lack of appropriate oversight and governance enabled him to conduct his covert dealings out of his law office without arising suspicion from his partners or the firm’s management team.
Leadership styles that harm firm culture
The Institute of Internal Auditor’s 2016 Pulse of Internal Audit report noted that a majority of survey respondents say behavior modeled by top executives is the greatest factor influencing culture. Employees mirror leaders’ behavior, which can create group norms that tolerate corruption. The June 2016 issue of Internal Auditor magazine categorized seven leadership styles that may have a damaging impact on a firm (described below). These traits don’t guarantee corruption within an organization, but they do point to the conditions in which it can thrive – at least at the top.
- Autocratic leadership: Characterized by egoism, narcissism and a feeling of entitlement
- Closed-minded leadership: Characterized by high-control, low inclusion and little to no tolerance of dissent
- Manipulative leadership: Characterized by extreme image-consciousness and deception
- Secretive leadership: Characterized by a lack of transparency in decision-making and a tendency to be unusually connected with outside parties of whom they are quite protective, sometimes to the detriment of the business
- Deflective leadership: Characterized by a lack of willingness to take responsibility for failures, not seeking out the root cause of problems and preferring talk over action
- Intimidating leadership: Characterized by an environment of fear and intimidation, overreaction to mistakes, and a lack of empathy
- Improperly focused leadership: Characterized by a focus on inappropriate and often personal objectives over company strategy
Assessing culture in M&A
It’s especially critical to consider culture when you are approaching a merger or acquisition. In those cases, it’s not only your culture you need to assess – it’s also the other firm’s.
Research has shown that one third to one half of all mergers fail to meet expectations due to cultural misalignment and personnel issues, according to John W. Olmstead, MBA, PhD, CMC, president of Olmstead & Associates, Legal Management Consultants. Cultural due diligence should be a key part of your M&A due diligence process.
When assessing a merger or acquisition, firms should consider certain aspects of each other’s culture such as:
- Do both firms share the same work ethic and values?
- Do any of our practice philosophies differ?
- How do our client acceptance and retention policies compare?
- Do our missions and visions align?
- Are there any potential cultural issues at the top?
- What tone is management setting?
When looking at the marketability of your own firm, an assessment of your firm’s culture can help you identify potential issues within your own organization that may make your firm an undesirable fit for a suitor.
A positive culture can actually add value to your firm and help to make it more successful and therefore desirable to potential buyers. Many leading organizations attribute their superior performance and accomplishments to their organization’s culture. In a 2015 study by Duke University of 1,900 executives around the world, 79% said culture is among the top five things that make their company valuable.
However, many companies still have a long way to go. In that same Duke study, only 15% said their own corporate culture is where it should be, and 92% said improving their culture would enhance company value.
Role of internal audit in evaluating culture
So where does internal audit fit in and how can a culture audit help?
The profession of internal audit is evolving. Its role within organizations across the globe is expanding to address the changing risks companies are now facing and provide assurance regarding board members’ biggest concerns. By definition, internal audit is “designed to add value and improve an organization’s operations. It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance processes.”
The internal audit team (both in-house and outsourced) is often uniquely positioned to assess corporate culture and governance due to the nature of its activities and detailed insight of operations across the entire organization.
The primary role of internal audit when it comes to culture is to “assure boards that the culture they have set is reflected in practice throughout the organization,” according to a May 2016 report on organizational culture by the Chartered Institute of Internal Auditors. One thing they can do is help to identify unhealthy behaviors that may undermine the organization (such as those listed above).
The report goes on to say: “Assurance providers can also advise on the robustness of the control framework. Internal auditors can, indirectly, help to embed the culture through the way they conduct audit activity; the advice and insight they provide to boards; and through the ways they flag up where the culture is not as expected. This way, the assurance provider can play a role in supporting (or ‘carrying’) positive cultural traits, or calling out traits that are not helpful.”
If the lessons at the organizations mentioned above have taught us anything, it’s that the existence of an inappropriate culture can be dangerous to an organization and its employees. Engaging your internal audit team to conduct an assessment of your firm’s culture can help you to avoid potentially detrimental issues, recognize more value, and in the case of a merger or acquisition, help determine a desirable fit.
