Weekend Reading: Audit Culture & ‘Tone from the Top’ — Lessons from the Banking Sector

By: Stephen J. Scott , Founder & CEO of Starling

Working from home during Covid lockdowns, I'd spy my teen-aged daughter attending class online, the teacher appearing on her laptop screen. Alongside, on her iPad, she'd be chatting with any number of classmates over Zoom. At the same time, some entertaining TikTok video would be running on her iPhone. Another screen might offer a study guide, a music video, or a game. Or all the above. How could she possibly focus with all that racket?!

Alarmed that she might not be taking her classes seriously, or absorbing the material adequately, my wife and I would raise concerns. But we soon came to recognize that what, for us, seemed like multi-screen-madness was, for our daughter and her generation, simply normal.

This was front of mind for me last week when EY made headlines after firing junior employees who were "caught" taking several mandatory online training classes at once. 

Perhaps these young professionals were simply attempting to balance their intense workloads, while completing required training modules. If so, it is likely that few of them will have regarded such multitasking as wrong and, indeed, it is more likely that most will have viewed it as the only sensible way to manage multiple demands on limited time. Many of their senior colleagues, reports suggest, did likewise, though those senior fee-earners went without similar punishment. Cue the class-action attorneys…

The incident raises uncomfortable questions about the disconnect between proclaimed organizational values and today's operational realities. Audit firm leadership rightly emphasizes the importance of training and professional development — establishing an appropriate "Tone from the Top" — but oft-heard complaints are that they simultaneously burden junior staff with workloads that make dedicated training time a luxury few can afford. As the audit sector faces an accountant shortage, stories like this one from EY are unlikely to inspire young people to don a green visor.

This cognitive dissonance, between formal policy and practical reality, calls to mind a piece from our 2023 Compendium, by Starling Advisor Gary Cohn, past-Director of the US National Economic Council, and Jay Clayton, past-Chair of the Securities and Exchange Commission. In a piece titled "Bank Regulation: Are We Going to Lie to Ourselves?," Cohn and Clayton argued that regulatory rule books had grown so fat that good people in organizations found themselves forced to decide which rules they were going to follow, and which they'd merely say they had. EY’s junior auditors appear, at least, to be trying to “do it all.” 

Follow the Leader

Following the lead of banking regulators, in the last few years, a number of audit sector regulators have begun to regard firm culture as "a thing” that warrants their attention. And like their banking sector peers, audit regulators have arrived at this realization after a number of misconduct scandals triggered financial and reputational consequences for the industry. 

The evidence continues to pile up. Last week it was reported that PwC's profits in Asia fell 12.7% following high-profile scandals in China and Australia, including a $62 million fine and a six-month operating ban in China for having "concealed or even condoned" fraud at collapsed property developer Evergrande. Earlier this year, KPMG Netherlands faced a record $25 million fine from the US Public Company Accounting Oversight Board (PCAOB) after widespread exam cheating was discovered. And these are just two of the many recent examples we have covered on Starling Insights. There are many, many more.

Culture is seen as the root cause of this misconduct and lapses in audit quality. Culture, thus, warrants supervisory attention.

Regrettably, however, in their efforts to address the cultural deficiencies highlighted in these scandals, many audit regulators and audit firms have continued to follow the lead of their banking sector peers in yet another way: they have emphasized "Tone from the Top" as the primary lever by which culture is set and culture change is to be achieved. While well-intentioned, this represents a fundamental misunderstanding of how organizational settings drive human behavior.

Despite its role in conventional wisdom, the "Tone from the Top" is of far less importance than often thought. For instance, the Ten Commandments may have provided the ultimate "Tone from the Top" during my Catholic upbringing. Yet every church features a "confessional booth" where the faithful regularly confess their breaches in faith. With belief and behavior in constant conflict, the Church has afforded an institutional mechanism for dispelling cognitive dissonance. 

Please forgive the Sunday-School lesson. But the moral of the story is simply this: no matter how compelling any "Tone from the Top," compliance remains dubious. The reality is that humans pattern their behavior on that which they witness among peers. Sociologists call this the "common is moral heuristic." Regulators call it "culture." 

Tone-Deaf

Last week, I had the privilege of addressing these issues at the PCAOB International Institute on Audit Regulation in Washington DC. (Many thanks to Chairwoman Erica Williams and Board Member George Botic for inviting me to share my views)

As audit sector regulators from across the globe grappled with questions like declining audit quality and plunging interest in the profession among the young, I highlighted the importance of learning from, rather than mimicking, the example set by their banking sector peers in their own efforts to address culture.

Culture is not "soft stuff," I emphasized in my keynote presentation. While less tangible than formal governance frameworks, culture is no less structural or important in driving performance outcomes. I marshaled the image of the DNA double-helix to demonstrate how I see the relationship between governance and culture: distinct but intertwined, working jointly to determine behavior. 

And drawing on our work at Starling, I argued that you cannot change organizational outputs (performance and problems) by focusing attention on organizational inputs (policies and processes). This includes "Tone from the Top." Rather, attention must go to organizational throughputs: the people, presumptions, and practices that actually drive behavior.

The recent EY incident illustrates the value of this diagnostic framework:

• Inputs — Management may have believed that its established policies (e.g., no multitasking during training) and processes (mandatory training sessions) had been made clear.
• Throughputs — But the people who were expected to enliven these policies and processes (young professionals with heavy workloads), were found to have behaved in a manner contrary to management presumptions (that there is enough time to dedicate to training while completing those workloads), and yet in a manner that was well aligned with commonly viewed practices among peers (widespread multitasking).
• Outputs — In short, operational reality was at odds with expectations for such. Performance thus differed from management aims and this was perceived as having created a problem ("cheating") that amounted to a firing offense. It is likely that, by firing the ‘misbehaving’ staff, EY leadership sought to re-establish a pious "Tone from the Top."

The tone they likely achieved is this: (1) do as I say, not as I do, (2) the rules are for younger cost-centers, not senior fee-earners, and (3) when you sin, even if unknowingly, you're to be damned and excommunicated. That should bring 'em flocking…

Take the Lead

As audit sector regulators follow their banking sector peers in recognizing culture as "a thing," they have an opportunity to avoid the pitfalls that have slowed banking sector efforts. 

• First, they should not waste time debating whether culture matters — it does, demonstrably;
• Second, they should not reduce cultural concerns to myopic discussions of "risk culture" rather than attending to culture in its broader manifestation and impact across organizations; and
• Third, they should not conflate formal governance structures with informal but nevertheless structural cultural drivers of organizational outcomes.

Instead, audit sector regulators should seek to examine, and influence, the organizational "throughputs" that drive behavior: people, presumptions, and practices. Setting the right "Tone from the Top" is necessary and important. But it is far from sufficient. 

This piece first appeared in Starling Insights' newsletter on November 3, 2024. If you are interested in receiving our thrice-weekly newsletter, among many other benefits, please consider signing up as a Member of Starling Insights.