Bank Board Members Address COVID-19 in Compensation Design

Do banking industry board members plan to adjust 2020 annual incentive plans to address COVID-19’s impact? At an NACD and Compensation Advisory Partners (CAP) virtual roundtable hosted on September 30 and titled “Compensation Strategy for an Unpredictable Future in the Banking Industry,” 52 percent of attendees in response to a poll said that they’d exercise discretion.

Meanwhile, 22 percent said that they’d adjust performance goals to reflect that COVID-19 made goals unattainable, 26 percent said they plan to make no adjustments, and not a single attendee responded that they’d exclude the pandemic’s impact from performance calculations.

As moderators Kelly Malafis, founding partner at CAP, and Eric Hosken, a partner at the firm, laid out in the discussion, incentive plans set in the first quarter of this year are not necessarily realistic anymore given all that has transpired since the pandemic was declared in March.

“We’re using a lot of upward discretion,” one attendee said. “We’re looking at metrics that maybe weren’t on the annual plan, the net interest margin compared to peers and performance in the Paycheck Protection Program. We’ve come up with three to four harder metrics even though they’re not in our plan and laid those over the individual’s [plan].”

Another attendee remarked on the impact of the adoption of the Current Expected Credit Losses (CECL) standard, which came into force this year. The standard requires financial institutions to proactively predict the losses they expect to incur over a loan’s lifetime. “CECL clearly impacted how we look at our financials this year. CECL has been treated differently by different banks, so the relative comparison is hurt. We’ve used discretion in setting up a scorecard—a resilient scorecard with pillars of financial, strategic and operational, risk and regulatory, and culture and talent, and [will score] one through five whether each point under those pillars is reached. We tried to create some degree of objectivity even though previous metrics had not been reachable. We also needed to determine what a capped amount for 2020 is.”

Overall, Malafis said, “You want to keep management engaged, but it won’t be at or above the target bonus—but it may not be a zero year. In a few cases, the performance is there to even support an above-target payout.”

Outstanding Performance Stock Units

A polling question asked attendees how the compensation committee will respond if their outstanding performance stock units (PSUs) have been impacted, and the majority, at 57 percent, said that they would make no adjustments. Other popular polling answers to the same question included that the committee will respond by adjusting performance goals or metrics to reflect COVID’s impact and the low-interest rate environment (21%), exercising discretion to adjust PSU payouts independent of calculated PSU awards (14%), and eliminating 2020 performance from the calculation (7%). No respondents said that they’d use pre-CECL methodology or net charge offs in place of provision.

Some respondents who answered that no adjustments would be made were concerned about accounting issues, such as the potential reversal of PSUs back into income.

“If you modify these PSUs, that would likely require disclosure of additional compensation in the proxy’s Summary Compensation Table; with annual incentives, you don’t necessarily have the same hurdles,” Hosken replied. “Companies making adjustments to PSUs—it’s hard to do. There are accounting and shareholder implications.”

Executive Retention

Hosken noted that stock prices for banks are still below pre-pandemic levels and asked, “With executive retention, are you going to have issues because the value of stock holdings are way down compared to companies in other industries?”

In the corresponding polling question, CAP asked if executive retention is currently a major concern for attendees and their boards. Almost half (52%) responded that it is not a primary concern right now, while 39 percent said it is, but no more so than last year. Nine percent replied that it is, and much more so than at the same time last year. In response, Hosken noted that these results are consistent with conventional wisdom. “Often you feel like talent will go to other banks, who are now facing the same situation. It would be more [of an issue] if there’s a concern that other businesses would recruit your talent.”

One attendee’s bank has seen two CEO departures in two years due, in part, to the coronavirus. “A variety of consultants told us it isn’t a good year to have much annual incentive compensation. At 40 percent of book value, it’s not terrible for banks we benchmark, but it’s below peers; that’s given us a lot of cover. All sorts of things seem to be going badly. But it’s tough because people worked extremely hard. In the CEO search, the response from consultants was really looking for us to focus on the long-term incentives part—it was portrayed as an industry shift toward multiple-year [incentives].”

Before and Beyond

In looking to the years ahead, the group also looked backward. One attendee asked for insight into the 2008 financial crisis and how what banks did then compares to what banks are doing now.

“The financial crisis was strange, lots of banks were subject to the [Troubled Asset Relief Program],” Hosken replied. “Pre-Provision Net Revenue was used frequently, there was a slower move into PSUs—it wasn’t heavy in the mix. They still had stock options. During the last crisis, banks were under scrutiny because they were viewed as partly responsible for the crisis—now it’s not so much about what the banks did, it’s something out of left field. I hope there’ll be more sympathy come proxy season.”

After the financial crisis, “banks asked how they could better adapt to unforeseen adverse impacts,” Malafis said. “More discretionary elements and metrics came about” as a result.

So, what changes were attendees considering at the time of the roundtable as they look toward the 2021 annual incentive design in light of COVID-19? For this polling question, respondents could select multiple answers, and 61 percent said that they would add relative measures or increase the weighting of relative measures, 33 percent would increase committee discretion, and 28 percent would consider using pre-provision performance measures, as well as wider performance ranges.

Hosken observed that a lot of compensation committees haven’t decided what they’re going to do yet. Between reflecting on 2020 and looking ahead to 2021, discretionary and wait-and-see approaches seemed to rule the day.

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Auditor Resilience Contributes to Capital Markets during the Pandemic

Capital markets are complex. Many factors contribute to their stability: public company financial performance, investor confidence, and legislative and federal government intervention, to name a few. The list is long, but one often overlooked contributor to the stability of capital markets is public-company auditors, who are demonstrating their resilience to deliver high-quality audits during the COVID-19 pandemic.

As the US Securities and Exchange Commission said of auditing in April, “the proper functioning of our capital markets depends on a regular supply of high-quality financial information that enables investors, lenders, and other stakeholders to make informed decisions.” And the proper functioning of the capital markets is an essential component of our national response to, and recovery from, COVID-19.

As public-company boards are well aware, COVID-19 is creating new and evolving risks that could require changes to the design and operation of internal controls or other processes related to financial reporting.

US public-company audit firms have vast experience with numerous accounting issues across myriad organizations. As a result, they can draw on this expertise to navigate complex accounting issues that may be new to many public companies in this crisis. For example, management is required to conduct going concern evaluations quarterly, but some companies are for the first time facing substantial doubt that they can continue to operate. Auditors serve as a vital communication link between all of the different relevant parties inside a company to make sure they are aware of their responsibilities and are performing robust going concern evaluations.

Auditors have also stepped up in other ways to address the challenges facing public companies and their boards during the pandemic. After the onset of the pandemic, auditors quickly adapted to the new normal of remote auditing while remaining laser-focused on audit quality. Audit firms quickly reinforced or instituted new policies and procedures to react to the facts on the ground. This was an essential step that contributed to the continuation of high-quality financial reporting during the immediate challenges the pandemic presented.

Auditors continue to serve as gatekeepers of the financial reporting ecosystem. They’re in regular communication with regulators, audit committees and boards, and company management, sharing information about what they’re seeing on the ground and how they are addressing those issues.

To help inform public companies and other financial reporting stakeholders of the ways in which auditors are stepping up to help maintain the orderly operation of capital markets during the pandemic, the Center for Audit Quality (CAQ) recently launched the Audit in Action campaign. The campaign highlights auditors through compelling videos, blog posts, and other dynamic stories to put a face to the people who play a significant role in keeping our capital markets functioning. 

Boards can leverage such auditor expertise and innovation to help them navigate complex accounting challenges during the pandemic. To further help with such challenges, the CAQ has developed a set of resources for financial reporting stakeholders, including boards, that cover everything from going concern to non-GAAP financial measures to goodwill impairments, and more.

Auditors know the strain facing public companies during the pandemic may be far from over. Thus, they will need to remain resilient and adaptable for as long as the pandemic continues. I have confidence they will do just that.

Ultimately, it takes all stakeholders in the financial reporting ecosystem, including public-company management, audit committees, internal auditors, and external auditors, to provide high-quality financial information that contributes to market resilience during these unprecedented times.

Julie Bell Lindsay is the executive director at the Center for Audit Quality.

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Beyond Messaging: This Is a New Era for Corporate Responsibility

At the same time that the COVID-19 pandemic has sharpened economic divides, the world is reckoning with the threats of prejudice, racism, and climate change. The role of corporations has never been more visible or important—especially as the pandemic’s economic shocks drive corporate consolidation, leading big business to dominate the economy. Increasingly, consumers, investors, the media, and potential employees are watching the ways in which corporations commit to their values. As social contexts and pandemic impacts evolve, meeting expectations for corporate social responsibility (CSR) is a moving target.

Prompted by the major anti-racism protests that erupted in the United States and filtered overseas in the early summer, corporations have been increasingly vocal about their commitment to racial diversity and inclusion. Many have committed to increasing diversity among their own ranks, and still others have tied executive pay to meeting such goals. Other companies have made spending commitments to further social justice causes; prompted by protests against police violence and racial injustice, sparked by the murder of George Floyd. For example, Bank of America Corp. recently committed $1 billion over four years to support economic initiatives focused on diversity, which has since been eclipsed by JPMorgan Chase & Co.’s pledge of $30 billion over five years to address drivers of racial wealth inequality. At the same time, corporations of all stripes have increased their messaging on social justice issues, which has struck some as simply posturing if they are devoid of concrete commitment and accountability. Indeed, activists and labor experts continue to call for the publication of diversity data in order to hold corporations accountable to their diversity pledges—calls with which few have complied.

One of the most prominent areas of changing expectations around corporate social responsibility is climate change; 2020, a year likely to be the hottest on record and to bear witness to extraordinary natural disasters, has seen a series of major corporate pledges to take more action on combating climate change. Financial institutions and investors in particular have increased their scrutiny of climate impact, aiming to both reduce the negative impact of their portfolios and increase support for sustainable businesses. Just this month, a group of thirty of the world’s largest investors, collectively managing $5 trillion, pledged to align their portfolios with the climate goals of the 2015 Paris Agreement. Major corporations have also committed to net-zero emissions goals within the next few decades. This climate consciousness has been urged by corporate giants across sectors, from Walmart and Amazon.com to oft-criticized energy majors such as Total and BP. While many of these pledges have been critiqued for lack of concrete follow-through or realistic plans for implementation, the increasing prevalence of climate targets is changing how corporations engage with climate change.  

With higher expectations come higher reputational risks: along with pressure from activists and consumers to improve records on social and economic goals, public scrutiny may limit the size and diversity of prospective talent pools. Oil majors, for example, have experienced difficulty attracting young graduates due to their negative climate records, and law firms that represent big oil have faced boycotts from top law school graduates. Reputational risks can also come in the form of increased data leaks or cyberattacks in efforts to expose and shame companies. Conversely, a growing number of corporate leaders are embracing heightened corporate social responsibility as a pathway to profitability. A quarter of global CEOs now strongly agree that investing in climate-friendly initiatives can lead to new business opportunity, up from 13 percent in 2010, according to a PwC survey of 1500 global CEOs. 

Government failure to address social and environmental issues is another factor changing expectations of the private sector; when regulation and governance have not risen to meet the demands of the moment, simply following the government’s lead is no longer sufficient. The fallout from the COVID-19 pandemic only increases the stakes for corporate sustainability and social responsibility. As political polarization and paralyzed governance continues to hinder many of the world’s largest economies, the private sector has more space, and faces more pressure, to lead and take action on urgent issues.

In this context, seizing opportunities to raise the profile of your company’s social responsibility efforts and to mitigate future risk are increasingly crucial, and could include the following actions: 

Coordinating with industry leaders to establish and finance an annual scorecard that will serve as a public display of accountability on engagement efforts. Activists, consumers, and the media have consistently called for more transparent accountability efforts. Periodic surveys of internal staff and the general public can also provide a metric for gauging progress. 
Developing relationships with carefully vetted social and environmental nongovernmental organizations that can partner with businesses for events, talent recruitment, public statements, and more. 
Getting rid of corporate jargon like “CSR” and reframing value initiatives as “corporate conscience,” “corporate citizenship,” “sustainable commitments,” or otherwise, to more authentically convey values in company statements and websites. 
Better publicizing engagement efforts on social media to proactively build rapport with potential recruits, remaining aware of the issues that animate the next generation of talent.
Considering the ramifications and potential benefits of being a corporate pioneer versus remaining in the middle of the pack when planning strategies around value engagement. The next generation of talent and consumers value leadership on the issues that matter to them.

Karl V. Hopkins is a partner and the global chief security officer at Dentons.

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How the Compensation Committee Can Commit to a Culture of Diversity and Inclusion

The racial justice movement, the gradual shift toward increased transparency around pay equity and workforce representation, and the upcoming US presidential election have all combined to create a unique moment in time—one in which many companies are feeling renewed hope that progress with regard to racial equity is possible. However, despite years of hard work and millions of dollars spent by companies on diversity initiatives, very little has changed when it comes to Black and Hispanic representation in management over the past 30 years. The summer’s protest movement has led to a reckoning of sorts. Why has progress been so elusive? How can boards ensure they are doing all that they can to oversee a culture in which great talent can succeed, regardless of race or gender?

For many companies, the answer lies in engaging the board on talent strategy with a focus on diversity, inclusion, and equity. We are seeing a continued trend of compensation committees taking on additional responsibilities outside executive compensation, including culture, talent, and diversity. A recent study by Willis Towers Watson found that a third of the largest 100 S&P 500 companies now formally include culture, employee relations, and engagement in their compensation committee charters, and the committee’s name is sometimes amended to reflect this expansion of responsibility. Here’s how boards can set up their compensation committees—and diversity initiatives—for success.

Rethinking Process

One way to ensure the compensation committee (and in many cases the full board) is fully engaged in the oversight of progress around diversity and inclusion initiatives is to make certain that discussions of talent strategy, including the diversity of talent, take place throughout the year—including on the compensation committee. Often this discussion is relegated to a single meeting annually and is left to the chief human resources officer or chief diversity officer alone to manage and own. The involvement of the CEO and entire leadership team has been shown to significantly improve diversity outcomes for a company, especially when it comes to increasing representation at senior levels. The board can facilitate this by committing to frequent and ongoing discussions around the ways in which diverse talent is sourced, promoted, and surfaced to the board.

The Levers of Change

For many companies, the best way to measure whether efforts to create an inclusive culture and increase worker and management diversity are successful is to set long-term goals that apply to a broad population. These goals may be internally communicated or externally disclosed, as companies such as Accenture, BlackRock, and Google have done. The board should receive regular updates from management on progress against goals and should hear from management how it plans to measure and improve outcomes on a long-term basis.

A major focal point of the push for increased diversity and inclusion at companies has been the issue of accountability. How are companies and management teams to be held accountable for making a difference? Progress is often slow and difficult and lacks direct and immediate ties to the financial performance for which CEOs are responsible.

Questions have been raised regarding shareholder primacy and the importance of other stakeholders in the corporate world, most prominently with the Business Roundtable’s 2019 Statement on the Purpose of a Corporation. If corporations are truly expected to play an essential role in improving our society, compensating employees fairly while fostering diversity and inclusion as part of that mandate, a logical conclusion is that these outcomes should be encouraged through tying them to executive pay. Although only a minority (some studies report around 15 to 20 percent of the S&P 500) of companies currently include diversity metrics in their incentive plans, an unwillingness to do so may be perceived as a disconnect between what a company says is important and what it is willing to reward in practice.

If diversity incentive metrics are to be considered, an important question is whether they should be tied to short-term pay (through the annual incentive plan) or long-term pay. The vast majority of companies that use diversity incentive metrics do so through the short-term incentive plan. However, given that increased representation of diverse talent in senior roles is almost always years in the making by virtue of supporting diversity in the leadership pipeline, positioning this in both the annual and long-term plans may be more effective. This would allow executives to be rewarded in the near term for taking actions that should yield sustainable improvements in representation over time—for example, actions that will grow the pipeline of qualified, diverse talent. The ultimate success of those actions in driving improved representation should be reflected in the executive’s long-term compensation. In particular, a design in which executives may lose money if goals are not achieved, rather than simply including diversity goals in a basket of individual objectives, may go further to change behavior in ways that are sustainable and effective long term.

The role of the director has become more demanding and more complex than ever before. In addition to overseeing the company’s financial and operational performance and its obligation to create value for shareholders, the board is now tasked with a multitude of environmental and social responsibilities that challenge some of our most fundamental assumptions regarding the role of the corporation. Ensuring that diverse talent has an equal chance to thrive is a business imperative as well as the right thing to do, but making it happen takes aggressive action. As with any business imperative, the support and leadership of the board is critical to the company’s success in achieving these vital objectives.

Ani Huang is the president and CEO of the Center On Executive Compensation.

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Will There Be More ‘October Surprises’ for Boardrooms?

Surprise! The month of October in the United States is famous for them. Political candidates often save their best for last—and this year is no different, despite the surge in early voting by more than 28 million Americans, according to a Politico report. Prior to this month, as reported in our Q3 Washington Review, Congress had only passed 158 laws; now in mid-October that tally is 169 and growing. The pace is one new law per day, rather than barely one or two per week.

For directors, the most significant laws thus far this year have been the stimulus bills offering relief to businesses and individuals—especially the Coronavirus Aid, Relief, and Economic Security (CARES) Act.

Of course, the big law everyone is waiting for is the next $2 trillion-plus relief bill—and that could be on the docket soon. As of October 1, 2020, more than 1,000 bills have been introduced in US Congress mentioning coronavirus in the title, text, or summary. Of those, nine have become law, as described below. In the House of Representatives in the first half of the year, we saw the passage of six relief bills, including the $2.3 trillion CARES Act, H.R. 748, mentioned above and covered in this blog and fact sheet.

Still pending are the several hundred COVID-19 bills proposed earlier this year—including financial relief bills sponsored by Democrats and liability protection bills sponsored by Republicans. Of note is the updated H.R. 8406, the $2.2 trillion Health and Economic Recovery Omnibus Emergency Solutions (HEROES) Act, a major COVID-19 relief bill that passed the House on October 1. (For legislative history, see this summary from the House Committee on Appropriations.)

Meanwhile, states have been busy, as reported by the National Conference of State Legislatures (NCSL), who has a database on State Action on Coronavirus (COVID-19) which lists COVID-19–related bills in 37 categories, such as education, health, or transportation. To be included in this COVID-19 legislative database, a bill must include provisions related to the coronavirus. As of October 1, all 50 states had enacted coronavirus legislation; the total for COVID-19–related bills at the state level was 3,030, with 577 enacted as laws. (For more on coronavirus legislation, see the Board Implications of the CARES Act, as well as the NACD COVID-19 Resource Center.)

So far, one in three states (16) have enacted laws that limit liability for businesses during the COVID-19 crisis. Most recently, in Georgia, the state’s legislature passed GA S 359, Georgia COVID-19 Pandemic Business Safety Act, which provides for certain immunities from liability claims regarding COVID-19. The law refers not only to health-care providers but also to businesses, nonprofits, and governments. The law includes the wording of a warning sign posted outside of a business that says those who enter do so at their own risk.

COVID-19 has also been a focus for the US Securities and Exchange Commission’s June 23 CF Disclosure Guidance: Topic No. 9A regarding COVID-19 disclosures, as well as a COVID-19 roundtable held June 30, during which Commissioner Elad Roisman argued against rules that would dictate what environmental, social, and governance topics must be covered in disclosures, saying “Who is in a position to codify a list of environmental or social issues for the foreseeable future?” Commissioner Roisman, a Republican, notes that COVID-19 was not predictable, so it could not have been disclosed as a risk factor.

As far as courts go, COVID-19 has affected a variety of company stakeholders, some of whom are taking legal action. So far in 2020, more than 2,000 lawsuits have been filed in federal and state courts, says this article. For details on how customers, employees, and shareholders are suing over COVID-19, see our Q3 Washington Review report, which also covers other developments from the quarter with regards to finance and investment, environmental regulation, and diversity—in particular, a new California law mandating racial inclusion. This newly enacted AB 979 mandates inclusion of directors from “underrepresented communities” on the boards of California-based public companies.

In summary, stay alert for surprises, especially with respect to COVID-19 funding. In this volatile month, almost anything can happen.

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The Leading Advantage: Partnering With DE&I Consultants

Dr. Brandi M Baldwin, of CPI Austin, Texas, is a psychology and business professor turned coach who focuses on D&I, motivating millennial leaders, and advocating for equity in all levels of organizations.

This episode explores key components and measures in a successful DE&I coaching or consultant engagement.

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The Leading Advantage: DEI An Organizational Journey

Adrianna Gabriel of CCI Consulting joins the show to discuss how organizations can begin or continue forward on the path of their DE&I Journey.  As an Executive Coach and Training Consultant, Adrianna specializes in Diversity & Inclusion to promote workplace cultures that increase belonging.  Cultural change can be difficult, but with a structured approach it, like other business challenges, can be overcome allowing organizations to flourish.

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Embrace an Inclusive Approach to Diversity for an Improved Employee Experience

Written by Adrianna GabrielExecutive Coach & Training ConsultantCCI Consulting, a CPI Firm

In the midst of the current pandemic, the social unrest after George Floyd’s death brought diversity and inclusion back to the number one spot on the agenda of many organizations who feel compelled to take immediate action.  As a result, HR leaders are being relied upon heavily to guide businesses through tough conversations. Many companies have rushed to initiate unconscious bias trainings, set diversity hiring targets, and add minority-owned vendors to the supplier list.  While these tactics do push organizations forward and serve to drive some measure of change, they only scratch the surface and likely overlook the most important piece in the diversity puzzle: inclusion.

Companies can hire diverse employees, but how will those employees feel when they get there?  Will they be invited to share their most unique and creative ideas, or will they be asked to fit the current culture norms and leave their authentic selves outside?  More than ever, top employees, no matter their age, race, or gender, are seeking inclusive workspaces where all the pieces of their whole selves are considered to be assets rather than weaknesses.

Making inclusion central to your culture and employee experience doesn’t happen overnight, but through deliberate effort and committed leaders, organizations can begin taking steps to ensure that all employees feel welcomed, celebrated, and trusted.  Below are a few points for consideration when ramping up or reinforcing inclusive behaviors at your organization.

Do It for the Right Reasons

While great research has been done to highlight the business and financial returns that diversity provides, organizations will not obtain those results through representation alone.  By positioning metrics at the forefront of the business case for diversity, the human factors associated with caring for your “most valuable assets” get negated or forgotten altogether.

Organizations implementing new diversity-based initiatives with the sole intention of quelling disgruntled customers and employees may find that promises aren’t lived out day-to-day. Over time, this can erode trust and just-in-time efforts will fall on deaf ears.  Leading with a focus on inclusion without tying it to return on investment or reputation will position you as a company who doesn’t just do things right, but who also does the right things.

Take a Systematic Approach

Inclusion is not a training event.  As stated, trainings are a wonderful start when developing maturity around D&I in the workplace. For example, it is important to teach employees the skills needed to have challenging conversations while displaying empathy and staying within legal boundaries.  However, to reinforce behaviors, learning in training, policies and procedures should be examined to determine how well they support or discourage an inclusive environment.  Consider ways to prevent biases from creeping into performance management and succession planning conversations.  Evaluate hiring and onboarding strategies to ensure an inclusion-based approach.  When integrated with the organizational systems that keep the business moving forward, inclusion goes from theory to practice and a method for accountability is developed.

Embrace Continuous Learning

When developing inclusivity, organizations have come to see that initial steps, though well intended, may be a bit clumsy.  Outgoing messaging may be misinterpreted or even too general to have an impact. Internal conversations open the floodgates to a variety of opinions and beliefs. During this time, it is important for organizations to acknowledge the potential for mistakes up front, but to also commit to learning and improving moving forward.  Like with picking up a language, understanding can only be achieved when we marry our current knowledge to something new.  Moving beyond diversity and into inclusion requires taking steps past good intentions and into ongoing improvement.

Allow Time

Like any other culture change, changing the way that people think and engage around inclusion requires patience, compassion, and time. Even with the right messaging and procedures in place, employees will naturally embrace change at varying rates and as a result of different touchpoints with the concepts.  Don’t be surprised to find that some employees are hesitant to call each other out on exclusive behaviors or are not bravely displaying their authentic qualities all at once.  Continue to share the stories of committed leaders who had the vulnerability to include, thereby making it safe for others to do the same.   Over time, remain vigilant about keeping inclusion on the front burner, and the environment will slowly but surely shift.

In this new world of work, creating inclusive environments doesn’t mean asking employees to change their personal beliefs, but it does mean that they are expected to uphold a new standard of workplace behaviors because diversity is great, but it only wins when we take an inclusive approach.

Adrianna GabrielExecutive Coach & Training ConsultantCCI Consulting, a CPI Firm
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