Corporate Culture

Gary B. Gorton is the Frederick Frank Class of 1954 Professor of Finance; Jillian Grennan is Assistant Professor of Finance at the Duke University Fuqua School of Business; and Alexander Zentefis is Assistant Professor of Finance at the Yale School of Management. This post is based on their recent paper.

Research in finance and economics on corporate culture is at an exciting stage. As we describe in our survey on Corporate Culture, we are on the precipice of a new paradigm in the study of corporations. While futuristic visions of a workplace once seemed far-fetched, leaders foresee an immersive, hybrid world where social interaction, commerce and the internet all meet. Analogous to leaders’ visions of an internet where one is inside of it, rather than on the outside looking at it, economics and finance scholars are moving from an external, contract-based view of corporations to an internal approach that seeks to understand firms’ inner workings. Researchers have long been interested in firms, management, workers’ incentives and output, but for convenience reasons, many scholars simplified away from the internal, social elements. Yet new advances in theory and data are enabling researchers to bring these elements—that in sum make up what leaders often refer to as corporate culture—into the set of forces that can be modeled and measured.

Focusing on the inner workings of corporations is critical: Most people spend the majority of their lives working. In the United States, the volume of transactions that occur inside corporations is roughly equal to that which occur in open markets. Many corporations have thousands of employees who somehow cooperate to produce goods and services.  While some corporations generate expansive wealth for their investors, offer innovative solutions to problems, and are persistently more productive, otherwise similar corporations are much less successful. Executives believe these differences are linked to culture. In a large-scale survey of corporate executives, culture ranked as the number one long-term value driver (Graham et al., 2021). Importantly, major shifts in research are taking place theoretically and empirically that will allow for corporate culture research to thrive.

From a theoretical perspective, it is the transition from a property rights-agency costs paradigm for corporate finance to newer models. Since Ronald Coase famously asked why firms emerge at all in a decentralized economy that is orchestrated by the price mechanism, the dominant answer has always been property rights and agency costs. In sum, property rights that are specified in contracts prescribe how costs and rewards are distributed among participants in a corporation. In modern firms, the separation of ownership and control creates an agency relation between principals (the firm’s outside stockholders) and the agent they hire (an inside manager) to perform a service on their behalf. This relationship automatically produces problems, as the principals cannot possibly ensure that the agent always acts in their best interests. Restricting the deviant behaviors of the agent would come at a cost, either through monitoring the agent like a prisoner, or paying him off like a mercenary.

While this principal-agent relationship sits comfortably at the definition of the firm as a “nexus of contracts,” it is not a suitable explanation of an entire firm—that interdependent collection of individual energies and choices that somehow cooperate, at times clumsily, to perform a vital function. As we highlight in our review chapter, markets and firms offer contrasting methods to arrange production. In markets, contracts govern the purchase of parts and services that compose production. While markets have social aspects, and firms have contracts and incentives inside them. Typically, in firms, the shared values, customs, and norms coming from a corporate culture govern employees’ joint development of those parts and services. This means a new explanation for the theory of the firm is possible. An explanation that relies on corporate culture, because culture at times is more efficient at carrying out production than detailed contracts. In such a model, the firm’s boundary encircles the parts of production for which a manager optimally chooses corporate culture as the organizing device (Gorton and Zentefis, 2021).

From an empirical perspective, novel computational techniques and big data have encouraged many creative measures of corporate culture. We document the variety of empirical approaches for measuring corporate culture that have emerged by broadly categorize the various measures of culture into: (i) field-based surveys and interviews, (ii) experimental approaches, (iii) time-invariant approaches, (iv) time-varying approaches, (v) societal and biological approaches, and (vi) network-based approaches. We carefully evaluate the pros and cons of each of the measure while highlighting what will likely be fruitful paths forward for measurement. We also highlight some important open research questions in measurement: do different ways of measuring corporate culture lead to consistent implications for firm decision-making and outcomes? What is the correlation between cultural elements and the potential for specific cultural styles to emerge? Is there an optimal culture that is firm-specific?

Next, we summarize how the new empirical measures are able to explain several observed behaviors in corporations. While corporate culture involves many elements, it can broadly be defined as a pattern of behavior that is reinforced by systems and people, and is manifest in the norms or expectations that people have for how they need to behave to fit in and succeed in the corporation. From such a definition, it becomes apparent that examining systems like corporate governance, which may reinforce or work against culture, is critical for understanding the inner workings of firms. What may be surprising to scholars of corporate governance is that these systems can crowd out positive elements of culture like integrity or collaboration (Guiso et al., 2015, Grennan, 2019). In reviewing the empirical literature, we highlight many studies showcasing the links between culture and risk-taking, ethics, and merger success.

In conclusion, we believe corporate culture deserves substantial attention going forward, and we hope our review chapter helps to build a bridge to enable this future by selectively canvasing the economics and finance literature for the most promising areas to contribute to this exciting area of scholarship. Our survey contains a review of the theories of corporate culture, the measurement of corporate culture, and relevant empirical findings. We also pose a series of ideas and questions that we believe young and old scholars alike should look investigate. We highlight questions linking culture to traditional aspects of corporate finance and collective decision-making, and we encourage researchers to examine the many catalysts for cultural change such as leadership, governance, investors, technology, advocates within the firm, and society as we believe understanding the influence of catalysts will help simultaneously advance managerial best practices and academic knowledge.

The complete survey is available for download here.

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