Print
E-MailDennis Campbell is Dwight P. Robinson Jr. Professor of Business Administration at Harvard Business School, Ruidi Shang is Associate Professor of Accountancy at Tilburg University, and Zhifang Zhang is Associate Professor of Accountancy at Warwick Business School. This post is based on their working paper. Related research from the Program on Corporate Governance includes Pay Without Performance: The Unfulfilled Promise of Executive Compensation by Lucian A. Bebchuk and Jesse M. Fried; The Growth of Executive Pay by Lucian A. Bebchuk and Yaniv Grinstein; and The CEO Pay Slice (discussed on the Forum here) by Lucian A. Bebchuk, Martijn Cremers, and Urs Peyer.
Corporate culture homogeneity refers to the degree to which different individuals within a firm share the same beliefs, values, and preferences. For instance, Handelsbanken and Southwest Airlines, the former notable for its long-standing corporate culture centered on the primacy of human-centered decision-making in banking and the latter for its strong culture of collaboration and empathy among employees, both institute a variety of unique internal management practices to ensure that their preferred corporate values are widely shared and strongly held among employees. The specific content of such strong corporate cultures can be highly idiosyncratic to different firms and difficult for outsiders to classify or replicate. Nevertheless, the high degrees of homogeneity in employees’ beliefs are widely viewed as leading to better alignment between executives and employees within these firms.
Theories and evidence indicate that, due to such increased alignment, corporate culture homogeneity is associated with a range of desirable firm features, such as more delegation, less monitoring, higher employee motivation and coordination efficiency, faster decision-making, less conflicts within firms, and ultimately higher productivity and more stable performance. For example, many aspects of Southwest’s organizational success have been attributed to the homogeneity in this underlying cultural value including faster turnaround of its planes allowing more flights per day, higher customer satisfaction, and better overall productivity. Much of the coordination needed to achieve fast turnaround requires employees from different functions (e.g. customer service representatives, gate agents, and cleaning crew) to work together. This is facilitated by employees having strongly homogeneous shared beliefs in the value of collaboration and would be hindered if some employees either did not share this value or even believed more strongly in the sanctity of individual, and often unionized, functional roles.
Despite these theories, findings, and observations having direct implications for the task and monitoring environments faced by CEOs and their boards, empirical evidence on the role of corporate culture homogeneity in facilitating incentive alignment between firms and shareholders is generally lacking. Our study explores this issue by examining how corporate culture homogeneity within firms is associated with the design of CEO compensation contracts.
Theoretical Framework. Corporate culture is widely viewed as a stable feature of organizations that evolves to help them adapt to their respective environments and affects a variety of organizational features and outcomes. Therefore, we assume that boards are, in equilibrium, making CEO compensation decisions taking the existing culture into account. We argue that, first, the internal organization features of culturally homogeneous firms could reduce task complexity for their CEOs and the need for boards to use compensation contracts to incentivize CEOs to take costly actions to further enhance internal organization efficiency. Second, corporate culture is widely recognized in the literature as evolving to be well adapted for firms given the environments in which they operate. Therefore, for firms that have already developed high degrees of corporate culture homogeneity, boards may be more reluctant to impose risk in their compensation choices which might induce CEOs to take decisions that could weaken or otherwise alter the existing culture. Third, the widely shared and strongly held cultural values and beliefs that have evolved in firms with high degrees of corporate culture homogeneity can function as a benchmark for boards to evaluate CEO actions in uncertain environments. Therefore, it may be easier for the boards of these companies to ex post monitor CEO performance and rely less on ex ante incentive alignment.
We thus predict that, due to reductions in both agency and monitoring costs, firms with high degrees of corporate culture homogeneity would rely less on equity-based pay than their culturally heterogeneous counterparts. Besides equity-based pay, we also explore how corporate culture homogeneity could be associated with other elements and features of CEO incentive contracts, such as the bonus, salary, and total pay as well as the use of non-financial performance metrics.
Anecdotally, it is not difficult to find real-life examples that fit our prediction. Consider the examples of Handelsbanken and Southwest Airlines noted earlier for their high degrees of culture homogeneity. Handelsbanken does not use equity-related incentive programs for any of its executive officers. In fact, in its annual report in 2022, Handelsbanken states explicitly that “…the Board has established that the Bank’s remuneration system must be consistent with the Bank’s business objectives and business culture…” and that “…fixed remuneration is fit-for-purpose for sound, sustainable operations, and is therefore applied as a basic principle. Variable remuneration is applied with great caution”. Southwest Airlines, on the other hand, relies more substantively on equity pay in its CEO compensation but does so with less intensity and conditional on considerably more non-financial metrics than its similarly sized airline peers.
Measurement and method. We capture corporate culture homogeneity using a text-based measure developed in the organizational behavior literature which assesses the degree of homogeneity in employees’ culture-related comments posted on the company review website Glassdoor.com. This measure captures the similarity in the distributions of the cultural topics mentioned across employees’ written comments for each firm year. By focusing on the degree to which different corporate members systematically share the same perceptions about the culture in their firm, this measurement approach is well aligned with economic theory-based definitions of corporate culture homogeneity.
To better test our predictions about the equilibrium relationship between corporate culture homogeneity and CEO compensation design, we also construct indicators for firms with stable long-term culture homogeneity versus heterogeneity and create a matched sub-sample based on propensity score matching. Firms with stable culture homogeneity in our sample include firms like Apple, Costco, Southwest Airlines, Starbucks, and Hilton, most of which are well known for their emphasis on maintaining strong cultural values and norms. Examples of firms with stable culture heterogeneity include Xerox, Cardinal Health, and GE, many of which are subject to features that make corporate culture difficult to maintain (e.g., fast growth through acquisitions).
Besides Glassdoor, we also draw on several other data sources (i.e., Compustat, ExecuComp, CRSP, and Incentive Lab). Our sample spans from 2010 to 2019, including more than 1,000 (5,000) U.S. public firms (firm-year observations).
Main findings. We first document that firms with higher degrees of corporate culture homogeneity tend to rely significantly less on CEO equity pay. We also find that these firms do not appear to substitute equity pay with salary or cash bonuses, resulting in significantly lower levels of CEO total pay and lower (higher) percentages of variable (fixed) to total pay. We further find that, when adopting equity pay, firms with higher degrees of corporate culture homogeneity tend to use a significantly larger number of non-financial performance measures.
Further, we extend our analyses of explicit CEO incentive contracts to examine whether similar patterns hold for CEO implicit incentives. We find similar patterns of weaker CEO incentives in culturally homogeneous firms with the sensitivity of forced CEO turnover to both accounting and market performance decreasing with the degree of culture homogeneity. We also find that corporate culture homogeneity is associated with weaker tournament incentives of executives, which are proxied by the pay gaps between CEOs and other top executives. Additionally, we examine the association between corporate culture homogeneity and the compensation of CFO and other top executives and find that the results are similar in terms of direction and significance when compared to our CEO compensation results.
Contributions and implications. Our study provides some of the first direct empirical evidence of the relationships between corporate culture and both the level of equity pay and strength of incentives for top executives. By focusing on CEOs, our study suggests that theories of corporate culture and formal incentives, which have largely been developed in the context of the internal organization of firms, are also important for understanding differences in external contracting between top executives and shareholders across firms. The consistency in our findings across a broad range of incentive design choices (e.g., reliance on equity, the use of non-financial performance measures, and implicit incentives) points to corporate culture homogeneity as an important factor in explaining the variation in CEO compensation design across different companies.
