Does corporate culture really matter?

Credit: Josh Stunkel

Staff | Oct 12, 2015

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Every month, the Big Question video series brings together a panel of experts for an in-depth discussion. In this edited excerpt from October’s episode, Chicago Booth’s Amanda J. Sharkey and Luigi Zingales, along with Alain Cohn, a postdoctoral scholar at Booth, explain what corporate culture is and whether leaders can change that culture if it goes bad. The discussion was hosted by Hal Weitzman, Booth’s executive director for intellectual capital. 

What is corporate culture?

Amanda J. Sharkey: It’s a set of shared assumptions or values that employees in a company have in common. We think of organizations having a strong culture when those values are extremely widespread and deeply held by employees in the organization. Values are a set of deeply held beliefs and norms about what’s appropriate to do. Another aspect of culture is more cognitive, and involves how you see the world.
Luigi Zingales: The culture of a company is a combination of values and expectations, and it’s not just companies that have it. The finance group here at Booth meets promptly at 1:20 p.m. You go to other groups and they’re not as punctual. There is a set of expectations that people have. They coordinate on that, and it’s very important to cultivate. What we don’t understand fully is how to form and maintain a culture.

Where does corporate culture come from?

Zingales: First, there is an element of selection, which is very important in companies. Second is assimilation, seeing the example of how others behave. In our finance group, the leading example is Eugene F. Fama. He’s always there on time. The only time that he was two minutes late was the day after he won the Nobel Prize. That gives you a code.  

Alain Cohn: Corporate culture matters for companies because it’s a key determinant of their reputation. Warren Buffet recently wrote to a manager at one of his companies: “We can afford to lose money—even a lot of money. But we can’t afford to lose reputation—even a shred of reputation.” Culture is closely connected to a firm’s reputation, because a firm’s reputation is like a public good. It’s individually costly to contribute to a good reputation, but everyone at the firm benefits from it.

Zingales: Culture is also a way to create an incentive scheme that cannot be designed properly with monetary incentives. For example, a lot of employees, especially in sales, have an interest in compromising on quality to make sales. How do you tackle that? You create a set of values; you punish or reward people based on those values; and they become part of the firm’s overall system of incentives.

To what extent do individual leaders shape the culture of an entire company?

Sharkey: In a small firm, an individual leader plays a big role. As organizations get bigger, there are two levers for putting a culture in place. One is employee selection. When companies say they’re hiring on the basis of cultural fit, this means they’re taking into consideration the company’s core values and how well the employee fits with those values. The other big lever is socialization: training or inculcating people into the organization’s culture.

How do you enforce corporate culture across national cultural boundaries?

Zingales: It’s particularly difficult when you merge companies. If you grow organically, it is easier to maintain a culture even when you go into a different environment. If you buy a company in China, it’s very difficult to transmit those values to China overnight. A lot of companies are rightfully worried about what happens in other countries, because they’re not sure that the culture translates equally across borders. In high schools in Italy, you have to let others copy your tests. If you don’t, you’re considered a scumbag. Collusion and cheating are standard in some countries, and in others they’re absolutely not. However, regardless of where you operate, if you select and socialize properly, you can have a very distinct culture.

Cohn: It’s a big challenge for global banks. Citibank lost a lot of money because their branch in Mexico issued fake loans to an oil company. It’s important that the leadership actively manages and ensures that values are upheld in branches in other countries with cultures different than the headquarters, that people comply with the norms of the company.

Zingales: Leadership is important, as is how you implement the values. A C-suite executive once told me, “When I send a memo, nobody really believes what I say until I fire somebody.” Unfortunately, a lot of companies these days send internal memos just to cover their behinds in case of a scandal, to say, “There was a memo and a procedure in place.” Employees are smart. They understand immediately if a procedure is designed to be followed or not. Once you start punishing people because they don’t follow it, then they comply.

How do you measure culture?

Cohn: You can’t directly ask employees because it’s unlikely you’ll get honest answers. But you can ask employees for their views on what other employees would think. That is one way to get honest responses.

Sharkey: I’ve looked at annual reports and gone back about 50 years to determine how many pages are devoted to discussing the company’s history, culture, and core values. There’s been a dramatic increase over time in the amount that companies talk about these things, which suggests that having a culture and a statement of values is a must-do for legitimate businesses these days. The question, then, is how deeply that is felt.

Is there a big gulf between what employees think goes on in companies and what companies say goes on?

Zingales: In my research, we asked employees how much they think their management is trustworthy. It’s not particularly correlated with how much companies emphasize integrity. But it is correlated with company profitability. This is not a causation; but, it seems there is a positive correlation between how trustworthy employees think their managers are and how valuable and profitable the company is.

Do industries have a culture, as well as individual companies?

Cohn: We studied bank employees and find that in the control condition they were surprisingly honest, more honest than every other subject pool we investigated. But the general perception of bankers is very different. When we asked the general population to predict the behavior of certain groups, they thought bankers were more dishonest than criminals.

But we also find that although people who entered banking were not inherently dishonest, when they got into the industry their behavior changed. There’s something about the culture in the banking industry that leads people to behave in a different way than they might otherwise. It is not specific to one particular bank but widespread throughout the industry.

There are many factors that affect culture and they’re likely to affect all companies within an industry. For example, during the financial crisis institutions were struggling. They had their backs against the wall, and winning was everything. This is one way that the environment can affect every single company within an industry.

There’s also the effect of employees moving between companies. For example, when the Glass-Steagall Act was removed in 1999, banks started to hire investment bankers, who brought a certain culture into the banks, which then spread through the entire institution: when they were fired, or got a better offer from another bank, their values spread to different companies like a virus.

Does ranking companies affect their behavior?

Sharkey: Corporate culture harnesses the power of peer effects. If I think Luigi is going to show up on time to the meeting, I better get there on time as well. In one study, we looked at companies that were newly ranked on their environmental performance. A straightforward insight would be that as soon as a company gets ranked, it starts improving its performance because it doesn’t want social movements targeting it, say, or shareholders thinking it has old technology. But we also looked at how firms respond to their peers being ranked. We find the effect of being ranked is much stronger if several ranked peers are also affected. The peer effect, copying one another, is a powerful incentive to change behavior.

Could companies educate their employees better about their corporate culture?

Sharkey: There absolutely has to be communication around corporate culture, but actions speak louder than words. Seeing what type of behaviors are rewarded, which type of people get promoted, and who’s held up as the stand-out, high-status folks in the organization—that tells employees a lot about the cultural values, more than just having the CEO say a few words.

Zingales: We have a role as educators in shaping this culture. When we say that it’s rational to commit a crime when the expected benefit is bigger than the expected cost, we’re implicitly saying that it’s irrational not to commit a crime in that situation, that it’s irrational to be moral.

Cohn: The companies themselves should focus on having a code of conduct, for example, that has a clearly defined set of acceptable behaviors. Luigi’s work shows that many companies have a code of conduct, but employees cannot relate to it. It’s important to say in concrete terms what is expected of employees.