The value of corporate culture

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Abstract

We study which dimensions of corporate culture are related to a firm׳s performance and why. We find that proclaimed values appear irrelevant. Yet, when employees perceive top managers as trustworthy and ethical, a firm׳s performance is stronger. We then study how different governance structures impact the ability to sustain integrity as a corporate value. We find that publicly traded firms are less able to sustain it. Traditional measures of corporate governance do not seem to have much of an impact.

Introduction

Resigning from Goldman Sachs, vice president Greg Smith wrote in a very controversial New York Times op-ed: “Culture was always a vital part of Goldman Sachs׳s success. It revolved around teamwork, integrity, a spirit of humility, and always doing right by our clients. The culture was the secret sauce that made this place great and allowed us to earn our clients׳’ trust for 143 years”. He then adds “I am sad to say that I look around today and see virtually no trace of the culture that made me love working for this firm for many years.” In his follow-up book, Greg Smith seems to blame the demise of Goldman Sachs׳s culture to its transformation from a partnership to a publicly traded company.

While highly disputed by the company,1 Greg Smith׳s remarks raise several important questions. What constitutes a firm׳s culture? How can we measure it? Does this culture—however defined and measured—impact a firm׳s success? If so, why? And how can different governance structures enable or curtail the formation and preservation of a value-enhancing culture? In this paper we try to answer these questions.

Whether culture was Goldman׳s secret sauce or not, Goldman certainly went out of the way to advertise it. The first page of its Initial Public Offering (IPO) prospectus was enumerating the “Business Principles.” including “Integrity and honesty are at the heart of our business.” Yet, in this regard, Goldman is not unique. When we look at companies׳ Web pages, we find that 85% of the Standard and Poor׳s 500 (S&P 500) companies have a section (sometimes even two) dedicated to—what they call—“corporate culture,” i.e., principles and values that should inform the behavior of all the firms׳ employees. The value we find more commonly advertised is innovation (mentioned by 80% of them), followed by integrity and respect (70%). When we try to correlate the frequency and prominence of these values to measures of short- and long-term performance, however, we fail to find any significant correlation. Thus, advertised values do not seem to be very important, possibly because it is easy to claim them, so everybody does. Thus, is there another, more meaningful way, to measure values?

To this purpose we use a novel data set created by the Great Place to Work® Institute (GPTWI), which conducts extensive surveys of the employees of more than 1,000 U.S. firms. While only the list of the best 100 firms to work for is publicly disclosed, we have access to the full database. The advantage of this database is that it measures how values are perceived by employees, rather than how they are advertised by the firm. In particular, there are two questions in the survey that measure the level of integrity of management as perceived by the employees.

When we use these measures we find that high levels of perceived integrity are positively correlated with good outcomes, in terms of higher productivity, profitability, better industrial relations, and higher level of attractiveness to prospective job applicants. These effects are also economically relevant: a one standard deviation increase in integrity is associated with a 0.19 standard deviation increase in Tobin׳s q, a 0.09 standard deviation increase in profitability, and a 0.24 standard deviation decline in the fraction of workers that are unionized.

Since these statements are part of a longer survey instrument, we are concerned that there might be some “halo” effect, which might contaminate all the answers. In companies that pay more, for example, employees may tend to be happier and all the answers may tend to be more positive. To address this problem, we use as controls responses to questions that, though containing the halo effect, in theory are orthogonal to the integrity question, such as the answers to statements like “This is a physically safe place to work” or “I can be myself around here”. The correlation of integrity with positive outcomes survives these controls.

While these correlations do not prove causation, they suggest that companies׳ obsession with corporate culture might be justified, as some models have tried to capture. In O׳Reilly (1989) and Kreps (1990), corporate culture is considered relevant because employees face choices that cannot be properly regulated ex ante. Thus, corporate culture acts as a constraint. In Erhard, Jensen, and Zaffron (2007), adherence to integrity acts as a commitment not to engage in economic calculations. In this way, for example, an employee will not trade off customers׳ satisfaction for larger profits today. Thus, maintaining a culture of integrity can have some short-term costs (the forgone profit today), but also long-term benefits.

If a culture of integrity is valuable, why do some firms end up losing it? We know from Edmans (2011) that firms included in the 100 “best firms to work for” (as measured by the GPTW ranking) tend to have a higher future abnormal stock market return. Since integrity and trust play a role in the determination of being named one of the 100 best, we can interpret this result as saying that the market initially underestimates the value of the integrity capital and only over time—as the profits come in—appreciates its value.

If this is true, it might be value-maximizing (at least in the short term) for publicly traded firms to underinvest in integrity capital. To test this hypothesis, we analyze whether ceteris paribus publicly traded firms in the GPTWI data set have a lower value of integrity (as measured by the survey responses) than privately held ones. We find this to be the case, even after controlling for industry, geography, size, and labor force composition. Public firms have an integrity value that is 0.21 standard deviations below similar firms that are private.

Not all firms see their integrity drop when they go public. Venture capital-backed firms do not seem to experience any drop. This different outcome might be the result of a longer horizon generated by the presence of a large shareholder or by a better organizational design made by professional founders.

To disentangle these hypotheses, we test whether the presence of a large shareholder or other corporate governance characteristics affect the level of integrity capital. We find that the only corporate governance characteristic that is statistically significant is the presence of a large shareholder (at least 5% ownership share), yet it has a negative correlation with the level of integrity. Thus, it looks like a focus towards shareholders׳ value-maximization undermines the ability of a company to sustain a high level of integrity capital.

The rest of the paper proceeds as follows. Section 2 introduces the theoretical background of the analysis. Section 3 describes the set of values advertised by S&P 500 companies. Section 4 presents the main data used. Section 5 discusses how we deal with the econometric problems created by a potential halo effect. Section 6 presents the correlation between integrity and firm׳s performance measures. Section 7 explores the relation between integrity and several governance variables. Section 8 concludes.

Section snippets

Definition of corporate culture

There are several definitions of corporate culture. One view (see, for example, Cremer, 1993) is that culture represents the unspoken code of communication among members of an organization. A related view is that culture is a convention that helps coordination, like which side of the road we drive on. The managerial literature focuses on the notion of culture as “a set of norms and values that are widely shared and strongly held throughout the organization” (O׳Reilly and Chatman, 1996). In this

Advertised values

One of the functions of stating specific corporate values is to attract employees with a similar value system. Goldman, for instance, has advertised to the world (including its investors in the IPO) the importance of integrity as a value. According to Greg Smith, this value was also used aggressively in recruiting pitches. Thus, we want to start by analyzing what values corporations choose to advertise.

The Great Place to Work® data set

Since the most claimed values after innovation (which has an easy-to- interpret economic meaning) is integrity, we will focus on integrity. Measuring integrity is not easy. While integrity could sometimes be in the eye of the beholder, the relevant eyes in an organization are those of the employees. Thus, ideally, we would like to measure how workers perceive that top managers uphold integrity as a value. A data set assembled by the Great Place to Work® Institute (GPTWI) fulfills this goal.2

Econometric concerns

As Table 2C shows, the individual responses to the various distinctive statements asked in the employees׳ survey are highly correlated. For example, the agreement with the integrity statement has a 0.91 correlation with the agreement with the ethics statement. This pattern raises the serious possibility that, in addition to a standard omitted variable problem, there might be a so-called “halo effect” pervading all the answers. Thorndike (1920) defines it as “a problem that arises in data

Integrity and performance measures

We start with financial measures of performance, which we have available only for the subsample of publicly traded firms. Table 4A reports the estimate of a linear regression where the dependent variable is Tobin׳s q (in the first four columns) and the return on sales (in the last four). Besides industry and year fixed effects, as control variables we report a measure of size (log of the number of employees) and one of the two proxies for the halo effect: the employees׳ opinion on the safety of

OLS regressions

In Table 5 we explore the correlation between being a publicly traded company and the average level of integrity. In columns 1–3 we use the integrity measure as a dependent variable. Since founders tend to identify themselves with the company, we control for whether the founder is still on the board, expecting it to make integrity more sustainable. In addition, we insert several other control variables: a measure of size (log of the number of employees), the quality of employees’ benefits (both

Conclusions

In resigning from Goldman, Greg Smith claimed that a culture of integrity was “the secret sauce” that made Goldman great. He also claimed that this culture had deteriorated since the IPO. While we are unable to test his claims directly, we study whether, on average, a culture of integrity adds value and whether, on average, this culture is weaker among publicly traded companies. We find both these statements to be true. Integrity is positively correlated with financial performance and

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We thank the Great Place to Work Institute for sharing the data with us. We also thank Amy Lyman of the Great Place To Work Institute for clarifying many doubts about the data and for many and very useful comments. We are grateful to David Kreps and to participants at the NBER Conference on the Causes and Consequences of Corporate Culture and the MOVE workshop on Social Economics, Barcelona for helpful comments. We also thank two anonymous referees for their remarks and suggestions that have improved the paper considerably. Luigi Guiso gratefully acknowledges financial support from PEGGED, Paola Sapienza from the Zell Center for Risk and Research at Kellogg School of Management, and Luigi Zingales from the Stigler Center and the Initiative on Global Markets at the University of Chicago Booth School of Business. We also thank Cecilia Gamba, Lanny Lang, and Simone Lenzu for excellent research assistantship and Shastri Sandy for providing us the institutional ownership׳s data.

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