Should Investors Care About Corporate Culture?

Episode Transcript
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Veljko (00:00):
Hello, Kateryna.

Kate (00:00):
Hello, Veljko.
So, today we're talking about the topicyou were a bit reluctant to start with.

Veljko (00:07):
I don't necessarily believe in corporate culture as
being real, valid, measurable.

Kate (00:13):
It's very difficult to measure, but yeah, I'm pushing for
us to talk about corporate culturebecause I think it's important.
So let me give you a couple of examples.
Have you seen a movie... it'sa bit older, a few years back.
It's called "FreedomWriters" with Hilary Swank.

Veljko (00:28):
I do not believe I have.

Kate (00:29):
So in that movie, Hillary Swank works as a high school teacher.
And what you can see is that she totallysets up a classroom environment, creates
a classroom culture like no other.
And she really gets a group ofkids to graduate and go through
high school and learn to becurious, like no other teacher.
So, it's a clear example of how aculture was established in the classroom.

(00:52):
Of course, we're going to talkabout corporate culture, but I just
wanted to throw out an example ofhow you can identify a culture.
So if you watch that movie,Freedom Writers, I think you will
see an example of establishinga culture that's very vivid.

Veljko (01:07):
Tell me about the movie.

Kate (01:09):
You just got to see it.
It's based on a real life story.
She just does an incredible job,teaching a classroom of kids
from difficult neighborhoodsand understands their viewpoint.
And figures out a way to get themto want to learn and to be curious
and to basically graduate andhave a very different path in life
than they would have otherwise.

(01:30):
But this is not corporate culture.
So, let me give you anexample of corporate culture
and we'll start with Apple.
At the end of December, the DruckerInstitute released the management top
250 ranking, which ranks companieson customer satisfaction, employee
engagement, innovation scores, socialresponsibility, and financial strengths.

(01:51):
So, a lot of things thatrelate to corporate culture.
And guess who was at the top of that list?
Who was at the top ofthis management 250 list?

Veljko (02:02):
Given how you started, I'm going to guess Apple.

Kate (02:05):
Yes, that's right.
Because I've already mentioneda few things about Apple.

Veljko (02:08):
Are you sure it's not just alphabetical?

Kate (02:09):
Ha!
No.
Apple indeed has the highest score.
But that's funny.
So Apple, you know, one example of theculture in Apple, and we're going to go
back to Steve Jobs, is the stories thatget told and retold in Apple and, usually
an ability of a leader to drive meaning inthe organization, to infuse this meaning

(02:32):
and to connect work that people do tothe vision of an organization is very
important, especially now when peopleare looking for meaning in their work.
Steve Jobs wanted Mac to boot faster.
He basically wanted to have the boottimes in Mac reduced by 20 seconds.
We're going back in times that areprehistoric to some of our listeners.

(02:52):
So back to the, late 1990s, early 2000s.
So at the time reducing the boot speed by20 seconds, it was a big deal because it
took a long time to boot up a computer.
So the engineers obviously resisted this.
And what he told them is that, if wetake 5 million Macs, which is, what's
his projection for the sales at thetime, it's much bigger now, times

(03:15):
365 days a year times 20 seconds.
That's 36 and a half billion.
So basically he narrowed this thing downthat if they were able to reduce Mac
boot times by 20 seconds, they're goingto save over 16 human lives annually.

(03:36):
And that story kept beingtold and retold in Apple.
And the engineers reducedthe boot times by 20 seconds.
And apparently the story is stillalive more or less, but that's how he's
established a culture and he linkeda goal, an operating goal to a vision
that allowed people to really have atangible understanding and created this

(03:57):
culture of what Apple was at the time.
He said, "let's givelife back to the world."
"Let's give life back to the world."

Veljko (04:06):
But so is every goal that management sets, culture?
You know, you started almost criticalof engineers and then you were talking
about how, you know, he set up a veryclear goal, very clear, very measurable.

Kate (04:22):
You're digging too deep into it.
The idea there was just to see anexample of a story told and retold.
Stories build the culture.
The story itself didn't matter.
It was just an example of a story, butbasically stories build the culture.
Why?
Because corporate culture isa basically a set of belief.
It's a belief system.
But we are running ahead of ourselves.

(04:44):
We're getting into definitionsof corporate culture, and we're
going to dig in a lot moreinto it during our discussion.
For now, let's see what isour main question for today.
What's our main question?

Veljko (04:58):
Well, the main question is, should investors actually
care about corporate culture?
And, when we say should investors care,what we're ultimately asking, is, is
there a link here to firm profitability?
Is there a link here toportfolio profitability?
So, should investors care?

(05:18):
Does corporate culture havean impact on firm value?
Does corporate culture have an impacton the value of your portfolio?

Kate (05:24):
Well, if we look at it in that sense, another way to say that, ask
that question is perhaps what kindof aspects of corporate culture
have a negative influence on yourreturns, on the value of a company?
So which type of aspects of corporateculture are dangerous, are bad?
So that, that might be anotherview on the same question.

(05:47):
And, corporate culture, as wewill talk about, it influences
corporate performance, butmaybe it's a lot more than that.
It also has these ethical and ESGtype spillovers on other aspects, but
of course we can keep it more narrowand talk about corporate performance.

Veljko (06:03):
No, but I like this because on one side, I think you're absolutely right.
I think asking, does corporateculture matter is too vague.
I think that we really need to focuson which aspects of corporate culture,
which types of corporate culture matter.
And the other point that you're makingthere, is this idea that perhaps
it's easier to identify the types ofcorporate culture to avoid, right?

Kate (06:28):
To avoid.
That's well stated.

Veljko (06:30):
Having said that, let's get on with it.
Does corporate culturematter for investors?

Kate (06:36):
Let's do it.

Veljko (06:49):
Welcome to Questions in Finance,

Kate (06:52):
a podcast where we translate academic mumbo jumbo to answer
interesting questions in finance.
I'm Kate Holland.

Veljko (07:00):
And I'm Veljko Fotak.
Kate and I met when we were PhDstudents at the University of Oklahoma.

Kate (07:06):
Today we're university professors and we spend our days
teaching and researching companies,markets, and all things related.

Veljko (07:15):
So, okay.
Kate, you're saying Apple is one of themost successful companies out there.
And you're trying to convince methat it has something to do with
their corporate culture, right?
Or at least I think that this is whereall of this is going, but perhaps a
good point to start this conversationis, from definitions as always, right?

(07:37):
So what is corporate culture?

Kate (07:40):
We'll get to the definitions of corporate culture because there's a
couple of really excellent definitionsof corporate culture that are out there.
But basically we're merging finance,sociology, and psychology, so some
angles of management, but not quite.
It's basically a finance takeon management, I would say.
Corporate culture isbasically a belief system.

(08:02):
So it's something that's unwritten.
So for example, John Graham, JillianGrennan and Jillian has done a lot of
work in this area of corporate culture,Campbell Harvey and Shivaram Rajgopal

have a paper titled "Corporate Culture: Evidence from the Field." This is a paper (08:16):
undefined
published in the Journal of FinancialEconomics in 2022, so pretty recently.
They actually surveyed over a thousandexecutives and ask them a variety
of questions, but a majority, 84percent of these executives say that
corporate culture is quite important.
In this paper, Graham, Grennanand Harvey and Rajgopal says that

(08:40):
corporate culture is a beliefsystem, a coordination mechanism,
an invisible hand, how employeesinteract with one another, a standard
of behavior, a pattern of behavior,norms around how people treat people.
They also say it's part ethics,part work ethics, and part

(09:00):
ambience of the work environment.
Culture guides how thecompany really works.
It guides employee actions, butthese are not written rules.
These are all just communicated withoutthem being written down; understood
principles among employees, basically.
So when we started talking about,for example, storytelling was
one example of corporate culture.

(09:22):
So here's one definition, butwe're going to dig into it later.

Veljko (09:26):
So far, that's one definition by Graham
behavior." Can we summarize it that way?
Or is that restrictive?

Kate (09:34):
I think restrictive because, it's, as you've said, it's difficult to grasp.
So that's a big part of it.
It's an untold way to talkabout norms of behavior.
And some things that drivesthe group's behavior.

Veljko (09:46):
Maybe we can try to come up with defining characteristics, right?
So it's something that is shared.

Kate (09:53):
Shared meaning.
It's not an individual concept.
It's a shared concept amongpeople in the company.

Veljko (09:58):
I like this idea that culture is ultimately something collective,
something that affects a group.
To that point, Geert Hofstede, we'regonna talk about him more during this
episode, because, you Kate well know,he's known for developing a framework
for measuring culture across nations.

(10:21):
But he has this paper published inthe Online Readings in Psychology and
Culture in 2011, titled "DimensionalizingCultures, The Hofstede Model in Context."

Kate (10:32):
It's in reality a lot more exciting than the ways that it's titled.
The title is a bit boring, but inreality what Geert Hofstede has
done is extremely interesting.

Veljko (10:44):
Absolutely.
But here I really just want tofocus on the definition of culture.

And what he's saying here is (10:49):
"Culture is the collective programming of the mind
that distinguishes the members of onegroup or category of people from others.
It is always a collective phenomenon.
But it can be connectedto different collectives.
Within each collective, there is a varietyof individuals." This is interesting

(11:11):
how he puts it. "If characteristicsof individuals are imagined as
varying across some bell curve, thenthe variation between cultures is
the shift of the bell curve when onemoves from one society to the other.
I think that's a beautifulway of putting it into words

(11:33):
and thinking about it, right?

Kate (11:35):
Another definition, for example, by Cramers, who contributed a lot to
this literature, is that corporateculture is a "widely-held belief, not
written down." "Corporate cultureassumptions, do not arise instantaneously,
but are due to repeat success,routine, and the way to do things.

(11:55):
It's a stock of shared knowledgeamong employees, given limited
human capacity to process andcommunicate information." A corporate
culture allows people to basicallyshare knowledge with fewer words.

Veljko (12:11):
It's something that I see a lot of these definitions.
It either accumulates overtime or it's immutable, right?
There are some definitions ofcorporate culture that talk
about... it's an unchanging core.

Kate (12:24):
You know, I would not be so fast at pointing out the unchanging.
It's definitely very sticky, We willtalk about things that change culture.

Veljko (12:32):
It's something that's also, intangible, right?

Kate (12:36):
I think that's a great way to point it out because, translating
into our finance speak, right?
We are always concerned about,investment in tangible assets.
More recently, like over thelast 20 something years, also
investment in intangible assets.
And you're right to say that corporateculture is a type of an intangible asset.

Veljko (12:58):
So maybe we can start from there, right?
It's an intangible asset.

Kate (13:02):
But unlike other intangible assets, this one is rarely included
on balance sheets of companies.
The valuation of this intangibleasset, we can see it through
performance changes, but it's notreally valued on the balance sheet.

Veljko (13:16):
My colleague, Feng Gu, he's, the current chair of the
accounting department at Buffalo.
And, Feng had a very successful booka couple of years ago with Baruch Lev
on the "End of Accounting." one ofthe big themes of the book is that
our current accounting standards arenot, keeping up with the importance of

(13:40):
intangible assets in the modern economy.
But so you're saying it's anintangible asset is one that's
often undervalued, right?

Kate (13:49):
I'm not saying undervalued.
I'm saying,

Veljko (13:52):
well, you said it's not valued at all

Kate (13:53):
On the balance sheet.
So that's why you thoughtabout accounting right away.
So one thing that we do see out there and,you know, both of us have been recently
reading Alex Edman's book, " May ContainLies," which is, by the way, phenomenal.
We totally recommend it.
It's a lot of fun.
But Alex Edmans, his 2011 paper showsthat firms ranked as best workplaces,

(14:19):
which are usually the Apples, the onesthat have the best corporate culture
have higher future abnormal returns.
So corporate culture gets reflectedin returns in the long term, but.
It's not reflected in thecounting balance sheet numbers.

Veljko (14:35):
You're absolutely right.
That paper is reallyhighly cited, Edmans 2011.
We ourselves cited itduring our episode on ESG.
What he does, is he identifies,

Kate (14:46):
best places,

Veljko (14:47):
best places to work for, right?
Or at least he uses asurvey that identifies them.
And this is based on employeessatisfaction, basically, right?

Kate (14:56):
Which is the employee engagement score is one of the main parts of this
Drucker's Institute Management Top250 surveys that they talked about
at the beginning where Apple's at thetop of it, not only alphabetically.

Veljko (15:08):
No, it's interesting because I think that one of the findings
in that survey is that what's mostimportant to employees is respect
and managerial responsiveness.
But again, to go back to what wewere saying is this paper about ESG?
Or is it about corporate culture orESG is ESG part of corporate culture?

Kate (15:33):
They are gonna be, of course, highly related, right?
Because culture sets this as, as we'vementioned, untold ways communicated,
across employees, without beingwritten down way of doing things.
So,

Veljko (15:45):
It feels to me like again, we are using this big term corporate
culture and we are capturing a lot in it.
But when you look at the Edman's paper,it's really about employee satisfaction.

Kate (15:56):
That's one aspect of culture that's important.
If we were to break down theaspects of corporate culture.
So you said that what's importantto employees is respect, right?
There is another paper by Luigi Guizzo,Paula Sapienza, and Luigi Zingales.
It's published in 2015 in the Journal ofFinancial Economics, and it's titled "The

(16:17):
Value of Corporate Culture." And that'sLuigi Zingales who has a Capitalisn't
podcast, which we're also fans of.
They look at basically corporatewebsites to see what companies
say as their top corporate values.
But it seems like.
Theirs is not the only paper.
There's others that findthe same attributes.

(16:38):
So how is corporateculture actually measured?
It is respect.
So what you've mentioned in AlexEdmand's paper, it is integrity,
teamwork, innovation, and quality.
Those are the top five measuresof corporate culture out there.
If our listeners would want to takeaway one thing from our episode,

(16:59):
I think it would be that corporateperformance, AKA stock returns, what
our listeners care about is relatedto one of those five measures of
corporate culture significantly more.
Do you want to guesswhich one of the five?
And let me repeat them again.
That's respect, integrity,teamwork, innovation, and quality.

Veljko (17:22):
So, you thought you got me there, but I did read enough of the
literature to know that it's innovation,or I think it's innovation, right?

Kate (17:32):
That that's correct.
That it is innovation in otherways referred to as adaptability,
the ability to perform.
To adapt to changing environments,flow and innovate, obviously, is more
related to higher future returns.

Veljko (17:47):
Let me play devil's advocate here for a second.
There are really two waysof measuring culture.
One is what the firm says its culture is.
I know from management papers that whenfirms talk about corporate culture,
they talk about innovation a lot.
Some of these findings werecircular to some extent, right?

(18:08):
It was a firm say thatinnovation is important and
hence innovation is important.
The other problem I have with thisstream of the literature, is that I
think that the question that we areasking today: "Does corporate culture
matter for investors?" in many ways, it'salmost too broad and too ill defined.

(18:31):
I think the correct question is, dospecific manifestations of corporate
culture, do specific traits matter,like, does innovation matter?
Does integrity matter?
But I think that this literature islosing a little bit of the plot in
asking, does corporate culture matter?

Kate (18:49):
So, let me also come back to the first things that you mentioned
and anchor on integrity there.
You said that there's two ways to measurecorporate culture, kind of what companies
say and advertise their corporate culturevalues to be and what it is in reality.

Veljko (19:04):
Correct.

Kate (19:05):
Actually, what matters is not what the company say.
So all the research that has examinedthis kind of says that whatever stated
on the website in the prescriptedreports of companies in terms of
how they want to portray themselves.
Of course, everybody wants toportray themselves as high integrity
and very innovative, et cetera.

(19:27):
It does not correlate with firmvalue, but what does matter is how
firms are in reality, whether theiremployees, for example, say that
they have high integrity, whetherin non prescripted communication
firms convey certain values as well.
So one, it's the non prescriptiveway of communicating corporate

(19:48):
cultures that matters.
And why I anchored on integrity isbecause, that paper by Guiso, Sapienza,
and Zingales, 2015, they show thatintegrity, as it's perceived by
employees, as they look at the survey,not as it's written up on the website
of the company, is related to Tobin's Q.

(20:08):
Okay, let me take a step backand translate two things here.
So what I just said is that the2015 paper shows that integrity as
perceived by employees is relatedto Tobin's Q. So I want to define
Tobin's Q, that's number one, and whatdoes it mean perceived by employees?
I said they use surveys.
I would like to mention which survey.

(20:29):
So the surveys that's used in the paper isthis Great Place to Work Institute, which
conducts extensive surveys of employees.
And what is Tobin's Q?
Tobin's Q is really a measureof corporate performance,
also managerial effectiveness.
But more specifically, how isTobin's Q usually measured?
We usually take the marketvalue of the company.

(20:50):
So the market value of equity.
What their shares are trading for timesall of the shares plus the market value
of debt divided by the replacementvalue of all of corporate assets.
So imagine if this companyburns down, what would it cost
to replace all of your assets?
In effect, it's a measure, it's aproportional measure of market value

(21:12):
to the replacement value of the firm.
When we talk about Tobin's Q, we usuallyuse it to measure, corporate growth,
valuation and managerial efficiencybecause if management is more efficient,
if corporate growth and valuations arebetter, Tobin's Q is going to be higher.
So they find that integrity as perceivedby employees in these great place to

(21:35):
work surveys is related to Tobin's Q,but there is no such association with
advertised values, the values thatfirms advertise on their websites.

Veljko (21:46):
They find some evidence that integrity matters, that integrity
correlates to Tobin's Q right?
And yet, from this relatively narrow,result, they come with a strong
conclusion that, culture matters.
And it seems to me like that's anextremely narrow definition of culture,

(22:09):
you know, like, why didn't they callthis paper, the value of integrity
rather than the value of culture?
I think that was the title, "TheValue of Corporate Culture." It
seems to me like there's a little bitof salesmanship in wanting to talk
about culture when really all you'retalking about is integrity, right?
And second, when you're looking at surveydata, are you measuring corporate culture

(22:34):
and, you know, managerial integrity, orare you measuring employee satisfaction?

Kate (22:40):
I think that employees could be satisfied in an environment with very low
integrity too, if they're paid up a lot.
So I think that if they're talkingabout integrity as perceived by them,
they are talking about integrity.
I'm, you know, being from the formerSoviet Union, there's plenty of examples
of, people being highly satisfied, a. k.a. the political leaders in environments

(23:02):
of very low integrity because thosehigher political ranks in the Soviet
Union were laden with corruption.
So integrity was talked about highintegrity, but in reality, everybody knew
that the perceived integrity is very low.
And they wouldn't say it in thesurveys at the place where they
work doesn't have high integrity.
But these are politicalleaders and we're talking about
anonymous surveys of workers.

Veljko (23:23):
And yet, regardless of whether you're talking about Russian, or Russian
employees and workers, you have a verydifferent society here, very different
social traits than those of Westerncorporate managers or or Western workers.

Kate (23:40):
Let's not mix in a societal culture characteristics.
Well, I would like actuallyto talk about societal culture
and corporate culture together.
That's actually a very interesting topic.
As you know, Geert Hofstede has puttogether six measures of societal culture.
That's the societal culture.
And I'd like to talk about how itis related to corporate culture He

(24:03):
worked for IBM and IBM at the time hademployees from a variety of countries.
And he saw that employees from the samecountry had very similar attributes.
So he created these societal culturemeasure motivated by IBM employees.
Because there's a lot of variation acrosscountries on various culture characters.

(24:23):
One thing they look at is long termorientation, uncertainty avoidance,
masculinity and femininity, powerdistance, how much people like or don't
like taking orders from others and thissense of peace or lack of conflict.

Veljko (24:40):
I fully appreciate Hofstede's classification, is that
I've, never really seen that asbeing about corporate culture.
And, you know, this word cultureseems to be used very differently in
these two streams of the literature.
Most of my research is on things acrossborders, so, when you said, let's do

(25:02):
an episode on culture, that's the firstthing that came to my mind, right?
Hofstede and yeah, Americans are more riskprone, individualistic than, let's say,

Kate (25:14):
Swedes,

Veljko (25:15):
Swedes, Swedes, yeah.
And yes, as you correctly point out,we've used this in our own paper, and
we've correlated some of these countrylevel attributes to investors' propensity
towards socially responsible investing.
And yet, again, this iscountry level culture.
This is not

Kate (25:34):
Country level culture does make its way into corporate culture.
There are several studies thatlook at the background of CEOs and
the cultural background of CEOs.
And they show that CEOs, culturalbackground gets represented in certain
corporate culture matrices as well.
So, whether you are an Italian bybackground or Ukrainian, Swedish, or

(25:57):
American and become a CEO of a company,that social cultures that you have in you
will flow into the corporate culture ofthe firm of which you become an executive.
And, you know, Jillian Grennan and herwork points out that among, several
things that can change corporateculture, change in people or management

(26:19):
is one of those things that can createthe change in corporate culture.

Veljko (26:23):
I will go back to Geert Hofstede here in his 2011 paper "Dimensionalizing
Cultures, the Hofstede Model in Context."And he starts here by saying that,
and I quote." Most commonly the termculture is used for tribes or ethnic
groups in anthropology, for nationsin political science, sociology, and

(26:45):
management, and for organizations,in sociology and management.
A relatively unexplored field isthe culture of occupations, for
instance, of engineers versusaccountants, of academics, or of
academics from different disciplines.
The term can also be applied to thegenders, to generations, or to social

(27:05):
classes." Here is where I think itgets really to your point, right?
Because I think there is a little bitof a disconnect here where Hofstede's
framework was developed originallyto compare cultures across countries.
But it's often applied in a different way.
And he's commenting on this here.

He's saying (27:26):
"However, changing the level of aggregation studied changes
the nature of the concept of culture."He continues here saying: "Societal,
national, and gender cultures whichchildren acquire from their earliest
youth onwards are much deeper rooted inthe human mind than occupational cultures
acquired at school or then organizationalcultures acquired on the job."

Kate (27:51):
Oh, can you read that again?
What are the societal ones?
Gender is one.

Veljko (27:56):
Societal, national and gender cultures, which societal,

Kate (28:01):
national and gender cultures.
So these are

Veljko (28:05):
acquired very early on by you and he's saying that these are much
more deeply rooted in the human mind.
Implicitly, less likely to changethan occupational cultures acquired
at school or organizationalcultures acquired on the job.
And then he gets even more specific.

(28:27):
He says, "The latter," implyingorganizational cultures, "are
exchangeable when people take a new job.
Societal cultures reside in oftenunconscious values, in the sense of
broad tendencies to prefer certainstate of affairs over others.
Organizational cultures reside ratherin visible and conscious practices.

(28:49):
The way people perceive what goes onin their organizational environment."

Kate (28:53):
Okay, obviously the two are linked.
If you have some societal preset, you'regoing to see what's happening in your
organization through that lens, whichis what Hofstede caught on in IBM.

Veljko (29:04):
Yeah, but let me push back against this concept even
a little bit further, right?
Because as we've discussed, weuse this term culture both to talk
about differences across nationsand differences across firms.
And in the back of mymind, it was bothering me.

Kate (29:19):
Oh, no, we, we, we talked specifically separately about societal
culture and corporate culture.
We talked about how one canget infused in the other.
If you have a CEO from adifferent country, the firm will
have certain characteristicsthat the CEO is going to bring.
So that's leaking into societalculture, into corporate culture.

Veljko (29:38):
But, but let me quote here.
I mean, I, I went deephere in research, right?
I really dug deep.
And I dug so much.
So deep that I read the Wikipediapage for Geert Hofstede.
I kid you not.

Kate (29:52):
The ultimate level of knowledge.
What did we ever dobefore Wikipedia, right?

Veljko (29:56):
No kidding.
So, here it gets interesting.
There is a paragraph on organizationallevel culture, in this Wikipedia
entry, and it starts saying, "Withinand across countries, individuals
are also parts of organizations suchas companies." Hofstede acknowledges

that, and here they quote him (30:14):
"The dimensions of national cultures are not
relevant for comparing organizationswithin the same country." But anyways,
from 1985 to 1987, Hofstede's lab, hisInstitute for Research on Intercultural

(30:34):
Corporation, actually tried to developdifferent metrics for corporate culture.
And they actually ran this researchproject and they actually came up
with six dimensions which they claimdescribed communities of practices
within firms and the six dimensionswere process oriented versus results

(30:58):
oriented, employee oriented versus joboriented, parochial versus professional,
open system versus closed system.
Loose control versus tight control,pragmatic versus normative.

Kate (31:14):
These different dimensions actually map in with the five
dimensions as we've discussed.
So they're like these maps aswell to where they're really
talking about the same thing.

Veljko (31:24):
In some sense, you're not wrong that it does seem to me
like he's trying to reinvent orapply a very similar framework.

Kate (31:32):
It's just about people naming the same thing slightly differently.

Veljko (31:36):
I know that management loves the "upper echelon" theory, right?
Which is this idea that the cultureor personality of people at the top
will affect the culture or behavior...

Kate (31:49):
Well, let me, let me give you your favorite, Daron Acemoglu so close to both
of our hearts because we like his work.
Well, listen, listen to this.
Daron Acemoglu with Jackson hasa 2015 paper where they show
that political events reflect andoften shift societal cultures.

(32:09):
They show that influentialpolitical leaders and presidents
can shape societal norms and valuesthrough policies or rhetoric.
So here they're saying certainpeople can change societal culture.
So why is that such a big stepto say that certain people, CEOs
can change corporate culture?

Veljko (32:28):
I do find this change by itself is a little bit inconsistent with... I know
you're already pushed back against that.
But I still remember corporate cultureas the set of immutable norms, beliefs,
and this idea that yeah, now you'regetting a new CEO and this set of
immutable beliefs actually mutates.

(32:50):
I have a little bit of an issue withthat and yet I don't disagree with it.
As a matter of fact, I don't knowif you're baiting me here, but you
have some interesting work that showsthe firm communication is affected
by the same political events, right?

(33:11):
Did you want to talk about this?

Kate (33:12):
I do.
I do.
I wasn't baiting you, though.
I really wanted to point out that thismore recent work shows that corporate
culture is dynamic and not static.
Perhaps more so than societal culture.
So that's another reason why it's moreinteresting to study culture from a
corporate perspective than societal,because corporate culture is subject to

(33:32):
the following shocks that can change it.
Number one, internal shocks and,number two, external shocks.
So when we're talking about internalshocks, what can happen is that
systems or formal institutions likecompensation or close election votes,
they can actually influence culture.

(33:53):
If, the CEO has a certain culturalbackground as measured by Hofstede
scores that we've talked about,or a certain political identity.
That can bring about a certaincorporate culture, that will
create the change in it.
And also number three or C is events.
So a firm can enter a new life cycle.
So a firm goes from being private topublicly held through an IPO or there's

(34:18):
an M& A or merger and acquisitionof a firm, or there's a leveraged
buyout where it becomes private again.
Those lifestyle events can createchanges in corporate culture.
These are all examples of internal events.
And then of course the firm alsocan be influenced by external
shocks that can shock their culture.
Obviously regulation changes, right?

(34:40):
Regulation changes cancreate new cultures.
People.
So while a CEO is an internal member,what we study in our Kashoggi paper
is how shareholders or investorscan influence things in the firm.
So these external people and thechanges in ownership actually bring
about changes, in the culture and alsosocial and geopolitical events, such

(35:03):
as the MeToo movement or wars, canalso bring about or spill over from
the external, to the internal culture.
So I just wanted to summarize some of thethings that can change corporate culture.

Veljko (35:17):
So for example, you're saying "Me Too," all of a sudden, what
the corporation becomes more awareof racial issues, the treatment of
minorities, and that changes the way thecorporation works, behaves towards...

Kate (35:31):
Yeah, I would say that the general public becomes more aware
and the change in the generalpublic's view pushes for changes in
firms as well because, it's it's...basically correlates with firm value.
So there's a paper by Ane Tamayo and HenryServaes, where they look at some of the

(35:52):
Me Too events and the Weinstein scandal.
And what they show is that aroundthe time of those events, the share
price of certain companies increases.
What are those certain companies?
Those are the companies with a higherproportion of women as their executives.
So, it brings about this awarenessthat it's important and we care, a

(36:15):
certain group of investors cares andthen other companies take a clue.
But yeah, I think a lot moreresearch should be done there.
And this paper by Ane Tamayo and HenryServaes is like the first step there,
but I think it's not only the, Peoplewithin the firm become more aware.
It's that external awarenessof a topic becomes greater.
And it spills over to the company.

Veljko (36:37):
Some of these changes that you're describing are driven by customers, right?
So if my customers all of a sudden aremore concerned about racial issues,
and I'm hiring a minority spokesperson.
I mean, let's think Nikeand Colin Kaepernick, right?
Is this good marketing or is thisa shift in corporate culture?

Kate (37:00):
Great point.
Everybody who studies corporate cultureis concerned with the question, is
it an actual change or is it what wecall mildly strategic communication?
That's a mild way of saying, I don't know.
Strategic communication, right?
So not actually makingchanges, but just talking.

(37:21):
Talking the talk, butnot walking the walk.

Veljko (37:24):
Oh, okay.
So some sort of,

Kate (37:26):
strategic communication.

Veljko (37:27):
It's not greenwashing.

Kate (37:29):
It's strategically communicating.
Strategically communicating.
Yes.
So, a key paper here by KaiLi and co authors who in
2021 do something super cool.
They go into the earnings calls, butnot the pre-scripted portions and non
pre-scripted portion of earnings calls.
And they quantify firms based on thefive key dimensions of corporate culture,

(37:55):
respect, integrity, teamwork, innovation,and quality from this unscripted portion.
They show that what firms messageabout is indeed correlated
with their corporate outcome.
So for each one of the corporateculture values, they find a very
prominent actual corporate outcome.
So for example, for integrity is if youlike firms that have high integrity,

(38:17):
they would be less likely to restatetheir financial results because they
would have been more honest in thefirst place and they indeed find that
firms with higher messaging on integrityhave lower accounting restatements.
So, how firms talk about corporateculture and the cross section is
related to corporate outcomes.

(38:39):
And that's Kai Li's 2021 work.

Veljko (38:41):
So, so this is interesting.
How do we reconcile this with the findingsby Guiso, Sapienza and Zingales, right?
They made a big deal about how the waymanagers talk about integrity or in
general about culture doesn't matter.
It's about how they behaverather than about what they say.

(39:04):
And their findings seem to suggestthat actually the two don't always
correlate very highly, right?

Kate (39:10):
So they're not, Kai Li is not looking at how they, the
executives talk about corporateculture in a pre-scripted sense.
What the authors are doing isthey're examining that portion
of the earnings report that's notpre-scripted . So it should reflect
the actual behavior of the firm.

(39:31):
But you know, what you mentioned bringsabout another question, we've talked
about all of these changes, right?
That corporate culture changes.
And I mentioned six variousthings that can change it.
And then here they're saying thathow firms talk about corporate
culture actually correlates to actualoutcomes or corporate outcomes.

(39:51):
I mentioned that happens in thecross section or across firms.
So they are not lookingacross the time series.
So they are not looking withinthe firm and how firms change the
discussions of corporate culture.
I do a little bit of that in mypast paper with Esther Im, and
again, a shout out to Esther.
What we wanted to know is whether firmstalk differently about their corporate

(40:16):
culture, when there are differentpolitical changes in the United States.
So, to boil it down to a simple question,we ask whether a firm that's headquartered
in an area that votes Democrat versusa firm that's headquartered in an area
that votes Republican talk differentlyabout the Corporate cultures, those

(40:38):
five, dimensions, integrity, respect,quality, innovation, and teamwork,
during different presidencies.
So, you know, imagine the presidencyof George Bush or Barack Obama
or Donald Trump or Joe Biden.
Do these firms Republican votingareas and Democrat voting areas change

(40:58):
how they talk about their corporateculture across different presidencies?

Veljko (41:02):
The most beautiful example of these seems to be Zuckerberg, right?
All of a sudden he's going to the gym.
He's bulking up.

Kate (41:08):
It's a tough one to disentangle from his life cycle stage.
You know, he's not a teenager anymore.

Veljko (41:14):
Okay, fair enough.
But it does seem that his shift inimage has somehow coincided with
the election of Donald Trump, right?
And so again, is this just messaging?
Is this a shift in corporate culture?

Kate (41:31):
So what we, you know, there's several questions in there.
One, you're asking, why do wethink if we document changes,
which we do, why does they happen?
What's motivating them?
And two, is it, AKA strategiccommunication, which isn't followed
by actual changes in culture?
Or is it like an actual culture change?

(41:52):
So I think I, I'm hearingthose two questions.
So, a couple of things there,what we think, is encouraging the
spillover of societal culture ordifferent presidencies into corporate
culture is multidimensional.
Number one, there's research showing thatpolitical alignment between the president

(42:14):
and you or the CEO or the analyst reallyinfluences your opinion about the economy.
So for example, if you are a Democratand I am a Republican, and we just had
the recent election of a Republicanpresident, I am going to be a lot more
optimistic and in a euphoric type of way,so over optimistic about the economy.

(42:35):
That result is shown in a variety ofpapers like people who are politically
aligned, have more kids, a credit analystwho are politically aligned, ranks the
same company as another analyst that'snot politically aligned as having
better future performance and prospects.
So people have this overly euphoricrose glasses on them, when the president

(42:56):
in power is aligned with their party,perhaps this is related to some of this
literature on pride and they're proud andthey're winning societal culture and that
spills over to their economic outlook.
That's been documented across multiplepapers that the economic outlook
is significantly more positive fora politically aligned individual.

Veljko (43:18):
But that's pretty clear, right?
I mean, I vote for party X becauseI think that their economic plan
is smarter than party Y. They win?
I'm optimistic about the future.
This changes my expectations aboutthe future, I don't necessarily see
these as a switch in corporate culture.

Kate (43:39):
But let me ask you a question.
You are this executive, you as a CEO, whois now politically aligned, which one of
the five categories of corporate culture,integrity, respect, innovation, teamwork,
or quality, would you talk more about?
Because now you havethese rosy glasses on.
So which one of the five integrity,quality, teamwork, innovation, and respect

(44:03):
would you elevate in your discussionsnow that you have a euphorically
more optimistic economic outlook?

Veljko (44:10):
I don't really have a prior on that.?
Why does optimism correlate with

Kate (44:15):
Because if you think things are going to be better economically, you
would want your firms to innovate more.
Usually it would be more willingto open up to more innovation.
And you would want to encourageinnovation more because you're
just more positive on things.
We step back innovationwhen we're not sure.
And when we are squeezedfinancially, et cetera.

Veljko (44:36):
Innovation is a risky activity.
Yeah.
And the more optimistic Iam, the more likely I am to
take on the risky activities.
Yeah.
Fair enough.

Kate (44:45):
So, that's one example and one spillover.

Veljko (44:48):
No, I guess in my head, I still have a hard time calling
that a shift in corporate culture?

Kate (44:55):
So I'm not saying that this is a shift in corporate culture.
I first was answering your questionabout what is the motivation?
So one of the motivationis this more rosy outlook.
There's another, which spillsout into firms talking more about
innovation and about quality aswell, because that's related to
some costs, cut measures, et cetera.

(45:16):
But, another thing is firms wantto create some type of a political
hedge, when they are politicallymisaligned with the president.
We've seen this in real life.
Firms have reduced their discussionsof DEI and climate risks, to
align politically, when theyhave previously been misaligned

(45:40):
politically with the president.
So here's some other examplesof corporate culture messaging
that might change politically.
Now you said, well, but I don't seethis as changes in corporate culture.

Veljko (45:51):
Exactly.

Kate (45:51):
You are actually exactly correct.
So when we take a look at whether theactual outcomes change, we don't see that.
So this is all strategic communicationby firms, when we're talking
about changes in their messagingon the political dimension.

Veljko (46:07):
I do feel like these are interesting points about corporate
culture in a general sense, but Iwould like to get us back a little bit
closer to the main question, right?
Should investors careabout corporate culture?
Does this translate into firm performance?

Kate (46:23):
Yeah.
And perhaps even easier, because asyou said, there is a lot to look at,
to think about with corporate culture.
To simplify it even further is perhapswhat should investors guard against or be
afraid of in terms of corporate culture?
What's bad for their investment?

Veljko (46:41):
Okay.
That's an interesting qualifier.
I guess what you're saying isthat corporate culture affects
the downside more than the upside.

Kate (46:50):
Where I was going with that is we know that this culture of innovativeness
or adaptability is extremely important.
And so the moment that we see a decline.
In that measure or for a company, wecan assume that the future value of
this firm will be declining becausethat's, that's really a bad signal.

(47:11):
That's what I was thinking more.
So I think that our listeners shouldwatch out for declines in companies'
ability to adapt and innovate.

Veljko (47:22):
So I did a little bit of research preparing, right?
And I found out in my research thatMIT apparently has a huge center for
the study of corporate culture, right?

Kate (47:34):
Oh, interesting.

Veljko (47:34):
I was, yeah, I was surprised, right?
They have a reputation for beinghighly quantitative and then
I have to admit, I'm not impressedby their work on corporate
culture, by the fuzziness of it.

Kate (47:48):
You want something concrete, you are fuzzy with this intangible
stuff, not very comfortable.

Veljko (47:54):
It's true.
And yet, I'm not sure that I have aproblem with all things intangible.
I have a problem with allthings poorly defined.

Kate (48:03):
I have a problem with all things poorly defined

Veljko (48:05):
At least we agree on this point, so, having said that, this actually comes
from a report titled "Measuring Culturein Leading Companies." And this is by
Donald Sahl, Charles Sahl, and AndrewChamberlain, dated 2019 and published
in the MIT Sloan Management Review.

(48:27):
By the way, MIT has thiscollaboration with Glassdoor
in developing cultural metrics.
I guess it's important to note thiskind of corporate sponsorships to
understand where the money's coming from.
You understand that theremight be potential biases here.
This article on measuringculture and leading companies.

(48:48):
Well, what I mean with biases, of course,if Glassdoor is paying you to produce
research on corporate culture, you bettersay that corporate culture matters, right?
Anyways, this MIT reportstarts by saying that corporate
culture matters, surprisingly.
And then the next sentence is "ahealthy company culture can

(49:10):
turbocharge corporate performance.
This same survey," they quote a surveyearlier, "of CEOs and CFOs found
that nine out of 10 believe thatimproving corporate culture would
increase the company's valuation.
And nearly 80 percent ranked corporateculture among the five most important
factors driving the company's valuation."

Kate (49:30):
You know where this is coming from?
This is coming from the work that JohnGraham and Jillian Grennan have done.
They've created a survey of executivesand they've added some of these
extra questions about culture.
If you read their joint paper, JohnGraham and Jillian Grennan they start
off with exactly what you're mentioning.
There's a, that is a significantmajority of executives say that corporate

(49:53):
culture is extremely important andit's unmatched in other things in that
survey in terms of importance thatexecutives prescribe to the concept.

Veljko (50:02):
And then the next sentence is "a growing body of research by financial
economists," I mean, this is interesting,these are management people, but they're
citing finance research, "has shownthat the good corporate culture is
correlated with a higher profitabilityand returns to shareholders."
Footnote five.
Now footnote five is citing the paperby Guiso, Sapienza, and Zingales,

(50:25):
which is on integrity and firm value.
Effectively showing that firms committingfraud are penalized by markets.
And then it's the Edmonds 2011 paper,again, where he finds that employee
satisfaction relates to firm value.
Firms that are deemed to be the bestplaces to work for see higher valuations.

(50:48):
And there's another paper they citedhere an Economics Letter from 2018.
The title is "Employee Online Reviews andEquity Prices." I took a look, satisfied
employees lead to more valuable firms.

Then they have a JFE (51:01):
"Crowdsourced Employer Reviews and Stock
Returns." Again, satisfiedemployees, higher firm returns.
And then they have a paper byChamberlain, I don't know the first
name, which is actually a Glassdoorresearch report, finding that, " best
places to work for" companies actuallyoutperform kind of an echo to Edmands.

(51:22):
So the big evidence herecomes down to two things.
Fraudulent firms are punished by markets.
Firms with satisfied employees outperform.

Kate (51:34):
I would like to add two more things to what you've mentioned.
You mentioned fraudulentfirms and satisfied employees.
I also want to add that research haspointed out that a corporate culture value
of innovation, also known as adaptability,is very important for firm value.
So let's also add that in, corporateinnovation and adaptability.

(51:57):
and one more thing that I'd like to add,that besides satisfied employees, what
the Drucker Institute ranks even higherin their Management Top 250 ranking
is actually customer satisfaction.
So satisfied customers arealso very important, very

(52:18):
important for firm culture.
But let me hang on to oneof the things that you said.
You said that the fraud culture,fraudulent culture matters.
Totally agree.
I think that there's a lot ofresearch pointing that out.

Veljko (52:32):
I have a wonderful paper on that.

Kate (52:34):
Oh, I would love to hear about it.

Veljko (52:36):
We have a paper with Erik Lie, Jiang Feng, and Haekwon Lee
and myself, where we show that firmsthat are revealed to be unethical,
suffer from a higher cost of debt.
In other words, when you behave in anunethical manner, your lenders require
higher compensation for lending to you.

(52:57):
The idea here is that once you have beenfound to, do something unethical, immoral,
people don't trust you anymore, right?
But the idea here is, if you have a lotof unpaid parking tickets, I think you're
more likely to run after I lend you money.
We make this implicit assumptionthat an ethical behavior spills

(53:18):
over commonly, but this literaturemakes it a little bit more explicit.

Kate (53:22):
Once a liar, always a liar.

Veljko (53:24):
Yeah.
Yeah.
But I think this is more of across section than a time series.
If you lie about X, you're probably lyingabout Y. But I guess I'm nitpicking.
What I want to really highlighthere is that there is also a stream
of this literature that linksreligiosity to firm outcomes.
And generally that stream ofthe literature is also linked to

(53:49):
this idea of trust and honesty.
There is this assumption, underlying herethat people will judge other people who
are religious as being more trustworthy,less likely to commit fraud, and perhaps
more honest about their accounting.
And because of that, they willlend them at preferential terms.
Grullon, Kanatas, and Weston have apaper that finds that firms that are

(54:14):
headquartered in highly religiouscounties are less likely to commit
either fraud or gray area behavior.
So they're less likelyto backdate options.
They actually are less likely to payexcessive compensation to executives.
And of course, that's going to besuper controversial, what's excessive.
And they're actually less likelyto restate earnings, right?

Kate (54:36):
And relatedly a paper by Gilles Hilary and Kai Wai Hui, a
2009 Journal of Financial Economicspaper titled "Does Religion Matter in
Corporate Decision Making in America."They look at investment by firms
headquartered in more religious areas.
And they find that those firmshave a lower investment rate.
So they build fewer factories literally,but so they have lower growth, but

(55:01):
they actually generate more positivemarket reactions when they do announce
their new investments, because they'regoing to be so well thought through.
And better investments.

Veljko (55:13):
That's really interesting, but I'm not sure, is that a
positive or a negative overall?

Kate (55:18):
A positive overall, or I guess it's pointing to a lower risk taken by areas
that are more religious, which usuallyhigher risk taking is linked to fraud.
So that's the connection.
to this fraudulent behavior there.

Veljko (55:34):
I was actually going to cite one more paper that
goes back to that connectionbetween lending and religiosity.
The paper I mentioned earlierby, by Grullon, Kanatas and
Weston, is across countries.
My colleague Jack or Feng Jiang,Kose John, Wei Li, and Yiming Qian.

(55:56):
They actually have a paper or thatdoes something similar at a county
level within the United States.
The title is "Earthly Rewards to theReligious Religiosity and the Costs
of Public and Private Debt." This ispublished in the Journal of Financial
and Quantitative Analysis in 2018.
And effectively what they find isthat firms in higher religiosity

(56:20):
counties have higher credit ratingsand ultimately a lower cost of debt.
They find that the impact of this is alot stronger during recessions and bad
times, it's a lot stronger when there isa greater degree of information asymmetry.
Anyways, I do find, this side of theculture, literature somehow intriguing.

(56:42):
I mean, it's almost likereligiosity allows you to get
to some sort of first principle.

Kate (56:48):
It goes to all the definitions of cultures that we've discussed, right?
It's a culture of religiosity in a way.
Because it's a set of unspokenrules shared among a community of
people that defines their behavior,especially in times of difficulty.

Veljko (57:04):
I would say within this framework, religion seems to me to almost be
a determinant of corporate culture
. Kate: Which goes back to Gerd Hofstadter's immigrants from different countries,
coming to the U S and working, manyof them working in the same firm, that
firm's culture is going to be largelyinfluenced by the social culture from the

(57:27):
country where these people came from.
Same as religion has an influenceon the corporate culture.
If many of these people are going tochurch and share the same set of beliefs.
I guess there's a bit of a carry overbetween societal or outside of corporate
culture, cultural traits, and whatspills over into the corporate culture.

(57:48):
Exactly.
And I think that's the mistake, insome sense, in some of this literature,
which maps societal cultural traitsdirectly onto corporations, ignoring
the fact that societal traits aredeterminants of corporate cultures, but
they're really not one and the same.

(58:09):
We've spoken in other parts ofthis podcast about how culture is
pervasive to, to the organization.
While in some sense, that makes itdifficult to study in a scientific
manner, because something that's sopervasive is always hard to identify.
It also, in some sense, makes ithard to determine the contours

(58:30):
of this literature on culture.
Because one of the things that I'mnoticing is that, the more we talk
about this, the more I realize there arestreams of the literature that in my mind
didn't necessarily map onto culture, butthat effectively speak about culture.
So you're talking about religiosity.
There is a very large literature on theimpact of religion on corporations and,

(58:52):
yeah, ultimately that's about culture.
Back to this question, should investorscare about unethical companies, or should
investors care about corporate culture.
Which ultimately translates into doescorporate culture lead to higher profits.
The answer here seems to be yes.
And yet what it boils down to is investorsshould find firms that are innovative,

(59:14):
adaptable and, let's say revolutionary.
Investors should identify firms withhappy and satisfied employees, presumably
as a proxy for a productive workforce.
And finally, investors shouldavoid fraudulent firms.

Kate (59:28):
They should avoid firms that have slowed their adaptability or innovation.
On the fraudulent firms they should forsure avoid fraudulent firms and they
should know which firms have like thishigher risk culture are more likely
to be fraudulent because there's apaper by Fahlenbrach, Prilmejer, and
Stulz, 2012, super interesting paper.

(59:51):
They basically show that the banks thatdid pretty bad during the financial
downturn of the two thousands,like, you know, when the big tech
firm, we had the big fallout whereexactly the same banks that didn't
do well in the 2008 financial crisis.
So, you as an investor shouldhave kind of known, okay, is

(01:00:13):
this bank has a bad culture.
And whenever the next crisis is aroundthe corner, this bank is going to
do worse than other banks as well.

Veljko (01:00:21):
But how could you have known that this bank has a bad culture?

Kate (01:00:24):
Because these banks perform the worst during the 2000 downturn.
And they were again the same banks.

Veljko (01:00:31):
But how do you know they perform poorly because of poor culture and not
because of poor risk-management practices?

Kate (01:00:35):
Because this is called the risk culture, so that's how this is referred
to in that paper is the risk culture.

Veljko (01:00:40):
A bad firm underperforms.
I mean, imagine walking intoa consulting meeting, right?
And telling investors that afterspending millions of dollars on your
research, you found out that investorsshould stay away from firms that are
fraudulent and investors should investin firms that are good at innovating.

Kate (01:00:58):
Yeah, a lot of the times, I guess that's what the message will boil down to.
Of course, it's going to be a two hourseminars that somebody charges like half a
million for, but yeah, it's going to boildown to a consultant saying, avoid firms
that are fraudulent and invest in firmsthat have high innovation or adaptability.
Again, dressed up in multiple examples andways and stretched through the two hours.

(01:01:23):
Do you remember during our episode onshort selling, we talked about hedge fund
managers that identified unethical CEOs,those CEOs that lied about which schools
they went to, where they graduated from.
These hedge funds basically sold thosefirms short and indeed they were correct

(01:01:44):
because these firms underperformed.
Kind of showing that if a CEO isunethical in one area, like, you
know, telling us some lies aboutwhich schools they went to, they're
also going to lie in other areas andperhaps lie about corporate performance.
Which is going to be then linkedto a more negative or worse
performance for these firms.

(01:02:04):
And there's other types of CEOproblematic behavior that has been
pointed out by previous research andthen linked to lower firm performance.
For example, you know, CEOs that liedabout which schools they went to, where
they graduated from, who had legalrecords, who had traffic violations,

(01:02:27):
companies that have option backdated,all of those behaviors are somewhat
unethical and they have been alsolinked to higher risk cultures or more
fraudulent cultures within these firms.

Veljko (01:02:43):
The part that I like the most, where I see some
value here is in the spillovers.
You mentioned that paper onCEOs and parking tickets,
parking violations, right?
Is that Mityadkov?

Kate (01:02:58):
There are actually several papers on this topic, and I think
the one that you are talking about isSergei Breginsky and Sergei Mitiakov.
It's a 2015 Journal of Financial Economicspaper titled "Foreign Corporations and
the Culture of Transparency, Evidencefrom Russian Administrative Data."
And what they do is they use incomemisreporting, based on the type of a

(01:03:24):
car that an individual in Russia drives.
The idea is the following.
If you drive a Mercedes versus youdrive a very cheap car, let's say, a
Russian made Zhiguli or Zaporozhets,but you report the same income, it's
very likely that the person who drives aMercedes is underreporting their income.
They also look at what fixes thisbehavior in a way, and basically the

(01:03:49):
entry of multinational, more transparentfirms than other firms in Russia,
fixes this income underreporting.
And they actually look at employeesthat joined private Russian companies
from these multinational firms.
So another paper there is Mironov.
This is Maxim Mironov, 2015, and that'salso a Journal of Financial Economics.

(01:04:14):
It's a paper titled, "Should One Hirea Corrupt CEO in a Corrupt Country?"
not surprisingly, or surprisingly,they also examine, Russia.
And what they look at hereare traffic violations.
So they look at two individuals who arevery similar in terms of how much money
they make, where they live, and so on.

(01:04:34):
And they find one such individualwith very few parking and traffic
violations, and another individualwith a lot of traffic violations.
And so they suggest that the one withfewer traffic violations is the one
who is a lot more likely to bribe thepoliceman, because bribing policemen
is a typical thing to do in Russia.

Veljko (01:04:55):
I find this hilarious.
It's such a post Sovietway of looking at things.
We're gonna just start by assumingeverybody's guilty, right?
And then the one that's not getting finedis the one that's paying bribes, right?
And so if you're getting fewer fines,you're actually more dishonest, right?
I love it.

(01:05:15):
We are just not even going toentertain the possibility that
people are actually honest, right?
But, but, okay, please go ahead.

Kate (01:05:25):
And so they look at what happens to these two individuals, and they
indeed find that the person who ismore likely to bribe policemen, the one
with fewer traffic violations, is alsomore likely to misreport the income
for the companies where they work.
So this lying behavior continues.
But the puzzle in this paper is, andlike the questions that they ask, is

(01:05:49):
whether it's better to be a corruptexecutive in a corrupt country.
Because they show that specifically inRussia, these, , corrupt executives who,
bribe the police and who misreport therevenues of the company, their companies
actually perform better than other firms.
And there's one more very interestingpaper in this parking violation space.

(01:06:15):
And that's a paper by RaymondFisman and Edward Miguel.
It's a 2000, 7 JPE, Journal of PoliticalEconomy, and it's titled Corruption,
Norms, and Legal Enforcement Evidencefrom Diplomatic Parking Tickets.
And what they look at, they lookat the parking by the United
Nations officials in Manhattan.

(01:06:37):
Because up until 2002, theseUnited Nations diplomats had
diplomatic immunity, which protectedthem from parking enforcement.
So what they find.
Is that a lot of the diplomats fromhigh corruption countries accumulated
a lot more unpaid parking violations,meaning they illegally parked,

(01:06:58):
while they had this protection.
In 2002, there was an enforcementto where these diplomatic license
plates of violators were confiscated,therefore unpaid violations
dropped sharply in response tothis 2002 change in regulation.
And it's specifically obviouslydropped from those who were violating

(01:07:18):
before, which were the diplomats fromhigh corruption countries countries
with high corruption indices.
So yeah, that was the threepapers, Braguinsky and
Mityakov, 2015, Mironov, 2015.
And Fisman and Miguel, 2007.

Veljko (01:07:36):
I thought that that was interesting, right?
Because what it shows is some sort ofcultural fixed effect, if you will,
or some sort of integrity fixed effect
.Whereas if I cheat on X, I'm more likely to cheat on Y,

Kate (01:07:50):
right?
Well, back to the paper, the Fahelbergpaper on banks, I mentioned that banks in
the US that did badly in the 2000 crisis,again, did badly in the 2008 crisis.
So In case we have a crisis coming inthe next year, I'm going to call it,
I'm going to say 2026 is going to be ayear of extremely bad returns in the U S

(01:08:11):
we can come back to that episode later.
But, you know, I think that peopleshouldn't be surprised if the banks that
didn't do well in the 2008 financialcrisis, they're going to be the same
banks that don't do well in 2026.
But, there's a paper by, AndrewKarolyi, and his co author Taboada.
It's a Journal of Finance.
They show that whenever a bank, and theydon't look only in the U. S. But when

(01:08:34):
a bank from a country that's, knownto be more corrupt gets acquired by
another bank from a country with strongergovernance, stronger standards, they
actually see that the bank in the targetcountry in the more corrupt setting
starts being a lot more transparentand increases its standards as well.

(01:08:59):
So there's kind of like this hopefulmessage that if there's a positive
influence by a firm that's in a corruptsetting being acquired by another
firm that's comes from more ethicalbackground, things change for the better.

Veljko (01:09:16):
I was under the impression that that work by Karolyi and Taboada was
usually cited as evidence of institutionaldifferences across countries.

Kate (01:09:26):
And governance.
Yeah, yes, I agree.
Institutional differencesacross countries.
But again, we've talked about howsocietal culture can spill into corporate
culture and institutional differences.
In this case, you're right.
This is more talking aboutthe more formal institutions.
I just didn't want to say, youknow, these banks is that I have

(01:09:47):
this high risk culture will justalways do badly during crisis.
I wanted to show a window of opportunitiesthat like, wait a second, this can change.
If they get acquired by somebodythat has higher standards.

Veljko (01:10:01):
Maybe I'm being unfair in some sense.
I get that because just becausesomething is nebulous and hard to
define doesn't mean it's not real.
And maybe corporate culture, Youknow, people will say culture is
pervasive to the organization, right?
So maybe one of the difficultiesthat I have with this is

(01:10:21):
it does affect everything.
It does affect my riskmanagement practices.
And yet there is something on theother side of my brain that keeps
saying, we know that all these thingsindividually matter, matter, right?
We know that integrity matters...

Kate (01:10:34):
but I think that if, over 87% of executives says that corporate culture
is the number one most important thing intheir firm, I think it really does matter.
I think that even an averageindividual would know what is
culture in the classroom, inthe company, in their workplace.

(01:10:56):
If you ask anybody, any oneof our listeners right now.
What type of culture doyou have in your workplace?
They would be able to understand whatculture is in their workplace now
compared to their previous workplace.

Veljko (01:11:09):
I would make the complete opposite argument that if you ask
10 people that work at the samefirm, what the corporate culture is,
you will get 10 different answers.

Kate (01:11:16):
There's several ways of measuring corporate culture.
One of them is surveys.
So when there's surveys that askpeople about corporate culture.
Actually, the employees fromthe same place line up on
very similar characteristics.
So I think this brings usto an interesting point.
How do you measure this corporate culture?
Given that there's so manydimensions, how do you measure this?

(01:11:36):
Maybe this can help boil it down.
One is surveys.
Of course it has its own problems.
Another one is like this time invariantfeature, including the risk culture,
which you also have a bit of aproblem with, and societal culture
spill over to the corporate culture.
That's, that's two.
Another one is things that bringabout some time variation changes.

(01:12:00):
And you know, I'd like to highlightthe last ones that's more promising
right now is the linguistic models.
So, a lot of research has usedthe recent language models to
pick out culture characteristicsof a firm from communications of
firms that are not prescripted.
So I think that's the most promisingcurrent application of creating

(01:12:26):
corporate culture measures for form.
It's not survey based.
It's not based on like these invariant,you know, risk type characteristics,
but it's coming from linguistic models.
To extract corporate culture previously,prior to these linguistic models, it
was almost like, as you were saying, itwas almost impossible to do research on
corporate culture because a lot of itwas just kind of like, blah, blah, blah.

(01:12:48):
And talking about ideas or surveys.
And we know all the biases withsurveys, but I think linguistic
models are making, this analysis.
a lot more interesting, a lot moreapproachable and a lot more tangible.

Veljko (01:13:03):
If we were to go back to the core question, should investors
care about corporate culture?
And what does that mean in practice?
Would you have a quickless than two minutes?
What does that mean for investors?
Is there a way to screen your portfolio?
Are there easily available metricsthat the average, because I appreciate

(01:13:24):
what you're saying about naturallanguage processing, and yet I'm
not expecting, you know, grandma,when she's worried about her pension
investments to download Python andstart counting words in a 10k statement.
What does this mean forthe average investor?

Kate (01:13:42):
I think an average investor who's invested in... hopefully they're broadly
invested in ETFs, they are not payingattention to individual holdings in their
portfolio, they're holding a broad base.
But the problem is, this current risethat we have in retail investors in the
U. S., many of them have concentratedpositions In the handful of companies.

(01:14:03):
So I think what we're talking aboutis, more interesting, more important,
and more applicable for these retailinvestors who hold concentrated positions
in a few companies because so much oftheir wealth has stayed up in that.
And there we have a few pointers ofwhat they need to be looking out for
and what they need to be avoiding.

(01:14:23):
We said that they need to avoidcompanies that have reduced
adaptability and innovation.
One recent example of this,and by recent I mean, you know,
we're at the beginning of 2025.
So we will be talking about 2022,2023, 2024, we can talk about
Skechers, Adidas, and Nike.

(01:14:45):
Actually, Adidas and Nike scaled backin terms of the adaptability cultural
value, the innovation cultural value fortheir customer base compared to Skechers.
And if you look at the last fiveyears of performance, and we're
talking specifically here about theirstock price performance and compare
Skechers, Nike, and Adidas, there isone clear winner, and that is Skechers.

(01:15:10):
And one reason for that is, again,the way that Skechers has adapted to
their customer need has been superiorto the adaptation that Nike and
Adidas have done over the same time.

Veljko (01:15:23):
But Kate, those are things that are really easy to say now ex-post.

Kate (01:15:27):
Right.

Veljko (01:15:27):
If I'd gone back five years ago, I'm not sure how, as an
investor, I would have identifiedSkechers as being the more adaptable
corporate culture than Nike, right?
And I've seen some ofthose recent media reports.
Skechers understood before Nike did,the real money was in the casual

(01:15:48):
wear rather than real athletes,for lack of a better expression.
And again, it's easy to look at theshare price of Skechers and the sales
of Skechers and ex-post stitch the storythat, here is a more adaptable company.
And we are concluding thisbecause they adapted better.

Kate (01:16:04):
Yeah.
I agree.
It's a tough one.
And as a great example there, right?
And that's used by a lot of managementpeople is Sony and Apple, because
everybody says that it's Sony'sthat should have invented the iPod.
They had all of the components, buttheir culture was not collaborative
enough and not adaptable enough.
And that's why Apple pulled aheadand came up with an iPod, even

(01:16:28):
though Sony should have been that.
But again, going with what you're saying.
If we lived, which we did, but weprobably didn't have investments in,
in Apple and Sony back in the earlytwo thousands, would we have been
able to see Sony as lagging on itsadaptability and Apple is pushing forward?
I don't know.
I mean, you're right.

Veljko (01:16:49):
The irony is, if I think of two firms that really mismanaged technology,
despite being technology firms, right?

Kate (01:16:56):
Kodak.

Veljko (01:16:57):
Okay.
You were going to say Kodak,I was going to say Xerox,
but yeah, Kodak, Xerox, Sony.
They're all companies that ex-postwe're going, these are technology
companies that mismanaged innovationand that causes them dearly, Kodak
and Xerox a lot more than Sony.
And yet, if you look, if you openmanagerial books from the early nineties,

(01:17:20):
and I remember because I was there, thesewere, you know, page one examples of
innovative multinational corporations.
It wasn't obvious, ex-ante,that there was something wrong
with... and, and Kodak, I wouldn'tnecessarily put in the same batch.
That's why I hesitated at thatmoment because, the biggest mistake
of Kodak was a business mistake.

(01:17:41):
They were afraid of cannibalizingexisting film business.

Kate (01:17:44):
So now everybody takes, takes pictures with their iPhones...

Veljko (01:17:47):
Xerox on the other side, it was just an incredible lack of vision.
In late 70s, early 80s, they had aninternal internet for exchanging messages
and they had video calls amongst their ownteams operating in different countries.
So they actually had somethingthat was doing video calls 15 to 20

(01:18:10):
years before the rest of the world.
And they used it for internal meetings.
They never thought of thisas something we can sell.
Famously, two of their employeesinvented the mouse and Xerox decided
not to commercialize it because theydidn't see any applications for it.

Kate (01:18:27):
Interesting.
These are vivid examples.
What you were saying is, okay, butif we were at the times there, would
we be able to actually see thatthis firm has stepped back on its
innovation and it's not as adaptable?
Okay.
Well, I'm going to throwin that's point number two.
Investors should look out for firms thatscale back on adaptability and innovation,
number two, they should look out forfirms that have a high risk culture.

(01:18:51):
Let's call it that way.
That haven't done well in theprevious crisis, especially banks.
Because this behavior isgoing to repeat itself.
So this way you can look back at thepast and figure out who didn't do well.
And then if there's an economicdownturn, you can divest from
those companies because you knowthat they're gonna again do worse.

Veljko (01:19:14):
There's something I like here about the persistency of behavior
that originates from the fact thatyou have a certain type of culture.
I didn't want to make this about ourpaper, but I go back to one of the
things that we find in our work withEric Lee and Jiang Feng and Haekwon Lee.
So in, in this paper, we lookat option backdating as a proxy

(01:19:38):
for unethical behavior of firms.
Option backdating refers tofirms misrepresenting when they
gave options to executives as partof their compensation package.
For a variety of reasons that areeffectively connected to taxation, you

(01:20:00):
can maximize compensation to your managerswhile minimizing your tax liabilities
if you issue a call options as part ofcompensation package on the day when
the stock price, is at its lowest.
Suspicious thing in this literatureis that you're often seeing
firms issuing stock options toexecutives exactly on the day when

(01:20:25):
the stock price is at rock bottom.
The first people working in thisarea hypothesized that managers
were just really good at timing themarket, and yet eventually we found
that they're not timing the market.
They're ex-post changing the dateat which options are awarded.

(01:20:48):
Now this gets even more technical, butmost of option backdating is not illegal.
It's actually unethical, butnot necessarily violating laws.
Depends on how exactly it's disclosedbut in our work we are going to be
looking at this option backdating asa proxy for non ethical firm behavior.

(01:21:11):
And what we actually do find isthat when firms are revealed to have
backdated options, banks will first ofall restrict capital that they lend,
and then they put stricter non priceterms to loans and increase interest
rates on loans as higher compensationfor a perception of high risk.

(01:21:33):
And what we find in that paper is thatit takes a certain amount of work.
Like there is no list ofbackdating firms, right?
What you have to do is you actuallyhave to look at when they award options.
But, the interesting thing, togo back to our investors, is
banks were actually doing thegroundwork to identify backdaters.

(01:21:57):
The information is public and yet itdoes require a little bit of processing.
You actually have to look at whenthey award options and stock prices
patterns and compare the two.
And it makes sense because in ourevidence we found that the average
bank officer is managing 20 loans.
The actual number wassomething like 16 to 17, right?

(01:22:18):
Whereas.
what we actually found is that we didn'tsee these effects in the bond market.
And one of the things that we found whenwe dig into that is that the average
corporate bond investor holds somethinglike 1600 bonds in their portfolio.
And the fact that identifying thiskind of an ethical behavior requires a

(01:22:39):
little bit of processing of information.
Data is free, information is not.
Actually leads banks to do the work.
And I mean, if you think about theliterature on banking, this is the typical
soft information that banks will process.
But it's the typical soft information thatmarkets will ignore because of volumes.
And one thing that we find in that paperis that after firms have been identified

(01:23:03):
as backdaters by banks, they're morelikely to issue bonds than get bank loans.

Kate (01:23:09):
I see you like to avoid the monitoring and stuff.
Yeah, very cool.

Veljko (01:23:12):
To avoid the monitoring of private loans or bank loans,
they migrate into the bond market.
The implication

Kate (01:23:19):
Hopefully they have a way of migrating to the bond market.
You're already looking at theselect group of firms here who
have access to bond markets.

Veljko (01:23:27):
Correct.
And one of the things that we find inour paper is a separating equilibrium.
The larger firms, for the most part,have access to the bond market, so
they migrate to the bond market.
The smaller firms

Kate (01:23:39):
shrink

Veljko (01:23:39):
stay with bank loans,

Kate (01:23:40):
and shrink, get smaller

Veljko (01:23:41):
Well, yeah, eventually, because either the capital gets rationed and
then the growth is lower, or theyactually find themselves paying higher
interest rates on loans, which alsoaffects the future profitability and, I
think we were talking about investors.
From our own paper I think it's thisidea that on one side, corporate

(01:24:05):
culture matters, especially an unethicalcorporate culture matters because it
correlates with other types of unethicalbehavior, but it's not easy to identify.
And yet, not identifying it.
Not only now you're at risk of lendingto somebody who's unethical or investing

(01:24:26):
in somebody who's unethical, but ifyou ignore these cultural red flags,
you suffer from adverse selection.
Bond markets are not processing thesoft information needed to identify
unethical borrowers in the way banks are.
Not only now they risk lending tosomebody who's unethical, they're
attracting unethical borrowers, right?

(01:24:47):
Because they're gettingscreened out by banks.
So you get that adverse selection,

Kate (01:24:53):
amplification almost.
I would say one more thing, probablylike you pointed out, requires maybe a
bit more looking around or processing.
That's going to be, and this ispointed out by Jillian Grennan's
recent work, it's companies that talkdifferently about their corporate
culture, those five things, integrity,respect, quality, innovation, and

(01:25:16):
teamwork across different mediums.
So on their website, in theirearnings calls, in their 10K or 10Q
report, in their annual report, 8kin their discussions with the banks.
If you see a company and Julianground creates a kind of a variable of
consistency of their communication, that'sinconsistent in how they communicate about

(01:25:40):
their culturally, they say one thing tothis group, but then another thing to this
group.
, Veljko: Huge red flag.
Huge red flag.
That's right.

Veljko (01:25:47):
All of this feels particularly dangerous.
On one side, we have all this researchsaying corporate culture does matter.
It does determine firm performance.
Then, two, we know that you ignoreit at your own peril, that if you
don't screen out bad companies,they will actually find you.

(01:26:09):
Some sort of adverse selection.
And then three, it's allreally hard to measure.
Perhaps we need to giveit a positive spin.
Where there's a gap in knowledge, there'san opportunity for us academics and
perhaps simply our profession hasn't yetdeveloped the right tools and instruments
to measure corporate culture accurately.

(01:26:30):
And so, let's give it a positivespin and let's look at this as
an opportunity for all of us.
And clearly some of these new techniquesthat you were alluding to on language
processing coupled with AI, thoseare really promising, I believe.
And give us hope that we might be ableto develop some new, usable metrics.
So I'm looking forward to reading allthe interesting research that's going

(01:26:52):
to come out of this over the next years.
Yes, let's wrap this up and Kate, doyou want to give us perhaps a brief
summary of what we spoke about today?

Kate (01:27:03):
We've talked about the definitions of corporate culture.
We've talked about how you are notvery happy with the fuzzy nature of it.
And we've outlined the three main thingsthat our listeners should pay attention to
in terms of avoiding in corporate culture.
we can review those again.
So, what is corporate culture?

(01:27:23):
Corporate culture is really like a beliefsystem or coordination mechanism, an
invisible hand, a pattern of behavior,a set of unwritten rules that allow
employees to communicate better, ashared knowledge, a shared knowledge.
We've concluded that there are severalmain characteristics of corporate
culture, which is respect, integrity,quality, teamwork, and innovation.

(01:27:49):
We've also talked about how the statedvalues of these five, attributes
don't really correlate with corporateperformance, but in less scripted
corporate communications, theirreflection in the less scripted
portions of corporate communicationdoes correlate with, corporate value.
One of the things thatcorrelates a lot is innovation.

(01:28:11):
We also mentioned a few others.
And if you are ourlistener and an investor.
You should watch out for bad,examples of, corporate culture.
You should avoid number onecompanies that start lagging
on innovation and adaptability.
Number two, you should watch out forcompanies that, have been known to be

(01:28:31):
unethical or fraudulent or have a highrisk culture in the previous time.
Look at the previous crisisbecause they're likely to not
do well in the next crisis.
And number three, red flag, watch outfor companies that talk differently
about their corporate cultures,those five characteristics, to
different audiences, employees,investors, loan managers, and banks.

(01:28:54):
So that's my summary of corporate culture.

Veljko (01:28:57):
You know, I guess you are convincing me that corporate
culture is important and relevant.

Kate (01:29:03):
I'm glad we're going to have this in the recordings.
That's why I can playit over and over again.

Veljko (01:29:09):
I was going to finish that sentence, I guess what I'm still not
convinced is that it's actionable, I'mstill not a hundred percent convinced that
it's, measurable, that it is measurablein a way that's truly, implementable and
useful to, to, to everyday investors.

Kate (01:29:28):
Yeah.
It's a challenge.

Veljko (01:29:29):
Indeed.

Kate (01:29:30):
Excellent!
I think we can finish it up at that point.
Well, thanks for listening.
We appreciate your time.
And if you liked our episode, pleaseleave us some comments, listen to
us on your favorite platform and,

Veljko (01:29:43):
And send us your questions in finance.
Cheers.
Cheers.

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