Corporate culture is a real (though intangible) asset

Corporate culture is such a hard thing to grasp. Most people agree that corporate culture is an important driver of success (or failure) in a company, but hardly anyone know how to measure it or where it comes from. Thanks to machine learning techniques that allow to examine earnings calls by senior executives, we can start to lift the lid a little bit on this black box.

Back in 2020, Kai Li from the University of British Columbia and his collaborators designed a machine learning algorithm to analyse the earnings calls of thousands of US companies between 2001 and 2018. By measuring how executives talk about their employees, customers, the quality of their products or the innovativeness of their business they defined five dimensions of corporate culture: (i) Innovation, (ii) Integrity, (iii) Quality, (iv) Respect, and (v) Teamwork.

The table below shows the top 5 and bottom 5 companies in the S&P 500 during the last five years of their sample.

Top 5 and bottom 5 companies in S&P 500 based on the five dimensions of corporate culture

Source: Li et al. (2020)

The very fact that Twitter shows up as second best company in terms of teamwork tells you already that corporate culture can change and that major corporate events like M&A are often the trigger for a significant shift in corporate culture (in the case of Twitter to the worse).

But this measure of corporate culture is linked to better corporate performance. In the original paper, Li and his colleagues showed that companies that score among the top 25% by the average score in each of these dimensions (companies deemed as having ‘strong culture’) showed higher asset turnover and inventory turnover and traded at 4% higher valuations than companies that were otherwise similar but did not have a strong culture.

The benefits of strong corporate culture seem to be particularly strong in bad times as a follow-up study of these companies during the pandemic demonstrated. Companies with a strong corporate culture were more likely to support their community but no more likely to cut costs than other businesses. Crucially, though, they were investing more heavily in product innovation and digitalisation which allowed them to adapt faster and better to the pandemic and its aftermath. This, in turn was then reflected in a more stable share price and higher returns for investors once markets recovered from the pandemic.