A strong corporate culture maybe linked to firms outperforming their peers explains Professor of Finance at the UBC Sauder School Business, Dr. Kai Li. Charging how ESG moving forward will be an important part of organizational culture.
Jamie: FTSE Russell is an index provider and research house under the LSEG umbrella. They specialize in convening the best ideas on evolving market trends and helping to develop strategies for global investors. In this series, we look at the evolution of the biggest of today's trends. In order to understand any company, you need to understand the culture and the people that run it, it's only after you understand them both that you can start to predict the trajectory that the company is on. To discuss the importance of correct management and governance, I talked to Dr. Kai Li, professor of finance at the Sauder School of Business.
Jamie: Well, Kai, thank you very much for joining us for our chat today. Now we're going to be talking particularly about corporate culture, which I know is your area of expertise. But before we talk about the evolution of corporate culture, can we perhaps just define what we mean by corporate culture?
Kai: Corporate culture is a set of set of beliefs and norms that the guiding members of the organization in all circumstances anticipated or unanticipated.
Jamie: Mm hmm. So, so is corporate culture, is it something that's organic to a company or something that's set by the leaders?
Kai: Great question. It is organic, and typically we would say corporate culture comes from the top. Lead by example. That's how the leaders can shape develop organizations implicit rules, unspoken rules of how to behave in any circumstance.
Jamie: So can you give us some examples of, you know, good corporate culture versus what you would consider poor corporate culture?
Kai: Good corporate culture, strong corporate culture is, I guess, they're just linked, because first of all, culture is not static, it's dynamic. So good...It depends on the market condition and how the world evolves. I know the theme of this forum is about sustainability and digital assets, etc. But think about five, 10 years ago, those things ESG, CSR were not as high people or corporate world mind as of today. So that's why when I studied corporate culture, the buzzword would be like innovation, quality, teamwork, integrity, etc. But I anticipate sustainability, climate change, social, economic and environmental performance will be high on every modern corporation and their leaders mind going forward.
Jamie: A theme that you've looked at is the relationship between corporate culture and a company's performance. So, can you talk a little bit about what findings you've had from looking at what effect good corporate culture has on the performance of a company in corporate world?
Kai: Everything is co-determined at the same time, so it's very difficult to say that there's a causal effect. See strong good culture will result in good performance. But what we can say is there's a tradeoff. So, to build a strong culture takes time, effort and resources. In the short term, you might not be outperforming your peers by the long term and during bad times, you really reap from doing investment in good corporate culture.
Jamie: So that's interesting. So during the good times, it's quite difficult to see whether the corporate culture is good or bad because it's only under times of duress where it gets tested. Is that correct?
Kai: That's right, because in crisis time, like the most recent of COVID, there's it's an unprecedented situation. There's even the top management is at a loss. What to do. But if there's a core value management, a rank-and-file employees will pitch in, they will do more without being asked and they are not asking for higher pay, for example. That's what we observe in the real world.
Jamie: So say specifically on that. How has the pandemic changed corporate culture today?
Kai: Pandemic can really raise great awareness that a firm must have his core value guiding principle for employees to outperform without asking for immediate compensation so that so corporate culture is almost like an insurance in bad times. You would really benefit from it because the employees are not pressing you for higher pay in order to work more and employees will be highly motivated to contribute, especially like innovation, customer service, product development to help the firm overcome the momentary major setbacks.
Jamie: OK, so I mean, when I think about the more traditional companies, the banking firms, the legal firms, I would think at the corporate culture there is probably less good perhaps than some of the more, you know, newer technology companies. Is that a fair assumption?
Kai: It's a great observation that it's in corporate finance or in a corporate world in general. There's industry specific effects. So exactly as Jamie you and kind of conjectured. So that's what we see. So, for high tech companies that they will be very strong in innovation and the quality. So, customer product services and to like to develop high quality products services to satisfy their customers. So that's like high-tech industry. We also see during the pandemic that we are fully aware of the health care industry. It does huge contribution so important to all of us in all dimensions. They also score very high in teamwork and integrity, which is reassuring to know people in those industry firms. In those industries, they practice those values.
Jamie: Now you mentioned ESG investing, and that's something that's been a huge trend over the past five years or so. Do you find that the rise in ESG of ESG investing is accelerating a move to better corporate culture from a diversity point of view?
Kai: Oh, definitely. As I said, corporate culture is not static, so it will be shaped by major events. As you see from the Wall Street, like going public is a watershed event that Goldman was a great example. And also is another good example that a culture will be shaped, which I use IBM's acquisition of Red Hat. So here these climate change we all live and breathe with these extreme weather patterns, so there'll be rising awareness about we need to do something instead, just go to the bottom line. Now we have the triple bottom line. So, like, people profit the planet, so, ESG, environmental, social performance, diversity itself is part of the social performance, so they will tap and reinforce each other going forward.
Jamie: One of the other topics I wanted to discuss with you is how corporate culture is going to change over the next five years or so. And one thing that is inevitable is the place of AI within companies. And I think no matter what company you are, even the more traditional ones like accountancy and the medical world, A.I. will play a part. So how is that going to affect corporate culture and what do we need to do now to sort of prepare for it?
Kai: Just like from very beginning today during the interview, you will ask me how to define culture. I need to be parked because it's something you live and breathe. My personal experience, I have a very fortunate with starting a place with a great culture which collegiality. So, culture is really something so called intangible assets you can only experience, but it's not quantifiable. So that create great like there's so much work. It's not only in finance, accounting imagen in the literature. Everybody talks about corporate culture slash organizational culture, but it's just so hard to quantify it and then to establish a relationship between culture and performance. So previous work prior to mine people just did questionnaires and a survey, but that is just going to be a very small sample. You always have some related problems. So, what we did, I was very fortunate to be able to work with people with strong computer science background that we designed to capture culture from what the top of management preaches and the practice. We use textual data breaches. Earnings call transcript. Given your background, the income in capital market. So, the earnings calls. The purpose of the earnings call is to really talk about the firm's performance instead of promoting culture so that help us not to have these cheap talk kind of concerns.
Jamie: Just lip service, you mean?
Kai: That's right. But if the company has a strong culture, the words of the management will reveal what the core values they cherish, they embrace. So that's what we do is we score a culture use machine learning techniques from earnings transcripts, which typically CEOs, mostly most times the CEOs and CFOs talking about the past performance. So, the unintended consequence applies to capture culture.
Jamie: So I read in one of your papers that you went through as many as was over 200 000 transcripts. Yeah. So how do you do that? This is a machine that's going through picking out phrases that reflect, in your opinion, good or bad sort of corporate. So, what would be some of the phrases you would look for
Kai: So, for example, like a teamwork where we're looking at synonyms to teamwork, such as cooperation collaboration. But that's not enough. So, the technique we have is called the word embedding. So, what we do is we develop our own culture dictionary from a concept in linguistic that is words of similar meaning tend to show up in the same sentence as that, like just neighboring words. So that's how we develop our own culture dictionary. We all know Oxford Dictionary, that's a standard English. But here we develop our own culture dictionary starting from Basic C's words say, to capture a corporate culture of teamwork. We service teamwork, and it will come and see the word collaboration and cooperation. Let me just go to the earnings, uh, earnings call transcripts, and a look at any other words show up related to teamwork, collaboration, cooperation, and we have a frequency complex algorithm. Then we will be able to identify other subtle words that out, as such as talking about teamwork.
Jamie: And so your conclusion being that those earnings call transcripts, which included more of these, uh, teamwork style phrases, they have been the better performing companies?
Kai: Yes, that's what the association we established that this trade-off thing. So, it might take time and effort to build up culture. But once you have strong culture, it really helps you in the long run.
Jamie: I see so, you know, for any investor out there who's looking at investing in a particular company, whereas perhaps you would have originally just looked at numbers and balance sheets or things like that. Now you need to be looking at, you know, what is the corporate culture there, which is something you're measuring. So that makes a lot of sense. Yeah. So, going back to the issue specifically on A.I., I may ask you if you have a particular view on how quickly I will be integrated into the workplace, but also how will it change corporate culture because this is cutting edge technique?
Kai: On one hand, there's an ethical issue about privacy, right? So, I'm a Chinese national so, facial recognition like is ever present, and they never ask for approval. So, I think that part we really need to pay attention to is respect of privacy and recent scandals by Facebook, changing their name to META, etc. So, there are some acute downsides if you pay attention to how to manage the data for commercial use about receiving input from the customers up get like a permission. But on the other hand, it's powerful to sell just like my own research because of A.I. machine learning. I was able to capture a corporate culture that will be a quite important metric for the investment community when they look at their portfolio formation, for example, given they are very high ESG or environmental social performance, they can use you UI to score a potential portfolio firm and then make investment decisions. So, it's beneficial. Helpful.
Jamie: So some of the big tech companies, I imagine it's easier to have a better corporate culture if you're a smaller company. But as the company gets bigger and bigger, is it possible to still maintain a good corporate culture even when you've got companies like Facebook and Amazon that are just so big?
Kai: Yeah, just you raise this question. This is good when you also ask from beginning. So exactly how culture is come about. So from the top. So, like Alphabet's Google, they still have founders in place, so they really shaped the corporate culture. The other is competition like your how your peers are practicing, and you might not be one for lagging. If you are very bad in corporate culture, you might have an implode the situation, as we have seen in some other companies.
Jamie: So five years out, let's say 2026, what do you think the topics will be we're talking about in and around corporate culture?
Kai: That's a great one. I think these days they're going to be also an important role played by regulation. So, we have already heard that SEC is looking at a mandatory disclosure forms ESG performance that given firms listed on the market, they need to raise capital from investors, and they also must comply with the regulatory requirement. So, I anticipate going forward more of ESG related values will be an important part of organizational culture. It's like you just cannot just look at the bottom-line profitability, sustainability and equity. Diversity inclusion will be the value drivers going forward.
Jamie: So I guess what we're getting to is and this is something which I think your academic work is trying to concentrate on is will we ever be at a stage where we can have a measurable number, which tells us, like, what good corporate culture is because I'm thinking, if you're a young company starting out now, is there certain boxes you should be ticking even if you're starting out today?
Kai: Let's affirm the life cycle at different stage of a life cycle. You're going to have different priorities for from my own research given way, I measure corporate culture from earnings calls. That's by default. You are not a startup, you are not you are not doing your quarterly earnings calls. But I will look at all the success of all startup firms, those unicorns. I think culture should be from very beginning, like for you to be able to grow and to be successful. So. But in terms of measurement, that's hard because being a private firm, by definition, you have no obligation to tell people what you are practicing, what you believe in and how you train your employees within your organization. So that's a that's a data challenge.
Jamie: Just so I'm clear, when you talk about the coming from the top corporate culture starts at the top, are you talking about CEOs and CFOs? We talk about the board of directors.
Kai: So the stock market, right, I think 20 percent is by the high-tech firms and they are run by their founders and it's a corporate governance issue because even though we see that a board supposed to be arm's length would be independent, but we all know. That's right. So that policy is really the founder, under the CEOs, right? Which is unfortunate because we supposed to have yeah, we supposed to have an independent board, but it just on the book, but not in substance.
Jamie: So reading between the lines, you may look at a company like Facebook or Amazon, where the founders are still there. And you think it's a little unhealthy for the founder and CEO to be also involved with board selection choices.
Kai: That that's why that's a joke. It's like getting the Facebook you can now the fire, the founder, so you just change the company name. That's the going joke.
Jamie: And that’s what you thinks happened now?
Kai: That's exactly what happened, because nobody can fire Zuckerberg. So, unless you change the name,
Jamie: Sustainable investing and the role of ESG in corporate culture was certainly talked about for 10 years, but it didn't really translate into investment opportunities. Now, due to the rise in indices allowing more direct investments into ESG and sustainable themes, capital allocations are accelerating these trends, creating opportunities that are only going to get bigger and more diverse in the future.
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