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Administrative Science

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The Strength of Corporate Culture and the Reliability of Firm Performance


Jesper B. Sørensen
Administrative Science Quarterly 2002 47: 70
DOI: 10.2307/3094891

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The Strength of Prevailing research claims that strong corporate cultures
CorporateCultureand improve firm performance by facilitating internal behav-
ioral consistency. This paper addresses an unexamined
the Reliabilityof Firm implication of this argument by analyzing the effect of
Performance strong corporate cultures on the variability of firm perfor-
mance. This relationship depends on how strong cultures
Jesper B. S0rensen affect organizational learning in response to internal and
Massachusetts Institute of external change. I hypothesize that strong-culture firms
excel at incremental change but encounter difficulties in
Technology more volatile environments. Results of analyses of a sam-
ple of firms from a broad variety of industries show that
in relatively stable environments, strong-culture firms
have more reliable (less variable) performance. In volatile
environments, however, the reliability benefits of strong
cultures disappear.*
Much popularand scholarlyattention has been focused on
the hypothesis that strong cultures, defined as "a set of
norms and values that are widely shared and stronglyheld
throughoutthe organization"(O'Reillyand Chatman,1996:
166), enhance firmperformance.This hypothesis is based on
the intuitivelypowerfulidea that organizationsbenefit from
havinghighlymotivatedemployees dedicated to common
goals (e.g., Peters and Waterman,1982; Deal and Kennedy,
1982; Kotterand Heskett, 1992). In particular,the perfor-
mance benefits of a strong corporatecultureare thought to
derive from three consequences of havingwidely shared and
stronglyheld norms and values: enhanced coordinationand
controlwithinthe firm, improvedgoal alignmentbetween the
firmand its members, and increased employee effort. In sup-
port of this argument,quantitativeanalyses have shown that
firms with strong cultures outperformfirms with weak cul-
tures (Kotterand Heskett, 1992; Gordonand DiTomaso,
1992; Burtet al., 1994).
The existing literatureon the relationshipbetween culture
strength and performancefocuses on the consequences of
strong cultures for performancelevels but has not examined
how strong cultures affect performancevariability,or the reli-
abilityof firmperformance.This is surprising,since the argu-
ments relatingculturestrength to performancedraw particu-
? 2002 by CornellUniversity.
0001-8392/02/4701-0070/$3.00.
larattentionto the benefits of havinggreater internal
0 consistency in goals and behaviors.One should therefore
expect strong-culturefirms to exhibitless variableperfor-
I am indebtedto Diane Burtonfor insight- mance. This expectation is complicated,however, by the fact
ful suggestions. Particularthanksgo to
Ron Burtfor providingthe initialimpetus that the variabilityof a firm'sperformancedepends not only
for this paper,for sharingthe data, and on the abilityto maintainconsistency in internalprocesses
for providinghelpfulcomments on an ear- but also on the firm'sabilityto adapt to environmental
lierversion. Importantcomments were
made by PatriciaChang,DonaldPalmer, change. The relationshipbetween culturestrength and per-
RobertoFernandez,JonathanJaffee, Olav formance reliability,therefore, should depend on how strong-
Sorenson,and KarenWruck.Earlierver- culturefirms learnfrom and respond to both their own expe-
sions of this paperwere presented at
StanfordUniversity,the Universityof riences and changes in their environment.Incremental
Michigan,CarnegieMellonUniversity,
ColumbiaUniversity,and the Academyof
adjustments to organizationalroutinesshould be easier in
Managementmeetings. Jeanette Chung strong-culturefirms, because participantshave an agreed
providedable researchassistance. The upon frameworkfor interpretingenvironmentalfeedback and
Universityof ChicagoGraduateSchool of a common set of routinesfor respondingto differentsignals
Business and the MITSloanSchool of
Managementprovidedgenerous research from the environment.In relativelystable environments,
support.Directcorrespondenceto firms with strong corporatecultures should therefore have
sorensen@mit.eduor MITSloanSchool of
Management,E52-581,Cambridge,MA
less variableperformancethan firms with weak corporate
02142. cultures, in additionto performingat a higheraverage level.
70/Administrative Science Quarterly, 47 (2002): 70-91
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Corporate Culture

In more volatile environments, however, incrementaladjust-


ments to organizationalroutines may not be sufficient. This
suggests that the variance-reducingbenefits of strong cul-
tures may attenuate as environmentalvolatilityincreases and
may help explainwhy some strong-culturefirms have
encountered great difficultiesin respondingto changes in
their environment(Carroll,1993; Tushmanand O'Reilly,
1997).
Studyingthe relationshipbetween culturestrength and per-
formance variabilitytherefore has the potentialto shed light
on the abilityof strong-culturefirms to adapt to change. Per-
formance variabilityis also an importantoutcome in its own
right,because it plays a central role in a varietyof theoretical
approachesto organizations.Behavioraltheories of the firm
suggest that risktakingby managers depends on firm perfor-
mance relativeto aspirationlevels (Cyertand March,1963;
Bromiley,1991); highlyvariableperformancemay increase
the frequency of risk-takingbehavior.Similarly,while organi-
zations may attempt to bufferthemselves from environmen-
tal variabilityin orderto facilitateplanningand decision mak-
ing (Thompson,1967) and increase organizationalautonomy
(Pfefferand Salancik,1978), this may be more difficultwhen
performanceis highlyvariable.Organizationalecologists have
attributedcausal importanceto performancevariabilityby
arguingthat external stakeholderstypicallyattach value to
predictableperformance,giving reliablefirms a survival
advantage (Hannanand Freeman, 1984). Forexample, suppli-
ers will generallyprefercustomers that generate predictable
orders and reliablypay on time, and many employees value
stable employment prospects. Investors should generallypre-
fer to have less temporalvariabilityin performancefor a
given return(Bodie, Kane,and Marcus, 1996). Performance
variabilityalso affects the chances of failuredirectly:a simple
random-walkmodel of the accumulationand depletion of
organizationalresources suggests that for a given stock of
resources, firms with more variableperformanceare more
likelyto exhaust their resources and fail (Levinthal,1991a).
While these arguments from organizationaltheory suggest
the importanceof variabilityin overallfirm performance,theo-
ry and evidence in corporatefinance suggest that variabilityin
specific aspects of firm performanceaffect organizational
behavior.Forexample, firms with highlyvariablecash flows
find themselves at a competitive disadvantage,for two rea-
sons. First,highlyvariablecash flows implythat there will be
periods when a firmwill underinvestin worthwhile projects.
Some projectsthat are attractivewhen there is sufficient
internalcapitalwill be unattractiveduringperiods of internal
cash-flow shortfall,if externalcapitalis more expensive than
internalcapital.This is one reason why firms may wish to
engage in risk-managementactivities, such as hedging
(Lessard, 1990; Froot,Scharfstein,and Stein, 1993). Second,
firms with more variablecash flows have highercosts of
externalcapitalthan firms with more stable cash flows,
which means that fewer projects will be attractive(froma
capitalbudgeting perspective) in firms with variableperfor-
mance. The increased cost of capitalderives in partfrom
greater informationasymmetry in the externalcapitalmarket,
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because firms with highlyvariablecash flows are less likely
to be followed by marketanalysts. Empirically, Mintonand
Schrand(1999) found that firms with highlyvariablecash
flows have lower levels of capitalinvestment, lower levels of
analyst following, lower Standard& Poor'sbond ratings,and
higherweighted average costs of capital.Thus, if strong cor-
porate cultures lower performancevariability,strong-culture
firms are less likelyto suffer from underinvestment.
Forall of these reasons, corporateculturestrength has impli-
cations for organizationaloutcomes that go beyond their
effects on mean performancelevels. Inthis paper,I expand
on the relationshipbetween the strength of corporatecul-
ture, organizationallearningprocesses, and firm performance
and analyzethe implicationsof this relationshipfor reliable
performanceby explicitlymodelingthe temporalvariancein
firm performanceas a functionof the strength of corporate
culture in a sample of large, publiclyheld firms.
THESTRENGTHOF CORPORATE CULTURESAND FIRM
PERFORMANCE
Interest in the concept of organizationalculturehas exploded
in the past two decades. Researchers have approachedthe
topic with a wide arrayof theoreticalinterests, methodologi-
cal tools, and definitionsof the concept itself. Debate over
fundamentalissues of theory and epistemology is intense
(Martin,1992; Triceand Beyer, 1993). While some see
attempts to measure organizationalculturesand their effects
on organizationsas highlyproblematic(e.g., Siehl and Martin,
1990; Martin,1992; Alvesson, 1993), a large body of research
starts from the assumption that cultureis a measurablechar-
acteristicof organizations(O'Reillyand Chatman,1996).
These studies do not seek to interpretthe meaning of differ-
ent organizationalcultures or culturalforms per se but, rather,
focus on their consequences for organizationalbehaviorand
processes. Studies of the effects of strong corporatecultures
for firm performance,includingthis paper,fall withinthis tra-
dition. I adopt O'Reillyand Chatman's(1996: 160) definition
of organizationalcultureas "a system of shared values (that
define what is important)and norms that define appropriate
attitudes and behaviorsfor organizationalmembers (how to
feel and behave)" (forsimilardefinitions,see Rousseau,
1990; Kotterand Heskett, 1992; Gordonand DiTomaso,
1992). Moreover,a culturecan be considered strong if those
norms and values are widely shared and intensely held
throughoutthe organization(O'Reillyand Chatman,1996:
166; O'Reilly,1989; Gordonand DiTomaso,1992; Kotterand
Heskett, 1992). This definitionof culturestrength, in contrast
to some others, entails no assumptions about which values
and norms might enhance organizationalperformance(e.g.,
Ouchi, 1981; Deal and Kennedy,1982; Denison, 1990).
One of the key consequences of a strong corporatecultureis
that it increases behavioralconsistency across individualsin a
firm. Organizational culturedefines a normativeorderthat
serves as a source of consistent behaviorwithinthe organiza-
tion. Inthis sense, organizationalcultureis a social control
mechanism (O'Reilly,1989; O'Reillyand Chatman,1996). At
the same time, organizationalculturesframe people's inter-
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Corporate Culture

pretations of organizational events and basic assumptions


about organizational processes. Schein (1991: 15) empha-
sized that organizational cultures "provide group members
with a way of giving meaning to their daily lives, setting
guidelines and rules for how to behave, and, most important,
reducing and containing the anxiety of dealing with an unpre-
dictable and uncertain environment." Widespread agreement
about basic assumptions and values in the firm should
increase behavioral consistency (Gordon and DiTomaso,
1992) and thereby enhance organizational performance,
which is a function of the potential return to an organization's
activities and its ability to carry out those activities. The
impact of consistency on execution is important, since firms
with excellent strategies (high potential return) may perform
poorly if they fail to execute well, and firms that execute their
routines extremely well may compensate for suboptimal
strategies.
While it is possible that strong-culture firms may be better (or
worse) at choosing appropriate strategies, theories of the cul-
ture effect focus on the positive impact a strong culture has
on the execution of routines. Theorists have put forward
three interrelated explanations for the performance benefits
of strong cultures (Kotter and Heskett, 1992). First, wide-
spread consensus and endorsement of organizational values
and norms facilitates social control within the firm. When
there is broad agreement that certain behaviors are more
appropriate than others, violations of behavioral norms may
be detected and corrected faster. Corrective actions are more
likely to come from other employees, regardless of their
place in the formal hierarchy. Informal social control is there-
fore likely to be more effective and cost less than formal con-
trol structures (O'Reilly and Chatman, 1996). Second, strong
corporate cultures enhance goal alignment. With clarity about
corporate goals and practices, employees face less uncertain-
ty about the proper course of action when faced with unex-
pected situations and can react appropriately. Goal alignment
also facilitates coordination, as there is less room for debate
between different parties about the firm's best interests
(Kreps, 1990; Cremer, 1993; Hermalin, 2001). Finally, strong
cultures can enhance employees' motivation and perfor-
mance because they perceive that their actions are freely
chosen (O'Reilly, 1989; O'Reilly and Chatman, 1996).
Early studies reported mixed evidence of a positive relation-
ship between culture strength and performance (Siehl and
Martin, 1990) but generally defined culture strength in terms
of the content of organizational values and norms. More
recent studies, which defined culture strength in terms of the
degree of agreement and commitment to organizational val-
ues and norms, found evidence in favor of the linkage. For
example, Kotter and Heskett (1992) related mean perfor-
mance over a ten-year period to measures of the strength of
corporate culture and found that, across industries, firms per-
ceived to have strong cultures generally had greater average
levels of return on investment, net income growth, and
change in share price. Gordon and DiTomaso (1992) found
that the performance of insurance companies increased to
the extent that there was consensus surrounding cultural val-

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ues. Denison (1990), using both qualitativeand quantitative
evidence, also suggested that consensus surroundingorgani-
zationalvalues increases organizationaleffectiveness. Burt
and his coauthors (1994) reanalyzedKotterand Heskett's
data and found that the effect of corporateculturestrength
was contingent on marketcontext, with the performance
benefit of strong cultures being enhanced in highlycompeti-
tive markets.They reasoned that when firms in an industry
are highlyconstrainedby the structureof their markets,dif-
ferences in organizationalperformanceare more likelyto be
due to differences in the efficiency of organizationalroutines.
While priorresearch has focused on the relationshipbetween
culturestrength and mean performance,strong cultures can
also enhance the reliabilityof firm performanceunderthe
rightenvironmentalconditions. Performancereliability
depends on two factors:the consistency with which a firm
performs its organizationalroutinesand the degree to which
those routinesare well adapted to changingenvironmental
conditions.A key factor influencingperformancereliabilityis
therefore the natureof change in organizationalroutines in
response to experience. Inother words, reliabilityis a func-
tion of organizationallearningprocesses (Levittand March,
1988; March,1991; Levinthal,1991b). The linkbetween the
strength of corporatecultureand reliabilitytherefore lies in
the consequences of strong culturesfor organizationallearn-
ing processes.
Culture, Learning, and Performance Variability
Organizationalcultures and organizationallearningare closely
related. Infact, several authors have conceptualizedorganiza-
tionalcultures as the productof histories of organizational
learning.Weick (1985) characterizedorganizationalcultureas
the productof attempts by the organizationto impose coher-
ence, order,and meaning on its experiences. Similarly,
Schein (1992: 68) suggested that "cultureultimatelyreflects
the group'seffort to cope and learnand is the residue of
learningprocesses." Schein furtherarguedthat organizational
cultures are stronglyinfluencedby shared experiences in the
firm'searly historyand that, once established and taken for
granted,the firm'sbasic assumptions are difficultto change.
This suggests that organizationalcultures reflect the imprint-
ing of a firm'searlyenvironmentalconditions(Stinchcombe,
1965) and that they are subject to inertialpressures (Hannan
and Freeman, 1984).
While organizationalcultures reflect past learning,they also
define the context for future organizationallearning,which, in
turn, has consequences for performancereliability.Environ-
mental change poses dual threats to reliableperformance.
First,environmentalchange can create internalproblems by
increasingthe likelihoodof failuresin communication,coordi-
nation,and control.Second, environmentalchange can ren-
der existing organizationalroutines inadequateor inappropri-
ate. Such environmentalshifts demand learningand
modificationsin organizationalroutinesthat take the new
conditions into account. Unless the organizationdiscovers
such solutions rapidly,it will performhaphazardly.
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Corporate Culture

Strong-culturefirms should generallybe better than firms


with weak cultures at avoidinginternalthreats to reliableper-
formance, or breakdowns in coordinationand control. Effi-
cient and consistent firmfunctioningin the face of environ-
mental change depends on both appropriatenessand
coordination:employees must respond to events by deploy-
ing the rightroutines at the righttimes and in the right
sequence. Employees are more likelyto take actions consis-
tent with a firm'sgoals if they understandthose goals and
agree with them (Levinthal,1991b). If employees lack a clear
understandingof the organization'sgoals, coordinationwill
also be more difficult,as they are more likelyto take actions
that conflict with what is happeningin other parts of the
organization(Cremer,1993). Thus, heterogeneity in beliefs
within the organizationmakes performancemore haphazard.
If employees differ in their understandingsof the environ-
ment, they will either spend more time debating alternatives
or behave inconsistentlyand, therefore, be more likelyto
carryout routinetasks poorly.
Strong cultures minimizeheterogeneity in beliefs about the
state of the environmentand should thereby enhance inter-
nal reliability.Organizationalcultures codify the organization's
understandingof itself and its environmentand thus clarify
the organization'sbeliefs and goals for members (Weick,
1985; Schein, 1992). In strong-culturefirms, most members
work from a shared knowledge base and common beliefs,
which enhances organizationalreliability.As March(1991: 83)
argued, "Knowledgemakes performancemore reliable.As
work is standardized,as techniques are learned,variability,
both in the time requiredto accomplish tasks and in the qual-
ity of task performance,is reduced." Furthermore,strong cul-
ture organizationssocialize new members faster, in partdue
to the explicitcodificationof beliefs and to greater normative
pressures (Harrisonand Carroll,1991). This enhances reliabili-
ty by limitingthe length of time new members hold dis-
crepantviews and pose threats to the smooth execution of
organizationalroutines.This suggests the following hypothe-
sis:

Hypothesis 1: Firmswith strong corporatecultures will exhibit


more reliable(less variable)performance.

Culture, Environmental Volatility,and Performance


Inthe absence of environmentalchange, reliability,and per-
formance more generally,is simply a function of internal
organizationalprocesses. Environmentsdo change, however,
both incrementallyand more discontinuously.Organizational
performancein changing environmentsdepends on the abili-
ty of the firmto modify its routines in response to changes in
conditions.The natureof environmentalchange therefore
affects the relationshipbetween culturestrength and perfor-
mance, since organizationalroutines embody assumptions
about the state of the environmentand the expected path of
change in externalconditions.
When environmentalchange is incremental,and therefore
consistent with the basic assumptions underlyingthe organi-
zation's routines, organizationsachieve reliableperformance
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throughcorrespondingincrementaladjustmentsto routines.
March(1991) termed this exploitation;Lantand Mezias
(1992) used the term first-orderlearning.The consequences
of strong cultures-enhanced coordinationand control,goal
alignment,and increased motivation-should all increase the
speed and accuracywith which organizationsadapt to incre-
mental changes in their environments.In relativelystable
environments,strong-cultureorganizationsshould exhibit
more reliableperformancethan organizationswith weak cul-
tures because they are more adept at refiningand improving
established competencies. But excellence at exploitation
comes at a cost.
When environmentalchange is radicalor discontinuous,suc-
cessful adaptationcannot come about throughincremental
improvementsin organizationalroutines (Tushmanand Ander-
son, 1986; Hendersonand Clark,1990). Rather,successful
adaptationdepends on the abilityto discover alternativerou-
tines, technologies, and purposes. In short, adaptationto dis-
continuous change requiresexploration(March,1991) or
second-orderlearning(Lantand Mezias, 1992). Such
exploratorylearningdemands an abilityto perceive environ-
mental shifts and a willingness to accept the possible failure
and uncertainreturnsthat accompanyfundamentalchange in
organizationalprocesses.
Strong-cultureorganizationswill, in general, be ill-suitedto
exploratorylearning,for several reasons. First,strong culture
organizationsmay have greater difficultyrecognizingthe
need for change. Lantand Mezias (1992) suggested that sec-
ond-orderlearningis triggeredby suboptimalexperiences
that the organizationcan no longer ignoreand cannot handle
within its existing interpretiveframeworks.Because mem-
bers of strong-cultureorganizationshave a greater commit-
ment to a particularunderstandingof the world than weak-
cultureorganizations,they may be slower to detect
fundamentalchanges in environmentalconditions.Second,
the elements of strong culturesthat facilitatefirst-orderlearn-
ing may simultaneouslyimpede second-orderlearning.One
source of exploratorylearningis the presence of individuals
whose beliefs contradictthe organization'sdominantbeliefs.
Fora firmto learnfrom such individuals,it must both allow
them to maintaintheir deviant beliefs and be willingto incor-
porate potentialinsights into the organization'sprocedures. In
simulations,March(1991) found that organizationsthat are
good at learningfrom their members and exhibitweak social-
izationpressures will have the most accurate understanding
of a changingenvironmentalreality.Strong-cultureorganiza-
tions exhibitthe opposite characteristics.As Denison (1984:
18) noted, in a strong culture, "the lack of variety ... limits
the organization'sabilityto adapt to changes in the environ-
ment."
Finally,strong-cultureorganizationsmay be less likelyto reap
the benefits of any explorationthat does occur. Innovation
and change in organizationalroutinescan be fostered by
viable countercultures(Martinand Siehl, 1983), but counter-
cultures may be less likelyto emerge and persist in strong-
culturefirms. Moreover,even when counterculturescan be
sustained in strong-culturefirms, the transferof new ideas
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Corporate Culture

and knowledge to the dominantculture is fraughtwith diffi-


culty (Martinand Siehl, 1983; Tushmanand O'Reilly,1997). In
this respect, Weick (1985: 385) capturedthe dilemma of
strong cultureorganizationssuccinctly: "A coherent state-
ment of who we are makes it harderfor us to become some-
thing else."
This reasoning suggests that, other things being equal,
strong-cultureorganizationsshould have greater difficulty
respondingto environmentalvolatilitythan weak-cultureorga-
nizations.If environmentalchange sharplyreduces the value
of the organization'sexisting routines, strong-culturefirms
should have greater difficultyregainingtheir footing. Short of
such radicalenvironmentalchange, however, strong-culture
firms should still maintainthe internalorganizationalbenefits
identifiedby culture researchers:greater goal alignment,
superiorcoordinationand control,and higher motivationlev-
els than weak-culturefirms. In general, therefore, environ-
mental volatilityshould diminishthe performancebenefits of
strong corporatecultures:

Hypothesis 2: As industryvolatilityincreases, the positive effect of


culturestrength on mean performancedeclines.

Hypothesis 3: As industryvolatilityincreases, the positive effect of


culturestrength on performancereliabilitydeclines.

METHOD
Data
I investigatedthe effects of corporateculturestrength on the
reliabilityof firm performanceusing Kotterand Heskett's
(1992) data on the strength of corporatecultureamong a
sample of large, publiclytradedfirms in 18 markets. Kotter
and Heskett (1992) began with 21 markets defined according
to their own criteria.In general, these markets are analogous
to the marketcategories used in Fortunemagazine. Missing
data problems led Burtet al. (1994) to reduce the number of
industriesto 19 by eliminatingthe life insuranceindustryand
combiningsavings and loans and commercialbanking.Inthe
currentanalyses, missing data on the bankingindustryresult-
ed in the furtherexclusion of that industryfrom the analyses.
Kotterand Heskett asked the top six officers in the firms
selected for the study to complete a short, mailed question-
naire.The respondents were asked to assess the strength of
the corporateculture in each of the other sampled firms that
were in the same industryas their own firm. Respondents
were asked to assess the strength of corporateculture in the
late 1970s and early 1980s by judgingthe degree to which
managers at a firmwere influenced in their decision making
by a strong corporateculture (Kotterand Heskett, 1992: 161).
The survey providedrespondents with three indicatorsof a
strong corporateculture:(1) managers in the firmcommonly
speak of their company's style or way of doing things; (2) the
firm has made its values known througha creed or credo and
has made a serious attempt to get managers to follow them;
and (3) the firm has been managed accordingto long-stand-
ing policies and practices other than those just of the current
chief executive officer. Respondents were asked to rate each
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firmon a scale of one to five, and an average score across
respondents was computed for each firm.While Kotterand
Heskett (1992) used an inverse coding of culturestrength,
with 1 indicatinga strong culture, I have reversed their cod-
ing to ease interpretation.
A strong advantageof this measurement strategy is that it
measures culturestrength across a very broadrange of firms
and competitive contexts without requiringextensive culture
surveys withinfirms. Data on a varietyof industriesis critical
to testing the claim that the relationshipbetween culture
strength and reliabilityis contingent on industryvolatility.Kot-
ter and Heskett's measurement strategy leads a firmto be
characterizedas havinga strong cultureif other actors in its
industryassociate the firmwith a uniqueand common way
of doing things, relativeto other firms in the industry.More-
over, this distinctivebehaviormust be codifiedand have per-
sisted over time. This culturestrength variabledoes not
directlymeasure the extent to which there is consensus
within the firm, however, and an externalassessment of cul-
ture strength is suboptimalin certainrespects. It is possible,
for example, that some strong-culturefirms identifiedin the
sample are highlyfragmented but manage to projectan aura
of cohesion and consensus. It is importantto keep in mind,
however, that Kotterand Heskett's questionnaireasked
respondents to characterizefirms accordingto differentspe-
cific behavioralcharacteristics,not simplyto generate a glob-
al culturerankingthat might be more subject to image
manipulation.It seems less likelythat weak-culturefirms will
be able to exhibitbehavioralconsistency over time.
Furthermore,surveyingorganizationalmembers about their
firm'sculturemay be problematicwhen studyingvariabilityin
performance.As Weick (1985: 386) suggested, people may
be more likelyto attend to culturewhen their dailyroutines
breakdown and they are presented with unfamiliarsitua-
tions. The reliabilityof firm performancemay thereby affect
the measurement of culturestrength. Whilethis type of
response effect may affect externalevaluatorsas well, it
arguablyhas the greatest impacton internalinformants.
Kotterand Heskett (1992) checked the validityof their mea-
sure in several ways. Most importantly,they conducted inter-
views with managers of a selected subsample of firms in
which they asked respondents a series of questions about
the strength of corporateculture.The resultingscores corre-
lated well with the externalmeasures. Ultimately,however,
their measure assumes that firms with widely shared and
deeply held norms and values will exhibitthese externally
observable characteristicsand that firms characterizedby dis-
sension will be unlikelyto exhibitthe same characteristics.
An additionalconcern, as Burtet al. (1994) noted, is that the
culturescores generated by Kotterand Heskett's design
might reflect a response effect. Respondents may make
inferences about a firm'sstrength of corporateculturebased
on its performanceor size. Firmsthat are more visible or
salient to a respondent may receive higherculturescores. In
fact, a regression of culturestrength on a firm'saverage mar-
ket capitalizationbetween 1979 and 1984 (controllingfor
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Corporate Culture

industrydifferences in both variables)yields a positive and


significanteffect of firm size (t = 6.51, p < .01). Marketcapi-
talizationexplains 24 percent of the within-industryvariance
in culturestrength, suggesting that it is an importantfactor
but that there is substantialindependentvariationin the cul-
ture scores. I therefore includedfirm size in the models
described below.
Performancedata come from the COMPUSTAT database. I
measured corporateperformancein two ways: by the yearly
returnon invested capital(ROI)and the yearlyoperatingcash
flow for the six years from 1979 to 1984. The first half of this
period is the same as the periodabout which respondents
were asked to rankthe corporatecultureof firms. I extended
this periodfor an additionalthree years to allow for sufficient
variabilityin firm performance.Returnon invested capital
(ROI)is computed as yearly net income dividedby invested
capital(stockholders'equity minus currentliabilities).ROI,an
accounting measure of how profitablythe firm's managers
put invested capitalto use, is commonly used in studies of
corporateperformance(e.g., Smith et al., 1994) and was also
used by Kotterand Heskett (1992). Operatingcash flow was
operationalizedas annualsales less the sum of costs of
goods sold, selling, general and administrative(SG&A)
expenses, and the annualchange in workingcapitaland was
measured in constant 1984 dollars.I used operatingcash
flow as a dependent variablebecause this is the measure
used in the finance literatureto examine the consequences
of performancevolatility(Mintonand Schrand, 1999). These
performancemeasures are well suited for testing the
hypotheses in this paper,which concern the abilityof firms to
execute their routines consistently. Analyses using two addi-
tional measures of performance,returnon sales and net
income growth, supportedthe same conclusions.
I includeda numberof controlvariablesmeasuringthe firm's
size and financialposition. Operatingleverage was measured
as the ratioof fixed assets to total assets for each year.
Financialleverage was measured using the debt-to-asset
ratio.Finally,I controlledfor size in most models by including
the firm'smarketcapitalization.Descriptivestatistics and cor-
relationsare in table 1.
I measured industryvolatilityusing estimates from a Capital
Asset PricingModel (Sharpe,1964). This model relates the
returnon an individualsecurity to the returnon a value-

Table1
Descriptive Statistics*
Variable Mean a 1 2 3 4 5 6
1. ROI .09 .08
2. Operatingcash flow 1342.27 2895.10 .02
3. Debt-to-assetratio .41 .18 -.59' .03
4. Operatingleverage .42 .17 -.26* .34* .19'
5. Culturestrength 3.29 .79 .30' .29' -.40' .06
6. Log marketcapitalization 7.22 1.42 .25' .58' -.42' .21 .38'
7. Log marketconstraint -1.49 .72 -.26' -.21 .33' -.11' -.14' -.43'
p< .05.
* Culturestrength ranges from 1 to 5, with higherscores indicatinga strongercorporateculture.

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weighted portfolioof securities in the entire market(in this
case, the NYSE/AMEX and NASDAQ):

=
ri Oi + 3rm + ?

Here, B3measures the systematic riskof the security,or the


extent to which it covaries with the market.The returnsof
firms with p < 1 are less volatilethan the returnsof the mar-
ket as a whole, while firms with p > 1 are more volatilethan
the marketas a whole. Yearlyp parametersare estimated
separatelyfor each firm in Kotterand Heskett's (1992) data
using OLS. Dailyreturnsover the periodfrom 1979 to 1984
come from the CRSPdatabase. The industryvolatilitymea-
sure used below is the yearlymean of the B1'sfor all of the
sampled firms in an industry.Generally,industriesundergoing
fundamentalchange are likelyto be characterizedby greater
uncertaintyamong investors and hence greaterthan average
volatilityin stock-marketreturns.These scores are summa-
rized in table 2.1
Analysis
I operationalizedthe reliabilityof firm performancein terms
of the degree of variationabout a predictedmean perfor-
mance level; the greaterthe variation,the lower the reliabili-
ty. This definitionis consistent with previousstudies of risk
(e.g., Armourand Teece, 1978; Bowman, 1980). Past studies,
however, have typicallymeasured varianceabout the sample
mean, which is an unsatisfactorymeasure of reliabilityfor a
simple reason. If one uses the simple variance,firms that
have improvedtheir performanceover time will appearto
have unreliableperformancesimply because the mean is a
poor estimate of the time trend in performance.The same
will be true of firms whose performancehas consistently
declined. A measure of reliabilityin performanceshould also

Table 2

Industry Volatility Measures

Industry Mean o N firms

Aerospace 1.201 .127 10


Airlines 1.266 .196 10
Apparel .694 .120 8
Automotive 1.096 .304 9
Beverages .823 .099 8
Chemicals 1.050 .080 9
Computers & Office Equipment 1.317 .181 10
Packaged Food .741 .053 11
Forest Products/Paper .971 .095 10
Personal Care .844 .095 8
1 Petroleum Refining & Marketing 1.208 .191 10
I also conducted analyses using a differ- Pharmaceuticals .951 .142 9
ent measure of industry volatility, namely, Printing & Publishing .810 .229 9
the coefficient of variation in firm sales Retail-Food & Drug .617 .170 8
growth for each industry. The results of Retail-Non-Food & Drug 1.013 .244 10
those analyses parallel those below using Rubber .789 .108 7
the ROI measure, but not the cash flow
Telecommunications .620 .224 6
measure. This may be because the cash
flow measure is a direct function of sales. Textiles .743 .105 8

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Corporate Culture

allow for changes in performancelevels due to changes in


firm characteristics.I therefore first tried to account for firm
differences in the mean performancelevel using firm charac-
teristics. The variabilityin performancewas then defined as
the residualvarianceabout the predicted regression line.
I first used multiplicativeheteroscedasticity or variancefunc-
tion models (Davidianand Carroll,1987; Greene, 1997;
Sorenson and Sorensen, 2001) to estimate the effects of cul-
ture strength on reliability.These models involve extending
the standardlinearregression model of the expected value of
the dependent variableto includea model of the varianceof
the residual(or equivalentlythe dependent variable):

=
Yj JLi + OiEi

ni = E(y,)= P'X

ci = Var(y,)= exp(y'Zi)

where y, is the dependent variablewith mean [L and variance


ri.This produces a linearmodel for the mean of the depen-
dent variableand a log-linearmodel for the varianceof the
dependent variable,conditionalon a set of covariates predict-
ing the mean and variance.The y parameterscapture the
effect of covariates on the variancein the dependent vari-
able. Factorsthat increase the reliabilityof performance
should have y < 0. This model is estimated using maximum
likelihoodmethods (Greene, 1997; Weesie, 1998).
This modeling approachhas a methodologicalshortcoming, in
that the pooled cross-section time series data raise concerns
about autocorrelationwithinfirms, possibly due to unob-
served, time-invariantcharacteristicsof the firms (Greene,
1997). A prominentcandidatefor such an unobserved charac-
teristic is the content of the corporatecultures in the sample
firms. If, for example, the corporateculturestrength is corre-
lated with a particular(unobserved)constellationof values
and beliefs that encourage reliableperformance,inferences
about the effects of culturestrength may be faulty.Adjusting
for autocorrelationin the context of the multiplicativehet-
eroscedasticity model did not seem straightforward.I there-
fore adopted the following approach.Foreach firm, I estimat-
ed a separate regression of ROIor operatingcash flow on
the firm'sdebt-to-asset ratioand operatingleverage; since a
2 firm'sculturescore is constant, its effects cannot be estimat-
The firm-specificmodels have to be parsi- ed.2 These analyses should help remove the potentiallycon-
monious,since there are at most six
observationsper firm.I experimented founding influence of unobserved, firm-specificcharacteris-
with alternativespecificationsand found tics. Using this approach,I measured the reliabilityof firm
the same results when regressingthe performanceas the mean squared error(i.e., average
performancemeasures on operating
leverageand a time trendand when squared residual)from each firm's regression equation. If a
regressingthe performancemeasures on firm experiences alternatingperiods of high and low perfor-
the debt-to-assetratioand a time trend.
When regressed on allthree independent
mance, net of the values of the independent variables,the
variables(operatingleverage,debt-to- residualsabout its regression line will be greater,on average,
asset ratio,and year),the resultswere than if the firm performsconsistently. Firmswith more reli-
the same for the ROImeasure but not for able performancewill have smaller mean squared errors. I
operatingcash flow, for which the effect
of culturestrengthwas insignificant. then pooled the mean squared errorsacross firms and
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regressed them on each firm'sculturescore and dummy vari-
ables for industry.
RESULTS
Table3 presents estimates from the multiplicativehet-
eroscedasticity models of corporateperformance.The
effects of the covariates in this table are expressed relative
to the mean levels of the covariates in a firm'sindustry.This
is also true for the effects on the log variance;this is impor-
tant because it removes industrydifferences in performance
variability.One question addressed by the results for mean
performancelevels in table 3 is whether the performance
benefits of a strong culturepersist once the differences in
variancehave been modeled. This appears to be the case for
the ROImeasure. In models 1 and 2, the measure of corpo-
rate culturestrength has a positive and significanteffect on
ROI,even when controllingfor firmsize. Model 3 includes an
interactioneffect between corporateculturestrength and the
measure of marketconstraintused by Burtet al. (1994);
since the models includedummies for industries,the main
effect of marketconstraintis not identified.Industrieswith
highermarketconstraintscores are internallyfragmentedand
face well-organizedsuppliersand buyers; Burtet al. (1994)
showed that these marketsare more competitive and have
lower profitmargins(see also Burt,1992). Consistent with
what Burtand his coauthorsfound, the performancebenefits
of strong cultures increase with industrycompetitiveness. In
none of the models, however, does corporateculture

Table3
Multiplicative Heteroscedasticity Models of FirmPerformance Measures, 1979-1984*
ROI Operatingcash flow
Variable (1) (2) (3) (4) (5) (6)
Mean:
Debt-to-assetratio -.170- -.170" -.164- -3.301 2.200 45.732
(.012) (.012) (.012) (31.645) (31.496) (28.424)
Operatingleverage -.082# -.080" -.072" 301.249" -42.230 -59.631
(.014) (.014) (.014) (7.056) (46.591) (37.732)
Corporateculturestrength .006" .006" .017- 14.575 -.563 19.495
(.002) (.002) (.010) (1.559) (5.887) (16.057)
Log marketcapitalization -1.E-04 -2.E-04 14.009 15.188t
(.001) (.001) (6.902) (5.883)
Culturestrength x Log market .006- 5.014
constraint (.002) (11.072)
Log variance:
Corporateculturestrength -.41 8 -.437- -.683- .940- -.277- -1.790"
(.079) (.086) (.167) (.096) (.116) (.198)
Log marketcapitalization .073 .086 1.454- 1.485-
(.062) (.062) (.085) (.086)
Culturestrengthx Log market -.182 -.927-
constraint (.111) (.110)
X2 1038 1019 1031 3339 3589 3646
D.f. 38 40 42 39 41 43
Firm-yearspells 806 800 800 703 703 703
-
*p < .05; p < .01; two-sided tests.
* Models includeindustrydummies in the predictionequationsfor both the mean and
log variance;thus, all covariates
are relativeto the marketaverages. The model for operatingcash flow includesa controlfor the operatingcash flow
level in 1978. Standarderrorsare in parentheses.

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Corporate Culture

strength appear to affect the firm's operating cash flow sig-


nificantly.
The evidence in favor of hypothesis 1, on the effect of cul-
ture strength on reliability,is very strong, as seen in the
lower panel of table 3. Firms perceived to have a unique and
coherent culture relative to other firms in their industry have
less variable performance. This is true for both performance
measures. The culture effect is sizable: increasing the
strength of corporate culture by one standard deviation, for
example, leads to an almost 30-percent reduction in the vari-
ance of the return on invested capital [exp(.794 x -.437) =
.71]. Furthermore, there is evidence that the reliability bene-
fits of strong cultures are enhanced in more competitive envi-
ronments, as measured by Burt's market constraint measure:
the interaction effect is highly significant for operating cash
flow and marginally significant (at the .10 level) for ROI.
The alternative analysis strategy also supports the claim that
strong cultures lead to more reliable performance. Table 4
reports an analysis of the mean squared error from the firm-
specific regressions of ROI and operating cash flow, respec-
tively, on operating leverage and the debt-to-asset ratio.
Since the mean squared error is bounded by zero and highly
skewed, the dependent variable in table 4 is logged. Higher
levels of the mean squared error indicate less reliable perfor-
mance, so effect of culture strength should be negative. The
first three columns of both panels of table 4 show a pattern
similar to the estimates in table 3. Again, firms perceived to
have strong cultures relative to other firms in their markets
Table4
OLS Regression of Firm-specificMean Square Erroron Culture Strength*
ROI

Variable (1) (2) (3) (4)


Culturestrength -.265" -.275* -.472- -1.399"
(.096) (.113) (.213) (.458)
Mean marketcapitalization(log) .053 .049 .015
(.088) (.088) (.088)
Culturestrengthx Log marketconstraint -.144 -.187
(.132) .131
Culturestrength x Industryvolatility .906'
(.398)
R2 .06 .05 .06 .11
N 135 134 134 134
Operating cash flow
Variable (5) (6) (7) (8)
Culturestrength .245 -.242' -.738" -1.596"
(.131) (.112) (.219) (.455)
Mean marketcapitalization(log) .830" .817" .794"
(.092) (.090) (.089)
Culturestrengthx Log marketconstraint -.340- -.340"
(.131) (.129)
Culturestrengthx Industryvolatility .911-
(.425)
R2 .03 .46 .49 .51
N 123 123 123 123
"
p < .05; p < .01; two-sided tests.
* The dependent variablehas been logged. Models include industrydummies; thus, all covariatesare relativeto the
marketaverages. Standarderrorsare in parentheses.

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have more reliable performance, as evidenced by the statisti-
cally significant, negative effect of the culture-strength vari-
able. The support for the reliabilityhypothesis from these
estimates is particularlyreassuring, since the models in table
4 account for any unobserved firm-specific factors that might
influence variability,including differences in the content of
corporate cultures.
I tested hypotheses 2 and 3, that the association between
culture strength and performance depends on industry volatil-
ity, by interacting the culture-strength measures with the
yearly measures of industry volatility described in table 2.
Hypothesis 2 implied that the interaction effect between cul-
ture strength and industry volatility should have a negative
effect on mean performance. As shown in table 5, there is
no statistical support for hypothesis 2 in any of the models
estimated, although the coefficient estimates are in the
expected direction. There is substantial support for hypothe-
sis 3, however, as evidenced by the positive and significant
effects on the log variance of the interaction between culture
strength and industry volatility. This pattern is found using
both estimation strategies: the multiplicative heteroscedastic-

Table5
Contingent Effects of Culture Strength on FirmPerformance, 1979-1984*
ROI Operatingcash flow
Variable (1) (2) (3) (4)
Mean:
Debt-to-asset ratio -.1 69" -.1 66" 71.801 83.023"
(.012) (.012) (32.515) (28.749)
Operatingleverage -.080" -.073" -81.142 -73.242*
(.014) (.014) (41.260) (34.926)
Corporateculturestrength .003 .021 51.027 66.070"
(.006) (.009) (29.767) (29.162)
Log marketcapitalization -.001 -4.E-04 2.539" 18.458-
(.001) (.001) (6.495) (5.509)
Industryvolatility -.008 -.009 36.939 31.107
(.010) (.010) (28.124) (25.016)
Culturestrengthx Industryvolatility -.003 -.004 -54.975 -49.109
(.006) (.007) (35.478) (33.846)
Culturestrengthx Log marketconstraint .006" 8.530
(.002) (9.606)

Log variance:
Corporateculturestrength -1.816" -1.994" -2.382" -3.225W
(.310) (.344) (.364) (.316)
Log marketcapitalization -.005 .021 1.538" 1.532"
(.066) (.066) (.090) (.090)
Industryvolatility .419 .414 -.841 -1.134-
(.411) (.409) (.464) (.465)
Culturestrengthx Industryvolatility 1.428" 1.361 - 1.951 - 1.572"
(.307) (.307) (.342) (.308)
Culturestrengthx Log marketconstraint -.180 -.846"
(.112) (.105)

X2 1042 1052 3620 3677


D.f. 44 46 45 47
Firm-yearspells 800 800 703 703
-
p < .05; p < .01; two-sided tests.
* Models includeindustrydummies in the predictionequationsfor both the mean and log variance;thus all covariates
are relativeto the marketaverages. The model for operatingcash flow includesa controlfor the operatingcash flow
level in 1978.

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Corporate Culture

ity models in table 5 and the analyses in table 4 of the error


from the firm-specificregressions (models 4 and 8). These
estimates suggest that as industryvolatilityincreases, the
reliability-enhancingbenefits of strong corporatecultures
attenuate. Moreover,this effect is robust to the inclusionof
the interactioneffect between culturestrength and market
competition.

Figure 1. Conditional effect of culture strength on cash-flow variance.

1__

0- /

0cJ /J

-1- s ,'
-J

o r- /

r 2- - /.

0 .5 1 1.5 2
Industry Volatility

Figure1 presents the interactioneffect between culture


strength and industry volatility graphically, using the esti-
mates for cash-flow volatility from model 4 in table 5. Each
point on the solid line in figure 1 represents the estimated
reduction in the log cash flow variance due to a one-unit
increase in culture strength at a particular level of industry
volatility. The dashed lines are 95-percent confidence inter-
vals about this effect, computed according to the formula in
Friedrich (1982). The figure suggests that at most observed
levels of industry volatility, the strength of corporate culture
has a substantial influence on cash-flow volatility. At the
same time, this effect diminishes markedly as volatility
increases; when the volatility score equals approximately 1.5,
the confidence interval includes zero, and culture strength
has no reliability benefits. The interaction effect for the vari-
ance in ROI shows a similar pattern, although the confidence
interval includes zero at a lower level of volatility (at a value
of approximately 1.2).
DISCUSSION
The results indicate that the strength of corporate culture
affects the variabilityof firm performance and that this rela-

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tionship is contingenton the level of industryvolatility.Insta-
ble environments,firms perceived to have strong corporate
cultures exhibitsuperiorand more reliableperformance.This
suggests that in these environments,the consensus sur-
roundingorganizationalgoals and values characteristicof
strong-culturefirms enhances their abilityto exploit estab-
lished competencies. The benefits of a strong culturecarrya
cost with respect to adaptationin volatileenvironments,
however, as the reliabilitybenefits of strong cultures attenu-
ate as industryvolatilityincreases.
Hypothesis 2, that the positive effect of culturestrength on
mean performanceshould decrease in volatileenvironments,
was not supported. It is not immediatelyapparentwhy this is
the case. Substantively,it may be that firms with strong cul-
tures can weather short periods of volatilitywithout suffering
a drop in performance.This would be the case, for example,
if the improvementsin internalefficiency due to strong cul-
tures outweigh any difficultiesstrong-culturefirms have in
adaptingto changed externaldemands. Similarly,the reliabili-
ty benefits of a strong cultureduringperiods of incremental
change, such as the lowered likelihoodof underinvestment
(Mintonand Schrand,1999), may allow strong-culturefirms
to develop sufficient organizationalslack to withstand periods
of environmentalchange.
Methodologically,the lackof supportfor hypothesis 2 may
reflect shortcomings in the volatilitymeasure. It is difficultto
construct a single volatilitymeasure that applies across a
wide range of industries,and it seems likelythat the volatility
measure used here, based on stock marketreturns,only
imperfectlycapturedfundamentalor discontinuouschanges
in the environment.If, as just argued, strong-culturefirms are
in a relativelygood position to weather short-termvolatility,it
may only be when there are trulyradicalshifts in the underly-
ing technologies and competitive conditionsin an industry
that the mean performancebenefits of a strong culturedisap-
pear.
Several potentialalternativeinterpretationsshould be exam-
ined more carefullyin future research. First,unobservedfac-
tors may lead some firms to have high levels of performance
with littlevariability;
these firms may in turnbe more likelyto
develop strong corporatecultures. Forexample, consistently
high levels of performancemay make it easier for members
of the organizationto arriveat a consensus about the firm's
core values and norms. By contrast, individualsin firms with
haphazardperformancemay be less likelyto reach agree-
ment about what the firmdoes and why it is successful. This
alternativeexplanationcannot be ruledout conclusivelyusing
Kotterand Heskett's data, since a propertest would require
collecting time-varyinginformationon culturestrength. Sec-
ond, it is possible that a response effect caused by the
instrumentused to measure culturestrength could result in a
spurious association between culturestrength and reliability.
If respondents have difficultyassessing the culturestrength
of firms in their industry,they may turnto more easily
observable firmattributes.Respondents may implicitly
equate culturestrength with consistent performanceand
therefore assign high culturescores to firms with reliableper-
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Corporate Culture

formance. But neither unobserved heterogeneity nor the


response effect can explainsatisfactorilythe contingent
natureof the relationshipbetween culturestrength and relia-
bility.Reliableperformanceshould be more noticeable in
volatileenvironments, both to internaland external
observers. If the culturescores simply reflect perceptions of
reliableperformance,one would expect the positive correla-
tion between cultureand reliabilityto be strongest in volatile
environments,but this is not the case.
This study implicitlyassumes that the strength of corporate
culturecan be represented adequately by a measurement
taken at one point in time, a common assumption in studies
of the effects of culturestrength on performance(Denison,
1990; Kotterand Heskett, 1992; Gordonand DiTomaso,
1992). The validityof this assumption depends on the degree
of inertiain culturalsystems relativeto the rate of change in
environmentalconditions. Harrisonand Carroll's(1991) simu-
lations suggested that culturalsystems are relativelyrobust
in the face of turnoverand organizationalgrowth and decline.
More generally,organizationalecologists have argued that
organizationalstructures are relativelyinert (Hannanand Free-
man, 1984). It may therefore be reasonable to assume that
organizationalcultures also have inertialtendencies (Schein,
1992). Futureresearch should test the validityof this
assumption and explore in greater detail the processes that
drive change in the strength of corporateculture.An interest-
ing question in this respect is whether culturalstrength
changes in response to unreliableperformance.
Finally,both the theory and the evidence in this paper focus
on the strength of corporateculture in terms of consensus
but do not address the question of culturalcontent. An
importantissue for future research is how the bias against
exploratorylearningin strong cultures might be mediated by
the content of the corporateculture.The statisticalanalyses
in this paperaddress centraltendencies: while strong-culture
firms on average exhibit less reliableperformancein volatile
environments,some strong-culturefirms handle the volatility
better than others. Futureresearch should investigate why
this is the case. The answer may lie in other organizational
characteristicsof the firms in question-for example, differ-
ences in organizationalstructures,the delegation of authority,
and incentive systems-in additionto the content of firm cul-
tures.
In terms of culturalcontent, a shortcomingof Kotterand
Heskett's data is that they may underrepresentfirms with
strong cultures of exploration,for two reasons. First,the
measurement of culturestrength relies on outsiders' percep-
tions of a firm havinga recognizableway of doing things. If
strong cultures of explorationlead to frequent changes in
organizationalroutines, it seems unlikelythat they will be
identifiedwith a particularway of doing things. Second, the
composition of the sample may create a survivorbias against
strong cultures of exploration.Most organizationalenviron-
ments are characterizedby relativelylong periods of incre-
mental change, interspersedwith periods of volatility.The
returnsto exploitationdominate the returnsto exploration
duringincrementalenvironmentalchange. Apartfrom the dif-
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ficulties inherentin designing and maintaininga cultureof
exploration,firms with strong cultures of explorationshould
find themselves at a disadvantageduringperiods of stability
relativeto firms with,strong culturesof exploitationthat are
well-matchedto environmentalconditions. Research
designed to examine the mediatingeffect of culturalcontent
must be sensitive to this issue.
CONCLUSION
Firmswith strong cultures incura tradeoffwith respect to
their adaptiveabilityin the face of environmentalchange.
Strong corporateculturesfacilitatereliableperformancein rel-
atively stable environments,but as volatilityincreases, these
benefits are dramaticallyattenuated.This patternis consis-
tent with the fundamentaltradeoff between explorationand
exploitationnoted by March(1991) and suggests that strong-
culturefirms excel at exploitingestablished competencies
but have difficultyexploringand discoveringnew competen-
cies that better suit changingenvironmentalconditions.
While the tradeoff between explorationand exploitationhas
been acknowledged for some time, there has been little
empiricalresearch linkingthis tradeoffto organizationalchar-
acteristics. Organizationsmake implicitand explicitchoices
about the allocationof resources to each type of learning.
Some of the more explicitchoices are encoded in formal
structures. Forexample, the interdependenciescreated by
verticalintegrationdemand a commitment to a particular
technology and, hence, a shift of resources toward exploita-
tion. This affects adaptabilityin rapidlychangingenviron-
ments (Sorenson, 2001). Infranchisingorganizations,the bal-
ance between explorationand exploitationdepends on the
mix of company-ownedand franchisedunits (Sorenson and
Sorensen, 2001). In hotel chains, Ingramand Baum (1997)
found that the effects of operatingexperience depend on the
structureof the chain and the natureof the operatingexperi-
ences of chain members. The evidence in this paper sug-
gests that a firm'sinformalstructure,in the form of the
strength of its corporateculture,also affects the balance
between explorationand exploitation.
This research also helps us better understandthe costs and
benefits of strong corporatecultures. Corporatecultures con-
sist of ideas about the firm'suniquecapabilities,frameworks
for interpretingthe state of the environment,and routinized
means of respondingto environmentalchanges (Weick,
1985; Levittand March,1988; Schein, 1992). Strong-culture
firms have a high level of commitment to an established way
of understandingthe world, while weak-culturefirms exhibit
heterogeneity in participants'beliefs about the relationship
between the organizationand its environment.As long as the
organization'sperceptions of its environmentare reasonably
accurate, firms benefit from strong corporatecultures, both
by achieving higherperformancelevels and by doing so more
reliably.Strong-cultureorganizationsdo not bear the costs of
disagreement surroundingorganizationalgoals and the
means to achieve them. When environmentsare volatile,
however, explorationskills become more valuable.Success
in volatileenvironmentsrequiresbeing able to learnfrom
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Corporate Culture

new and changing situations. Involatile environments,the


assumptions formingthe basis of the corporateculture
become inaccurateat a faster rate. When the environment
shifts, strong-cultureorganizationshave no fall-backposition,
and the lack of internaldiversityin perspectives makes it
more difficultfor the firmto adapt.
These findings might lead one to conclude that the optimal
strategy for firms would be to develop strong cultures that
explicitlyencourage exploratorylearningand innovation(Gor-
don and DiTomaso,1992), but such a conclusion is unwar-
ranted.The value of a strong cultureof explorationstill
depends on the existence of environmentalconditionsthat
rewardexploration.If the environmentchanges to reward
efficiency and exploitationof organizationalroutines, firms
that are stronglycommitted to explorationshould have
greater difficultyadaptingthan firms with weak cultures of
exploration,because such an environmentdemands relative
stabilityin organizationalroutinesand the abilityto make
incrementalimprovements in efficiency. The difficulty
encountered by the firmwith a strong cultureof exploration
is, in this case, not an inabilityto discover new routines but
greater difficultyin discoveringa set of values and norms
that are appropriateto the new environment.
Finally,the fact that there are tradeoffs associated with
strong corporatecultures should not overshadow one of the
centralresults of this paper,namely,that strong cultures in
general lead to reductions in performancevariability.As
noted at the outset, firms benefit from reduced variabilityin
performance.Forexample, the fact that strong-culturefirms
have less volatile cash flows suggests that they are less like-
ly to underinvest.Strong cultures therefore create competi-
tive advantage not only by increasingmotivationand facilitat-
ing coordinationand control,but also by leavingthe
strong-culturefirm in a stronger position to respond to invest-
ment opportunitiesthat might solidifyits competitive advan-
tage. While the results in this paper suggest that strong-cul-
ture firms encounter difficultiesduringperiods of
fundamentalchange, the advantages that accrue to them
duringperiods of incrementalchange may make them better
able to weather periods of upheaval.
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