The Strength of Corporate Culture and the Reliability of Firm Performance

Abstract

In more volatile environments, however, incremental adjustments to organizational routines may not be sufficient. This suggests that the variance-reducing benefits of strong cultures may attenuate as environmental volatility increases and may help explain why some strong-culture firms have encountered great difficulties in responding to changes in their environment (Carroll, 1993;Tushman and O'Reilly, 1997).Studying the relationship between culture strength and performance variability therefore has the potential to shed light on the ability of strong-culture firms to adapt to change. Performance variability is also an important outcome in its own right, because it plays a central role in a variety of theoretical approaches to organizations. Behavioral theories of the firm suggest that risk taking by managers depends on firm performance relative to aspiration levels (Cyert and March, 1963; Bromiley, 1991); highly variable performance may increase the frequency of risk-taking behavior. Similarly, while organizations may attempt to buffer themselves from environmental variability in order to facilitate planning and decision making (Thompson, 1967) and increase organizational autonomy (Pfeffer and Salancik, 1978), this may be more difficult when performance is highly variable. Organizational ecologists have attributed causal importance to performance variability by arguing that external stakeholders typically attach value to predictable performance, giving reliable firms a survival advantage (Hannan and Freeman, 1984). For example, suppliers will generally prefer customers that generate predictable orders and reliably pay on time, and many employees value stable employment prospects. Investors should generally prefer to have less temporal variability in performance for a given return (Bodie, Kane, and Marcus, 1996). Performance variability also affects the chances of failure directly: a simple random-walk model of the accumulation and depletion of organizational resources suggests that for a given stock of resources, firms with more variable performance are more likely to exhaust their resources and fail (Levinthal, 1991a). While these arguments from organizational theory suggest the importance of variability in overall firm performance, theory and evidence in corporate finance suggest that variability in specific aspects of firm performance affect organizational behavior. For example, firms with highly variable cash flows find themselves at a competitive disadvantage, for two reasons. First, highly variable cash flows imply that there will be periods when a firm will underinvest in worthwhile projects. Some projects that are attractive when there is sufficient internal capital will be unattractive during periods of internal cash-flow shortfall, if external capital is more expensive than internal capital. This is one reason why firms may wish to engage in risk-management activities, such as hedging (Lessard, 1990;Froot, Scharfstein, and Stein, 1993). Second, firms with more variable cash flows have higher costs of ex...

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