First, understand the business. Next, ask questions about the company’s purpose and strategy, is the organization’s structure fit for purpose, does it tolerate mistakes and dissent, and does the compensation structure hinder- does it or does it facilitate the purpose of the business, how do leaders spend their time, and how does the business respond to a crisis. Trust interviews, not AI techniques or high falutin NLP. And be humbled by the results of such work.
A savvy investor once told me, “You spend too much time analyzing numbers and doing fundamental analysis of financial statements. You should spend more time doing fundamental analysis of the people running the business. »
My concern is that even fundamental analysis is rarely done well, as the information structures underlying fundamental analysis from providers such as Cap IQ or Bloomberg have become commoditized. However, I would like to focus on the human side of business in this article.
Company culture is perhaps the most important but underestimated value driver of a company. My co-authored research shows that a good corporate culture has a significant impact on a company’s productivity, ethical compliance, innovation and long-term performance. The SEC’s recent interest in human capital information has also focused investors’ hearts and minds on understanding corporate culture. It is also important to understand whether business leaders are “walking the talk” when it comes to culture to place empirically verifiable content in the often abstract debate about corporate purpose. Investors have traditionally avoided evaluating culture because it’s hard to define, harder to measure, full of “touchy feely” qualitative ideas that quantitative types are uncomfortable with.
Also, there is no ready database to which one can subscribe and upload data to get an answer. Many investors are interested in the question of corporate culture assessment, but few are committed to doing the necessary groundwork to get an answer. The crop tends to change slowly and is therefore a long-term differentiator of the wheat from the chaff. Investors with short trading horizons are unlikely to be interested in trading corporate culture. So if your horizon is indeed long and you’re ready to get down to business, what should you do to start assessing company culture. I suggest you start with the following questions.
First, understand the business
· What is the purpose of the business?
· What customer need is the company trying to meet, what is the solution and why does it work?
· Who is the competition and what advantages do they have?
· What are the obstacles to imitation?
· How is revenue generated? What are the company’s costs?
· What/who is the talent?
· How is capital allocated and is this exercise effective in creating long-term value?
· In particular, does the company invest enough in maintenance investments (material and immaterial such as R&D and SG&A) to maintain its current market share?
· How are management and the company’s top 50 executives compensated?
Then ask questions about the culture
Objective and strategy
· What is the declared culture of the company or what are the declared values of the company?
· Is there any evidence to suggest that these values are lived in practice (“is the company following the chops”)?
· Do the culture of aspiration and the culture lived seem adapted to the objective of the company?
· Do leaders think the culture is not where it should be? If so, what can be done to fill this gap?
· Is the organizational structure appropriate for the business objective it aims to achieve? More often than not, form does not follow form or business purpose.
· How long have the company’s CEO, C-suite, board of directors and key employees been with the company? The longer the better for cultural continuity and a longer investment horizon.
Innovation and risk taking
· Is constructive dissent within the company tolerated or is the company a dictatorship? What is the structure of sanctions in the company in the event of unsuccessful risk taking?
· How common are functional silos?
· How much importance does the company place on box checks rather than gut checks? It is an attempt to assess whether the company is more process-oriented than outcome-oriented.
· Does the company’s compensation and incentive structure hinder or promote the company’s corporate purpose?
· What kind of people are hired, promoted and fired by the company?
· Are employees engaged? Do they care, in any way, if declared cultural values are not lived out in practice?
· What kind of skills and leaders does the company celebrate?
· Does the compensation plan unintentionally reward reckless risk-taking/short-term results and intentionally reward adherence to cultural values?
· What specific KPIs are tracked and compensated by the company?
· Our research shows that leadership is the single most important driver of corporate culture. Therefore, it is important to ask how do leaders spend their time running the business?
· What do the company’s leaders appreciate?
· How a business responds to a crisis can be quite revealing. For example, in response to Covid-19, some companies have laid off employees. Others reacted, on the contrary, by maintaining or even increasing the benefits paid to their employees.
· If a Wall Street Journal article were to appear about the company, what would it most likely be about?
· Is the company best described as having an engineering culture, a sales culture or a financial culture? What are the advantages and disadvantages of such a culture and is it suited to the social purpose described?
Who should you interview?
These questions about culture can benefit from different perspectives. The obvious starting point is the company’s former senior employees. However, it is very useful to ask suppliers, customers (brand, reputation) and regulators how they perceive the culture of the company. Triangulating ideas from multiple stakeholders can be invaluable.
Are NLP-Based Approaches Worth It?
There are many papers that use natural language processing approaches to identify a set of words that denote a toxic culture (e.g., “dog-eat-dog” or “hierarchical” or “narcissistic” and so on) to from employee reviews on Glassdoor.com, news articles describing the firm, or from similar sites. How seriously should you take such a job? I personally believe that these NLP approaches are superficial and without context. Working on our academic paper on corporate culture, we found two intelligent humans barely agreeing 54% of the time when asked to classify words capturing corporate culture into several culture categories such as “adaptable”, “collaborative”, etc. If two smart humans can’t get along, trust the machines to do a better job. Not at the moment, in my opinion. Machines lack contextual nuance. For example, Steve Jobs has often been described as a narcissistic leader, but was a unique leader in a generation. The NLP algorithm would have classified Apple as a toxic culture. Hierarchical cultures have their place depending on the activity of the company. Will the same bag of words work for, say, European companies or Japanese companies?
Even if you argue that NLP is industry dependent, innovation means different things within the same industry. For example, Nvidia is well known for being innovative in the semiconductor industry, they try things, fail fast, and fail early. However, innovation at TSMC (another leading semiconductor company) is a very different matter as it is much more process driven. Therefore, there is so much more to learn about the impact of culture on business results and financial performance at the micro level. Personally, I prefer to interview knowledgeable stakeholders on the above issues instead of relying on NLP approaches.
The need for constant hypothesis testing
The end goal, of course, is to find reliable answers to these culture-related questions for publicly traded companies, and assess which ones can help us predict future operating performance and stock market returns. The investor must relentlessly make assumptions about how the answers to these questions help to understand what makes the business work and whether that insight can serve as a leading indicator of business performance.
The investor should also attempt to triangulate initial results with past and future achievements of relatively concrete numbers such as earnings, R&D results, free cash flow, margins, M&A performance, etc.
These were some preliminary thoughts on the difficult idea of how to start thinking about corporate culture as an investor. I wonder what kind of questions you might ask.