Both academic and practitioner spheres have embraced culture as a critical factor in determining a wide range of organizational outcomes. Culture generally impacts how people communicate and interact with each other. Companies are experiencing this same phenomenon: recent research suggests that the cultural background of leaders has a lasting effect on how they communicate with other key players. These actors include the capital market, employees and, most importantly, the board of directors. Although interactions with boards of directors often determine a leader’s course of action and therefore have a significant impact on companies, the crucial effect of culture on these interactions remains rather nebulous.
We argue that the proximity between the cultural backgrounds of the CEO and directors plays a critical role in shaping the relationship between the CEO and the board. In this study, we examine the dynamic cultural proximity between CEO and board – how the cultural proximity between CEO and board evolves over the years following the arrival of a new CEO in the organization. business and the implications of this development for corporate governance. Our definition of CEO-board cultural proximity is based on the cultural dimensions constructed by Hofstede (2010). We hypothesize that these dimensions shape board dynamics through an implicit bias and may change over the course of a CEO’s tenure. People who share the same cultural background have hidden assumptions, group norms, and similar values, which reduces the need for explicit communication. These common traits underlie the phenomenon of homophily, which drives social networks, political alignment and even friendship. In this way, culture serves as an implicit contract and an often overlooked element of intra-firm relationships.
Although the importance of culture is well established, the difficulty of constructing a comprehensive and accurate measure of culture has resulted in a dearth of research on this issue. Many previous studies have investigated culture in a multinational context, but these parameters have considerable endogeneity issues. Results may be determined by unobservable factors associated with different countries, including language, legal system, economic environment, and institutional environment. We attempt to overcome these obstacles by constructing a more granular measure of CEO-board cultural proximity. With a large sample of CEOs and directors from S&P 1500 companies, we measure cultural closeness of CEO and board of directors using both first and last name at the company year level . Using both first and last name creates a deeper profile of cultural background, as it can capture origin from multiple countries. The United States, as a country of immigration with widely varying cultural backgrounds, is an ideal setting to observe these dynamics. This framework allows us to examine the effect of cultural heritage while holding other factors such as language and legal system constant.
First, we find that the cultural closeness between the CEO and the board increases over time after a new CEO takes office. Relative to the year the CEO first took office, CEO-board cultural closeness increases by 11.5% of the standard deviation of the distribution of the cultural closeness measure at the end of her third year, and it increases by 13.9% of the standard deviation of the distribution of the measure at the end of its sixth year. This effect becomes even stronger as the CEO’s tenure approaches eight years. We find that this CEO-board dynamic is robust when CEO turnover is exogenous, i.e. turnover due to the death of the previous CEO, poor health conditions, or natural retirement, mitigating thus the fear that an omitted factor will cause this change. Finally, we monitor existing CEO and board networks, and the results remain strong.
The significant growth in cultural proximity contrasts sharply with the relative stability of the percentage of outside directors. Sarbanes-Oxley relies on the idea of an “outside director,” a director who is not strictly affiliated with the company, as a measure of board independence. However, our results suggest that the current regulatory approach overlooks a key dynamic underlying CEO-board interactions. Culture implicitly shapes interactions along multiple dimensions, and culture appears to shift significantly within organizations during a CEO’s tenure.
We then examined the driving forces behind this shift in CEO-board cultural proximity. How does the CEO manage to increase cultural alignment between the CEO and the board? One possibility is that the cultural closeness could be the result of decreasing board uncertainty about a CEO’s suitability after several years. We call this idea the “CEO Power Channel”. A second possibility, which we call the “entrenchment channel,” involves mediocre CEOs entrenching themselves and inefficiently gaining excessive power on the board. Ultimately, the evidence suggests that successful CEOs, as represented by ROA performance, gain more bargaining power as their tenure increases and can therefore influence board composition more.
After finding evidence that this dynamic exists, we finally explored how exactly this cultural closeness affects organizational results. Strategic corporate decisions, such as mergers and acquisitions, require significant coordination between the CEO and the board. The possible effects of a decrease in the board’s implied independence may be more complex than it first appears. On the one hand, increased cultural proximity can improve coordination between CEO and board due to reduced information friction and improved communication (Van den Steen 2010). On the other hand, it may also increase the tendency to groupthink, which could lead boards to avoid conflict and quickly access decisions without critical evaluation. We find, on average, that CEO-board cultural proximity is associated with better decision-making. However, for firms with weak governance, greater cultural proximity is associated with poorer M&A performance. These results suggest that cultural proximity promotes coordination when corporate governance is strong, but it may raise groupthink issues when corporate governance is weak.
This study makes several contributions. First, we enrich the literature surrounding the cultural heritage of executives by examining the interaction of cultural backgrounds rather than studying each in isolation. In addition, the use of first and last name in our heritage analysis recognizes the complexity of an individual’s cultural identity. We encourage future studies to adopt this approach. Second, we contribute to a better understanding of the dynamic relationship between the CEO and the board. Many previous studies focus on an explicit measure of board independence, the percentage of “outside directors”, while we use culture as a more implicit measure. Given the importance of culture in determining a wide range of organizational outcomes, the inclusion of culture in independence analyzes is crucial.
Our research results highlight the importance of considering the impact of cultural proximity in corporate governance for researchers and practitioners. Although greater cultural proximity can boost communication in companies with strong governance, it can cause problems for companies with weaker governance. By thoroughly examining these dynamics, our study contributes to organizations’ understanding of CEO-board relationships and offers insights to help shape them effectively.
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