In our class these past two weeks, as well as in the 2010 discussion sections I am teaching, we have discussed the classic examples of externalities - pollution, parks, smoking, etc. However, another interesting (and relevant) market failure is that of companies with sub-optimal levels of cultural capital. In “The Economics of Why Companies Don’t Fix Their Toxic Cultures,” Kevin Stiroh defines cultural capital as a form of investment subject to market failures that explain why companies often fail to address poor corporate cultures. Investing in cultural capital reduces employee misconduct risk, just as investing in physical and human capital reduces liquidity risk and operational risk. The higher the cultural capital, the lower the misconduct risk and the greater alignment between a company's business outcomes and stated values. On the other hand, stated values and employee behavior differ in firms with low levels of cultural capital, yet many companies (like Uber until 2017) do not invest in cultural capital to mitigate this misconduct risk.
Firms do not invest in cultural capital for a variety of economic reasons relating to market failures. Externalities is one of them - employee misconduct creates externalities like lost consumer confidence in the firm and in the entire industry. This requires the assumption that consumers lose confidence both in firms with negative corporate cultures and in the overall sectors of these misbehaving firms. For example, a few powerful financial institutions made consumers lose trust in the entire financial sector during and after the Great Recession, and a few high-profile tech companies have led many people to question the values of the tech industry as a whole. Therefore, individual firms do not always incur all of the costs of their own misconduct. This leads to a negative production externality - firms with low cultural capital impose a negative externality on third parties, like other companies in the industry that have high cultural capital. Since these firms do not bear all of the costs of their negative corporate cultures, they do not take appropriate action to reduce their misconduct risk.
Market failures have implications for many business decisions beyond our typical examples of farmers and cattle-raisers. Negative corporate cultures, from financial irresponsibility to sexism, and companies’ unwillingness to improve them can be explained in part by uncorrected negative externalities.
1 comment:
Colette-
I found your analysis and the article you based it off of to be extremely interesting. The concept of cultural capital as an investment reminded me of my experience as an intern at Pfizer this past summer. Pfizer is a part of one of the most unpopular industries in the world, the pharmaceutical industry. Due to general societal perceptions of pharmaceutical companies as “evil,” I was very surprised to find that every colleague I interacted with, from those in the commercial to the scientific division to everything in between, centered each discussion around improving patient access to medicines. I asked my boss if this positive corporate culture, with an extreme emphasis on uniting all of Pfizer around common values of ownership, permeated beyond the signs in the hallways. She informed me that the CEO, since taking over in late 2010, made changing to this “OWNIT!” culture to promote “One Pfizer” a top priority, and that it has developed into an integral part of everyday business.
At the time I thought it was a wonderful cultural shift to make in an industry where such cultural transformation does not change peoples’ perceptions of you as “evil”. I now realize that it was a decision necessary for business. With blockbuster products going off patent in the last decade, Pfizer’s previously complex and discombobulated organizational structure, which contributed to the old culture, was having a negative effect on business and a negative production externality on employees, patients, and the industry as a whole. In the past few years, the promise of new products in the innovative pipeline has risen. Pfizer leadership realized that unless the culture transformed into one of ownership and passion for innovation, they were going to struggle massively with putting new blockbuster drugs to market, as all employees must be dedicated and driven for it to be successful. Put another way, the profit maximizing level of investment in corporate culture, Q*, moved closer towards the allocative efficient point, QAE. Pfizer’s underinvestment in culture capital, a negative production externality, was diminished not because the cost or benefit (supply or demand) curves changed, but because the change in business strategy from managing losses to pursuing innovation required a higher level of culture capital to maximize future revenue.
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