A Clash of Cultures: The Governance and Valuation Effects of Corporate Cultural Distance

Abstract

We find that the cultural distance between the CEO and a firm’s directors increases the sensitivity of CEO turnover and compensation to performance while enhancing shareholder value. This effect is concentrated in the cultural distance between the CEO and independent directors. More culturally distant CEOs adopt less risky financial and operating policies. To establish causality, we use the sudden exit of directors as a source of exogenous change in cultural distance. Overall, our results suggest that cultural distance increases information collection costs. This causes the board to monitor with increased rigor and to rely on “hard” information to assess CEO performance.

Keywords: Governance; boards; cultural distance; turnover; compensation

JEL Classification: G34