Worker satisfaction boosts future returns on companies’ stocks, but Wall Street has been slow to catch on, new research finds
January 1, 2013
For more information, contact: Ben Haimowitz , 212-233-6170,
When former General Electric CEO Jack Welch told the
Financial Times four years ago that "on the face of
it shareholder value is the dumbest idea in the world," and cited
workers as among a company's main constituencies, the irony was
obvious. Here was the man whose ruthless approach to employee
relations had earned him the nickname Neutron Jack (after a nuclear
weapon designed to kill people without destroying property) but who
now seemed to be suggesting that employees were worthier of top
management's concern than company investors were.
How important is worker satisfaction to corporate financial
performance? Notwithstanding Mr. Welch's apparent change of heart,
demonstrating such an effect has proved elusive. "There is still
much debate on whether these variables are actually related in
practice," begins a paper in the current issue of the scholarly
journal Academy of Management
The study then proceeds to provide what its author, Wharton
professor Alex Edmans, claims to be the strongest demonstration to
date not only that the two are related but that worker satisfaction
is a significant driver of firm value rather than just a happy
byproduct of it. Focusing on the yearly listing in
Fortune magazine of the 100 Best Companies to Work
For In America, the University of Pennsylvania professor finds that
those firms generate considerably higher annual stock returns over
the long term than the broad market does -- as much as nearly four
percentage points higher per year.
Equally important, Wall Street seems largely impervious to
this impressive impact. Noting the intangible nature of
employee satisfaction, the study asserts that "the stock market
uses traditional valuation methodologies, devised for the 20th
century firm and based on physical assets, which cannot accommodate
Moreover, the market is proving a slow learner: stock analysts'
under-appreciation of the effect has been even more pronounced
since 1998 than it was before, even though the visibility of the
Best Companies list greatly increased with its first appearance in
Fortune that year.
The paper concludes that its findings "support managerial myopia
theories in which managers under-invest in intangibles because the
market only values them in the long run,"-- that is, when their
effect "shows up in tangibles such as earnings announcements."
Thus the dilemma for managers in making investments to increase
job satisfaction: even if the effects on employees "are
independently verified and widely publicized, the market appears
not to fully value them...To encourage managers to invest for the
long-run, it may be necessary to insulate them from short-term
stock price movement -- for example by giving them stock and
options with long vesting periods."
Or, still another option may be to take companies private, as
suggested by the fact that the number of non-public firms on the
100 Best Companies list more than doubled from 30 in 1998 to 61 in
Initiated in 1984 and compiled since 1990 by a non-profit
institute in San Francisco, the list is based on two sources -- two
thirds on surveys of employees that gauge their trust of
management, pride in their work, and camaraderie with fellow
workers, and one third on questionnaires for management probing
such topics as company diversity, turnover, compensation, benefits,
time off, and work-family policies. Firms, about 400 each year,
apply to be considered for the list, which is typically published
in early February of the following year (this year in the
magazine's February 4, 2013 issue).
To make sure that stock returns of the Best Companies do not
simply reflect good publicity from appearing in
Fortune rather than actual employee job satisfaction,
the professor calculated returns from the month after appearance in
the magazine (thereby likely understating satisfaction's positive
effect) through January of the following year. To guard against the
possibility that the returns on Best Companies' stock reflect
factors other than worker satisfaction, comparisons between
honorees and the broad market controlled for key factors likely to
affect stock prices. Annual returns in excess of the broad market's
were 3.8% annually controlling for risk, 2.3% controlling for
industry, and 2.9% controlling for a combination of size,
book-to-market ratio, and momentum.
Prof. Edmans then undertook to gauge how these results squared
with analysts' forecasts of company earnings one year, two years,
and five years into the future. For all three time periods, he
found that the earnings of Best Companies beat analysts' estimates
by significantly more than earnings of peer firms did.
Moreover, the three-day market reaction to earnings
announcements was almost four times greater for Best Companies than
for other corporations.
Given that employee satisfaction boosts companies' future stock
returns, as the study finds, what are the implications of this with
respect to corporate social responsibility (CSR) in general? "CSR
involves firms' considering the interests of stakeholders other
than shareholders, such as employees, customers, or the
environment," Prof. Edmans writes. "To my knowledge, this is the
first paper that identifies a CSR dimension that improves stock
returns over a long period and after controlling for risk."
Traditional finance theory, he continues, holds that socially
responsible investing (that is, screening for companies that meet
some criterion of social responsibility or screening out firms that
don't) worsens returns by restricting the investor's choice set.
"Finding even one screen that improves returns is sufficient to
challenge this view," the professor writes. "Thus, these findings
provide motivation for extending the investigation to other
screens. If other forms of 'stakeholder capital' also benefit
shareholders (e.g., low pollution improves a firm's corporate
image) and are also undervalued by the market, certain other
screens may also improve returns."
The study, "The Link between Job Satisfaction and Firm Value,with Implications for Corporate Social Responsibility," is in the
November/January issue of Academy of Management
Perspectives. This peer-reviewed publication is
published quarterly by the Academy, which, with more than 18,000
members in over 100 countries, is the largest organization in the
world devoted to management research and teaching. The Academy's
other publications are the Academy of Management Review,
Academy of Management Journal, and Academy of
Management Learning and Education.