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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 Perspectives.

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 intangibles easily."

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 2011.

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.

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