Below is an article I wrote 2 months agone for the World Economic Forum. Since it's posted on the password-protected department of the WEF website, I reproduce it here.
Does corporate social responsibleness (“CSR”) improve theater value? When companies brand decisions, should they assist only almost shareholders or should they lead maintain other stakeholders (e.g. employees, customers, the environment) into account? This is a decades-old debate, but despite many cogent views on both sides, there’s surprisingly petty hard evidence.
In 1970, Milton Friedman famously wrote that “the social responsibleness of concern is to growth its profits”. This sentiment isn’t equally hard-hearted equally it may sound. Friedman argued that a companionship tin give the sack only growth its profits yesteryear taking other stakeholders into concern human relationship – producing high-quality products, treating its employees fairly, as well as having a goodness environmental reputation. Under this view, firms should focus alone on profits, as well as everything else volition autumn into place. Considering other stakeholders beyond the net implication is at the expense of shareholders: a dollar spent on reducing pollution (beyond the degree that volition avoid an environmental lawsuit) is a dollar that cannot survive paid equally dividends.
However, advocates of CSR fighting that the Friedman sentiment only holds inwards theory. In practice, it’s extremely hard to quantify the net implications of most socially responsible actions. H5N1 companionship could determine whether to grant an employee compassionate move out yesteryear trying to calculate the potential loss inwards morale as well as productivity if the move out was withheld, but these consequences are rattling hard to quantify. The CSR approach would survive to grant the move out only because it’s the correct affair to gain – because the finish of the companionship isn’t only to maximise profits, but to process stakeholders amongst compassion. Treating employees fairly volition eventually manifest inwards greater staff retentiveness as well as time to come productivity. However, these long-run effects are hard to quantify, so a theater focused alone on profits volition non invest inwards its stakeholders.
Whether CSR improves theater value has been studied extensively yesteryear management scholars. Most studies observe a positive correlation betwixt CSR as well as measures of theater performance, such equally profits. However, correlation doesn’t imply causation. It may non survive that CSR causes a theater to perform better, but instead that theater functioning causes CSR – only firms that are performing good tin give the sack afford to pass coin on its other stakeholders. In addition, around studies consider only i industry, or a curt fourth dimension period, as well as so are hard to generalize.
I decided to tackle this long-standing management interrogation using a methodology from a dissimilar champaign – finance. This approach involves linking CSR non to profits, but to time to come stock returns, which reduces contrary causality concerns. If it was high profits that caused CSR, as well as so the high profits would hateful the company’s stock toll would already survive high today, as well as so nosotros shouldn’t await higher stock returns going forward.
The adjacent determination is how to stair out CSR. The primary challenge is that CSR is extremely hard to stair out objectively, equally it’s intangible. Tangible measures gain be – for example, i could stair out workplace variety yesteryear whether there’s a minority on the board. However, tangible measures are relatively superficial as well as therefore slow to manipulate. For example, a companionship that cared petty almost workplace variety could seat a token minority on the board to “check the box”. H5N1 course of education challenge is that CSR comprises of many dissimilar dimensions – responsibleness to employees, customers, the environment, etc, as well as it’s unclear how to weight these dissimilar constituencies.
I therefore focused on i detail dimension of social responsibleness – employee satisfaction. I chose this dimension equally a rattling thorough stair out of it exists. Since 1984, at that spot has been a listing of the “100 Best Companies to Work for In America”. This listing is compiled yesteryear surveying the employees themselves – it’s the ultimate inwards fundamental, grass-roots analysis. Two hundred as well as l employees are randomly selected inwards a theater as well as asked 57 questions on diverse aspects of employee satisfaction (credibility, respect, fairness, pride/camaraderie), which had been developed through extensive discussions amongst managers, employees as well as workplace experts. As a result, it’s arguably the most respected stair out of employee satisfaction. Equally importantly, it has been available since 1984, as well as therefore I lead maintain a long time-series which comprises both recessions as well as booms.
The kickoff listing came out inwards a mass inwards March 1984, as well as so around other mass inwards Feb 1993, as well as and so inwards the Jan edition of Fortune journal every yr from 1998. My methodology involves buying a the Best Companies inwards Apr 1984, rebalancing the portfolio inwards March 1993 to lead maintain the novel listing into account, as well as and so rebalancing it every Feb from 1998. The i calendar month delay is because I want to seek non only that employee satisfaction improves theater value, but also whether the marketplace position recognizes this link. Even if employee satisfaction improves theater value, my strategy should earn no returns if the marketplace position recognizes this link. As shortly equally a companionship appears inwards the Best Companies list, its stock toll should larn up, so I shouldn’t survive able to generate returns yesteryear buying it i calendar month likewise late.
I compare the returns of the Best Companies non only to the overall market, but also to companies inwards the same industry. For example, Google is oft inwards the Best Companies list, but its high returns could survive due to the tech manufacture doing well, rather than its employee satisfaction. I also compare each companionship to peer firms amongst similar characteristics (e.g. size, dividend yield, recent performance, valuation ratios). In short, I elbow grease to command for equally much equally possible, to isolate the effect of employee satisfaction. I also take the effect of outliers, to ensure that whatever superior functioning of the Best Companies isn’t due to a few star performers such equally Google.
I observe that the Best Companies trounce the marketplace position yesteryear 2-3%/year, over a 26-year menstruation from 1984-2009. This outperformance is highly statistically significant, as well as also economically meaningful – a fund managing director who beats the marketplace position yesteryear 1%/year for v years is considered to survive skilled. Moreover, this outperformance is based on a rattling elementary trading strategy using world data on large firms.
The results lead maintain 3 primary implications. First, they propose that employee satisfaction is beneficial for theater value. While it may seem natural that companies should gain ameliorate if their workers are happier, this is far from obvious. Indeed, the 20th century means of managing workers is to sentiment them equally whatever other input – exactly equally managing director shouldn’t overpay for or underutilize raw materials, they shouldn’t gain so amongst workers. High worker satisfaction may survive a sign that workers are overpaid or underworked. However, the basis is dissimilar nowadays. Human uppercase is the primary property inwards many firms, as well as employee welfare tin give the sack improve productivity, retention, as well as recruitment.
Second, fifty-fifty though employee satisfaction may survive beneficial inwards the modern firm, the marketplace position doesn’t recognize this link. Even though I hold back a calendar month earlier forming my portfolios, the strategy generates superior returns. Similarly, the Best Companies typically study earnings that trounce analyst expectations – analysts aren’t aware of the benefits of worker welfare. Indeed, I demo that it takes 4-5 years earlier the marketplace position fully incorporates the value of employee satisfaction. This may survive because traditional methods of valuing companies are based on the 20th century firm, as well as emphasize tangible factors such equally short-term profits. This termination has broader implications for firms’ incentives to invest for the long-run. If investors proceed to value companies based on short-term profit, as well as so managers volition pursue short-term net rather than long-run growth.
Third, Socially Responsible Investing (SRI) – incorporating social considerations into portfolio pick – tin give the sack add together value. The traditional sentiment is that SRI is costly to investment performance, equally it involves screening out goodness investments as well as screening inwards bad investments. However, the Best Companies strategy generates high returns field supporting companies who process employees responsibly – investors tin give the sack gain good as well as gain good. This termination is a termination of the kickoff 2 implications – employee satisfaction is beneficial (the kickoff implication) but the marketplace position doesn’t recognise that it’s beneficial (the minute implication).
In concluding, it’s worth highlighting around caveats to my study. First, I’ve only shown a link betwixt stock returns as well as employee satisfaction, as well as non other dimensions of CSR. Further inquiry must survive done to study whether there’s whatever link amongst environmental protection, animate existence rights, etc. However, since the traditional sentiment is that no dimension of CSR should add together value, the results are an of import kickoff pace towards demonstrating the benefits of CSR to a greater extent than broadly. Second, field I command for many observable factors (industry performance, theater size, dividend yield, etc.), I can’t dominion out the explanation that an unobservable variable (e.g. goodness management) causes both employee satisfaction as well as superior returns. If so, my kickoff implication is no longer causal – improving employee satisfaction (without changing management) won’t improve stock returns. However, the other 2 implications remain. It remains the illustration that the stock marketplace position misvalues intangibles – exactly that the intangible existence misvalued is goodness management rather than employee satisfaction. It also remains the illustration that a socially responsible investor could lead maintain bought companies that process their employees good as well as earned superior returns.
Further reading:
Edmans, Alex (2011): “Does the Stock Market Fully Value Intangibles? Employee Satisfaction as well as Equity Prices”. Journal of Financial Economics 101(3), 621-640
Edmans, Alex (2012): “The Link Between Job Satisfaction as well as Firm Value, With Implications for Corporate Social Responsibility.” Academy of Management Perspectives 26(4), 1-19
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