Employee satisfaction as a guide to company performance

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Should companies pay their employees more or less? Or should they concentrate on improving non-monetary benefits, such as culture? Should they allow workplace flexibility, for men as well as women? Or is all that fluffy stuff going to impede a company’s returns and stock price?

A rare discussion on these aspects of ESG analyses was published by Research Affiliates of the US last month, with one of its advisors, Professor Alex Edmans, Professor of Finance at the London Business School and academic director at the Centre for Corporate Governance, interviewed by Dr Feifei Li, a Research Affiliates partner and head of investment strategy.  Edmans published his first landmark paper linking employee satisfaction to stock prices in 2011.

In his latest discussion, and notwithstanding his work on the subject, Edmans admits there are two schools of thought: one is that employee satisfaction is actually detrimental to performance because it may indicate the employees are paid too much and don’t work hard. On the other hand, if you treat workers better, by whatever means, you can hire better people who stay longer, while being better motivated and productive.

Edmans says: “A manager might think the way to motivate workers is to count the number of widgets they produce and pay them per widget. But in the intangibles economy we now live in, a lot of the things managers seek from workers can’t be measured, such as mentoring subordinates. Therefore, the way to actually motivate today’s workers is to make them happy to be part of the firm and to be inspired by the mission of the company.” There is also a third option: that there is no effect, he says.

Studies have, increasingly, shown that better governance is linked to higher stock prices but the market doesn’t necessarily appreciate that, still. Edmans says: “You might think it’s obvious that if a firm is better governed, performance should be higher, similar to the situation that if employees are happy, performance should be higher. But despite governance measures being public information, the market doesn’t take them into account. The market is good at looking at metrics such as earnings and profits and dividends, but less good at incorporating intangible factors such as governance or employee satisfaction.”

What Edmans’ work on ESG has shown is that specific ESG strategies work best for specific categories of institutional investors. The focus with ESG should be on material issues for a company in the industry in which it operates. For instance, in healthcare the issue may be the environment or in financials it may be trust.

He says: “Some [ESG or SRI]   funds may not be outperforming because they might be using the wrong criteria. I chose employee satisfaction because employees are material to almost every company. Employees are a key asset, so there is a good reason for a link between them and a company’s future stock performance.”

For super funds interested in investing in a strategy based on Edmans’ work, you can check out the Parnassus Endeavour Fund (formerly known as the ‘Workplace Fund’).  Morningstar reported in 2017 that the US mutual fund was the best performing large-cap equity fund over one, three, five and 10 years since its inception in 2005.

– G.B.

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