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Professor Alex Edmans, LBSwww.alexedmans.com | @aedmans

based on a TEDx talk, “The Social Responsibility of Business”, http://bit.ly/CSRTEDx

Does Employee Engagement Improve Firm Performance?

Credit: The M&S Company Archive

The “100 Best Companies to Work For in America” beat their peers by

2-3%/year over 1984-2009

“Costco's management is focused on ... employees to the detriment of shareholders. Why would I want to buy a stock like that?”

-- Equity analyst, quoted in BusinessWeek

Share-holders

Em-ployees

Share-holders

Em-ployees

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Employee Satisfaction and Firm Value: Traditional View Employees are no different from any other

input. Maximize effort, minimize pay (Taylor (1911))

No need for motivation or retention Satisfaction is a sign of managerial slack Little existing evidence that employee welfare

benefits shareholders Abowd (1989), Gorton and Schmid (2004), Diltz

(1995), Dhrymes (1998), Cronqvist et al. (2007)

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Employee Satisfaction and Firm Value: Modern View Human capital is increasingly important ES is an efficient form of compensation

Human relations theories: money is only an effective motivator up to a point (Maslow (1943), Hertzberg (1959), McGregor (1960))

Unlike perks, job satisfaction cannot be bought with cash

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Employee Satisfaction and Firm Value: Modern View ES is an efficient level of compensation.

“Efficiency wage” argument (Akerlof and Yellen (1986))

Motivation. Piece pay is no longer effective Rational view: satisfied employees work hard to avoid being

fired (Shapiro and Stiglitz (1984)) Sociological view: satisfied employees identify with the firm.

“Gift exchange” model of Akerlof (1982) Retention and recruitment

Intrinsic, not extrinsic incentives

1888 2015£100 ?

1888 2015

£100 £18,500,000

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Incentives for the Long Term Level 1 thinking: focus on level of pay

But $10m pay is 0.1% of a $10b firm Level 2 thinking: sensitivity of pay to

performance Fahlenbrach and Stulz (2011): no link between

equity incentives and bank failures Level 3 thinking: horizon of incentives

Edmans, Gabaix, Sadzik, and Sannikov (2012): escrow pay for several years to deter short-termism; vesting should extend beyond retirement

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Edmans, Fang, and Lewellen (2015) Vesting equity linked to

Cuts in investment (R&D, advertising, capital expenditure)

Just meeting earnings targets

[-5,-6) [-4,-5) [-3,-4) [-2,-1) [-1,0) [0,1) [1,2) [2,3) [3,4) [4,5) [5,6)0

100

200

300

400

500

600

700

800

900

T1 T3

Number of cents above forecast

Freq

uenc

y

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Informed Shareholders Basic finance theory teaches the benefits to

diversification; "prudent man rule" in the U.S. But small shareholders have little skin in the game

Bushee (1998): dispersed investors pressure managers to cut R&D to meet short-term earnings targets

Edmans (2009): large shareholders have incentives to analyze a firm's intangibles, rather than reacting exclusively to earnings

E.g. Warren Buffett

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The Side-Effects of Disclosure Increased disclosure seen as a remedy to

corporate scandals (e.g. Sarbanes-Oxley, Regulation Fair Disclosure, Dodd-Frank)

But can only force disclosure of “hard” information, not "soft" such as employee well-being

Edmans, Heinle, and Huang (2015): mandating disclosure of "hard" information will induce firms to focus on "hard" goals at the expense of "soft”

Porsche, Google

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Further Reading TEDx talk on “The Social Responsibility of

Business”: http://bit.ly/CSRTEDx “Does the Stock Market Fully Value

Intangibles? Employee Satisfaction and Equity Prices” (finance-oriented)

http://faculty.london.edu/aedmans/Rowe.pdf Huffington Post summary (non-technical): http://

www.huffingtonpost.com/alex-edmans/there-is-no-tradeoff-between-profit-and-purpose_b_7987934.html

“The Link Between Employee Satisfaction and Firm Value, With Implications for Corporate Social Responsibility" (management-oriented):

http://faculty.london.edu/aedmans/RoweAMP.pdf

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Further Reading (cont’d) Articles in the World Economic Forum

https://agenda.weforum.org/2015/08/how-can-we-help-businesses-think-long-term/

https://agenda.weforum.org/2015/02/why-companies-need-to-think-long-term/

https://agenda.weforum.org/2014/11/how-should-ceos-be-paid/

https://agenda.weforum.org/2015/01/why-happier-workers-matter/