The volume of assets under management that incorporate an element of socially responsible investing (SRI) has grown exponentially over the past decade, now exceeding $35 trillion, or approximately 40% of all professionally managed assets .
These investments are driven by strategies that take into account at least one dimension related to environmental, social and governance (ESG) factors in the selection of the portfolio. Whether these investment strategies perform better than others remains a source of debate among scholars and practitioners.
In our recent research, published in the Financial Analysts Journal, we focus on one aspect of corporate social responsibility: employee satisfaction. Using four decades of data, from 1984 to 2020, we find that a portfolio geared towards companies with the highest employee satisfaction outperforms an average portfolio by 2-2.7% per year.
A satisfaction bonus?
This is shown in the figure below, which compares the performance of an initial investment of $1,000 in a benchmark portfolio versus another oriented in companies of the most satisfied employees.
To build this last portfolio, we used the list of “100 best companies to work for” established by the Great Place to Work Institute, among which are, for example, Hilton, Cisco, Dropbox or Delta Air.
We further find that this outperformance is observed during most periods, but is highest during difficult economic times, such as the financial crisis.
These results are consistent with the idea that employee satisfaction remains undervalued by the stock market, although they are beneficial for the company and its shareholders – especially in times of crisis. Indeed, making employees happy involves policies that are costly in the short term but profitable in the long term, which is not necessarily the horizon of investors.
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Stock market prices therefore do not fully reflect these longer-term benefits. However, our results do show that investing in companies with excellent corporate cultures provides a significantly higher return when the benefits do eventually materialize.
The “E” and the “G” more than the “S”
Given the significant outperformance of companies with high employee satisfaction, funds could thus further exploit this information. Moreover, there is at least one fund of this type. The founder of one of the first socially responsible funds, Jerome Dodson, launched the Parnassus Workplace Fund (later the Parnassus Endeavor Fund) in 2005, whose main investment criteria are workplace quality factors. According to Morningstar, the fund’s performance since inception has been ranked among the best of any large-cap growth fund.
In a 2013 interview, Dodson explains the reason for the big difference in performance of his fund around the financial crisis, compared to the market:
“When you have workplace satisfaction, employees are willing to work harder during tough times. I think every organization has its ups and downs, but the downs aren’t as pronounced because everyone is sticking together trying to get through the crisis. And, of course, this constantly more committed performance inevitably shows up in the company’s results. »
Our results appear consistent with these ideas. However, an important question remains unanswered: why does the outperformance of this socially responsible investment based on employee satisfaction persist over time? One reason could be that most funds and investors have focused on exclusion/negative screening (e.g. excluding oil companies) rather than positive or best of category screening.
Consider qualitative factors
Another reason could be that responsible funds have focused more on the ‘E’ (environment) and ‘G’ (governance) dimensions of social responsibility rather than the ‘S’ (social) aspect. And within the S dimension, investors may have targeted factors such as pay ratio and (gender) diversity rather than employee happiness. Furthermore, most approaches to ESG investing are primarily based on ESG scores and easily quantifiable factors. These approaches therefore ignore important qualitative factors such as fairness, respect, pride and camaraderie that are used to measure employee satisfaction.
Of course, if market players realize the value of happy employees, and the stock market prices it correctly, the outperformance of great workplaces could diminish or disappear in the future. Given that the first evidence of the outperformance of exceptional workplaces was documented already more than ten years ago and that it has not yet disappeared, one can however think that it is not going away anytime soon.
By Hamid Boustanifar, Professor of Finance, EDHEC Business School andChief Vice Chairman, Bank of Korea Labor Union, PhD in finance, EDHEC Business School.
The original version of this article was published on The Conversation.