Elsevier

Journal of Corporate Finance

Volume 50, June 2018, Pages 84-108
Journal of Corporate Finance

Does it pay to treat employees well? International evidence on the value of employee-friendly culture

https://doi.org/10.1016/j.jcorpfin.2018.02.003Get rights and content

Highlights

  • We examine the impact of an employee-friendly (EF) culture on firm value and firm performance.

  • We show that firms with a more EF culture are valued higher and perform better stemming from improved technical efficiency.

  • Firms with better governance and those in countries with better investor protection benefit more from an EF culture.

  • We document a positive valuation associated with the enactment of laws aimed at improving parental leave policies.

Abstract

We examine the valuation impact of an employee-friendly (EF) culture. Using a sample of 3446 firms from 43 countries for the period 2003 to 2014, we show that firms with a more EF culture are valued higher and perform better (ROA, ROE). Consistent with the good governance view, the impact is stronger for firms in countries with better investor protection and for firms with better governance and lower agency costs. We further document a positive valuation associated with the enactment of laws aimed at improving parental leave policies. The impact on valuation stems from improved technical efficiency. Using various approaches, our results suggest that the impact of an EF culture on firm value is causal.

Introduction

Train people well enough so they can leave, treat them well enough so they don't want to.”

Sir Richard Branson

Is there value in creating a more employee-friendly (EF) culture? The quote above by Virgin Atlantic's founder signals what could be the start of a global shift in the way firms view and treat employees, raising important questions about efficiency for financial economists to consider. While firms in the tech sector (e.g. Google, Yahoo, Netflix, Microsoft) are well known for offering employees perks that include free meals, generous paid leave packages and in-building fitness and entertainment amenities, in addition to paying competitive wages, such perks have not been as prevalent in other industries.1 Yet, the media, government agencies, and corporations are beginning to pay closer attention to the treatment of employees. For instance, San Francisco recently became the first city in the United States to pass a law guaranteeing fully paid parental leave, while Virgin Group made headlines recently with its generous paternity leave policy in which new dads get up to 12 months paid leave.2 Are these firms following value-maximizing objectives when they offer employees perks like free meals and in-building fitness amenities? Or are these costs simply unnecessary extravagances that come at the expense of shareholders? To date, the evidence on this issue is limited.3

We study whether, in general, there are financial benefits to a firm by having an employee-friendly culture. There are two competing views on whether policies that create a more EF culture are value enhancing, and the evidence to date is relatively scarce and mixed.4 The good governance view argues that employee treatment is value enhancing. Building on the reciprocity view (Akerlof, 1982), by treating employees well managers may motivate workers to exert high effort, which should lead to improved performance and valuation. Edmans (2011), and Edmans et al. (2015), provide indirect evidence consistent with the good governance (and reciprocity) view and document that employee satisfaction is associated with superior long-term returns and valuation in countries with flexible labor markets. On the other hand, the agency view, based on the agency theory of the firm (Jensen and Meckling, 1976), argues that employee treatment may be driven by ulterior motives due to misalignment of managerial and shareholder incentives, and thus be value destroying (Pagano and Volpin, 2005). Consistent with the agency view, Cronqvist et al. (2009) find evidence that entrenched managers pay their workers more to enjoy private benefits (e.g. lower effort wage bargaining). Landier et al. (2009) also document that geographic dispersion is inversely related to employee treatment, and further find that divisions that are closer to headquarters are less likely to experience layoffs, and that such layoffs are less sensitive to divisional performance.

There is also evidence that employee treatment affects a firm's capital structure (Bae et al., 2011) and the level of corporate innovation (Chen et al., 2016; Mao and Weathers, 2015). A related literature documents a positive impact of employee stock ownership programs on productivity and innovation (Kim and Ouimet, 2014; Chang et al., 2015). Studies that directly assess the impact of employee treatment on firm value and performance have focused primarily on the impact of compensation, yielding mixed evidence. There is some evidence that higher wages are tied to superior performance (e.g. Mas, 2006; Propper and Van Reenen, 2010; Ouimet and Simintzi, 2015), yet other studies show that managers may derive private benefits by paying higher wages, leading to suboptimal outcomes (Pagano and Volpin, 2005; Cronqvist et al., 2009; Landier et al., 2009). Based on the conflicting views and mixed evidence, the question of whether having an EF culture is value enhancing is an empirical matter.

In this paper, we build on the existing literature by exploring the valuation consequences of an EF culture and by examining the conditions in which an EF culture is value enhancing. To do so we use a comprehensive measure of employee treatment for a large sample of firms covering 43 countries using data from Thomson Reuters' ASSET4 database (ASSET4). Using a broad sample of 3446 firms in 43 countries from 2003 to 2014, we show that firms with a higher EF culture are valued higher (higher Tobin's q and market-to-book) and perform better (higher return on assets, ROA, and return on equity, ROE). We test the good governance and the agency views on the valuation consequences of an EF culture by using various ex ante proxies of agency problems, including country-level investor protection, firm-level governance, corporate policies related to the free cash flow problem (Jensen, 1986), and managerial compensation structure (Ferrell et al., 2016). Consistent with the good governance view, we find that the impact of an EF culture on firm value is stronger for firms with fewer agency problems that may lead to a misalignment of managerial and shareholders' incentives. Further, we explore the channels through which an EF culture may impact firm value. Our results indicate that higher EF culture firms have higher sales-to-assets, lower costs, and have a greater number of patents. These findings support the good governance and reciprocity views that argue that treating employees well leads them to reciprocate by exerting high effort. The findings on patents lend support to Chen et al. (2016) and Mao and Weathers (2015) who document a positive impact of employee treatment on innovation for a sample of US firms.

Our study faces at least two problems related to identification. First, reverse causality is a concern because firms that are more profitable may be able to invest more in their employees, which results in a more EF culture. One aspect that may mitigate such concern is the fact that economic theories suggest that a firm's culture is specific to the firm and is largely fixed over long periods (see e.g. Lazear, 1995; Kreps, 1990). Second, there could be endogeneity bias caused by omitted variables. If the omitted variable impacts both firm value and a firm's ability to create an EF culture, our measure of employee-friendliness would not be exogenous to firm value, and the coefficients from OLS regressions would be biased and inconsistent.

We perform several tests to alleviate these concerns. First, we use an instrumental variables approach and project our measure of EF culture on two variables that capture a country's culture, borrowing from Hofstede (1980).5 Specifically, we use two cultural dimensions: Masculinity vs Femininity (Masculinity) and Indulgence vs. Restraint (Indulgence). The identifying assumption is that cultural values in a country may shape how firms treat employees, but should not have a direct impact on firm performance, other than through their impact on employee treatment.6 Using a Two-stage Least Squares (2SLS) approach, we continue to find that firms with greater EF culture have higher firm value. Second, we examine the causal effect between changes in Tobin's q and changes in employee-friendliness to directly address the reverse causality concerns. The results show that while there is a causal effect of changes in employee-friendliness on Tobin's q, past changes in Tobin's q have no significant impact on employee-friendliness. Third, we explore two quasi-natural experiments to examine the causal effect of employee-friendliness on firm value. We first test the differential impact on firm value for firms with high and low EF culture after a shock to economic activity and employment using the global financial crisis as an exogenous shock. We find that firms with greater EF culture prior to the crisis are valued higher during and after the crisis. We also assess whether treating employees well creates value by exploiting the staggered implementation of parental leave laws across several European countries during our sample period. Using a difference-in differences (DiD) methodology, we find that the enactment of these parental leave laws is associated with positive valuation effects, especially for firms that are most likely to have been impacted by the enactment of these laws (i.e. the firms with poor parental leave policies prior to the enactment of the laws).7 In all of ours tests, we continue to find that a more EF culture is associated with higher valuation, providing further support to our main findings.

Our paper adds to the literature on the impact of culture on firm performance (e.g., Guiso et al., 2015; Edmans, 2011; Edmans et al., 2015). Until recently, finance research has traditionally eschewed culture as an important determinant of financial decision-making (Karolyi, 2016). We contribute to this literature by exploring the valuation consequences of adopting an EF culture and by examining the conditions in which such culture is value enhancing. In doing so, we expand on prior studies by using a broad sample of firms from a large number of countries, which allows us to more carefully explore how country and firm-level characteristics can affect the impact of an EF culture on firm value. Unlike other studies in the literature, we use a shock-based design in some tests, to better establish causality in the EF culture-firm value relation. We show that an EF culture can add value, especially for firms with better governance and those in countries with better investor protection, where managerial and shareholders' incentives are more likely to be aligned. We further contribute to this literature by examining the channels through which an EF culture impact firm performance and value. We show that firms with a more EF culture have better technical efficiency. Our findings add further support to theories that emphasize the importance of employees as key assets in organizations (see e.g. Rajan and Zingales, 1998; Berk et al., 2010; Carlin and Gervais, 2009).

By studying the valuation impact of employee treatment, our study also contributes to the literature that examines the impact of employee treatment on capital structure (Bae et al. (2011)) and corporate innovation (Chang et al. (2015)), and to studies that analyze the impact of employee stock ownership programs (Kim and Ouimet, 2014). We contribute to this literature by assessing the extent to which an EF culture creates firm value. Importantly, we also examine the channels through which an EF culture adds value by exploring whether an EF culture affects technical efficiency and innovation. We further examine how country and firm characteristics related to the extent of agency costs affect the valuation impact of an EF culture.

Finally, we also contribute to the broader debate about corporate social responsibility (CSR) and whether certain CSR activities are consistent with value maximization (see e.g. Ferrell et al., 2016; Bénabou and Tirole, 2010; Krüger, 2015).8 We shed some light on this debate by showing how an important component of CSR, employee treatment, is value enhancing and by exploring the channels through which (and the conditions in which) employee treatment can affect firm value.

The paper proceeds as follows. In Section 2 we develop our hypotheses. In Section 3 we discuss the data and the methodology used in our study. In Section 4 we present our main results on the relation between EF culture and firm value and explore the channel for the valuation gain from having a higher EF culture. In Section 5 we provide robustness results and we conclude in Section 6.

Section snippets

Hypotheses development

The reciprocity view (Akerlof, 1982) argues that treating employees well (paying high wages) may motivate workers to reciprocate that treatment by exerting high effort. This implies that treating employees well by creating an EF culture may be value enhancing. Underlying this argument is a view (the good governance view) that argues that managers adopt policies to create an EF culture with the objective to maximize shareholder value. In line with this good governance view, Ferrell et al. (2016)

Measure of employee-friendliness

We measure an EF culture by focusing on how a firm treats its current employees. To do so, we rely on questions and attributes of social performance using data from the ASSET4 database. Specifically, we focus on the following five categories: 1) Employment quality – measures a company's management commitment and effectiveness towards providing high-quality employment benefits and job conditions; 2) Health and safety – measures a company's management commitment and effectiveness towards

Employee-friendliness and firm value

We first examine whether having an EF culture is associated with higher firm value. The primary regression specification is a standard OLS regression using Tobin's q (market value of assets-to-book value of assets) as our main proxy for firm value. Our regressions include several firm-level, country-level, and industry-level control variables used in prior research to explain Tobin's q (Aggarwal et al., 2009; Gompers et al., 2010; Doidge et al., 2004). Specifically, we include the following

Additional robustness tests

In Table 8 we present alternative specifications from our main valuation regression results found in Panel A of Table 4. Specifically, in Model (1) we report results from regressions in which we exclude US firms from the sample, as they account for roughly 24% of the sample. The results here are very similar in significance and magnitude as those in Table 4, Panel A. To examine whether our results are driven by firms that are included in the list of “Best Companies to Work for” (BC firms) used

Conclusion

Anecdotal observation suggests that some firms are starting to offer more perks to employees in an attempt to create a more employee-friendly culture. We examine whether such behavior is in line with shareholder value maximization and explore the conditions in which creating a more EF culture is value enhancing for shareholders. Overall, we show that firms with a more EF culture (e.g. firms that provide more benefits and training, and equal opportunities for advancement) have higher valuations

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