Like a church service or a court hearing, a corporate earnings call usually follows a prescribed procedure. Management opens with a customary warning to investors on the variable accuracy of forward-looking statements before launching into a review of financial performance. Once they’ve had a chance to highlight their successes, executives take turns fielding questions from analysts. At some point in this routine, they usually take a moment to thank employees for their contributions to the organisation – often crediting the workforce as its “greatest asset”.
Jensen Huang, chief executive of chipmaking titan Nvidia (US:NVDA), used the phrase when addressing staff on a quarterly earnings call in May. “Your brilliance and craft and the culture we’ve created are Nvidia’s superpower,” he added. The chief executive of Uber (US:UBER), Dara Khosrowshahi, expressed similar sentiments in early August, when the company reported its first ever profitable quarter. He said the milestone was “the result of the work of thousands of employees [...] who are the true heroes”.
Anyone who has watched the ride-hailing group navigate a string of workforce disputes and scandals – from wage wranglings to allegations of harassment by senior managers – might conclude that workers haven’t always been treated with this level of reverence. Nvidia, which came in at number six on an annual list of the best Fortune 100 companies to work for in 2023, appears to have few such problems. An impressive 97 per cent of employees surveyed said the company was a great place to work, and the same number reported feeling that management was ethical and honest in its business practices. The feel-good factor that comes from your company capitalising on a potentially transformative technological shift is unlikely to fully explain these results.
Some companies evidently think it’s beneficial to be regarded and acknowledged as a good employer. From a recruitment and retention perspective, it makes good business sense. But does a satisfied workforce somehow translate into profitability – or ultimately lead to market-beating shareholder returns? A small, albeit growing, body of research claims it does.
The price of inaction
Shareholders in Royal Mail’s parent company, International Distributions Services (IDS), are among those to have been reminded in the past year that the inverse can be true: an unhappy workforce that elects to take industrial action can ultimately damage the bottom line. The group reported an operating loss of over £1bn for the 12 months to the end of March, which it attributed to the combined impact of inflationary pressures and strike action by UK postal workers. In July, the Communication Workers Union (CWU) ultimately voted to accept the company’s offer of a 10 per cent pay increase over the course of three years.
All told, CWU members were engaged in the industrial dispute over pay and working conditions for 14 months. Broker Peel Hunt had International Distributions Services on a sell rating for a sizable portion of this time, with analysts stipulating in May that “a workforce wanting to raise productivity would make us upgrade”.
When workers across a variety of industries go on strike, as they have been across the UK, the productivity of the entire economy can suffer. Poor productivity remains one of the biggest economic problems facing the country – without improvements on this front, basic economic theory suggests that both output and living standards will continue to struggle. As the FT recently noted, the Resolution Foundation estimates that UK productivity has risen by 0.4 per cent in the years since the financial crisis, under half the level seen in the richest 25 OECD countries. The reasons for this are hotly contested, and labour productivity is only one piece of the puzzle. But there is no doubt workers’ output has taken some knocks in recent months.
According to the Office for National Statistics, nearly 2.5mn working days were lost to industrial action between June and December of last year. Strikes impact the economy in a number of ways, most obviously via output falling in the sectors where strikes occur simply because workers are logging fewer hours. But there are knock-on effects in other industries, too. For example, rail strikes may mean more people work from home, leading to falling weekday spending in cafes and restaurants in major commercial centres.
Although many strikes are ostensibly about pay, worsening working conditions and unfair treatment are also common grievances. Demands for greater remuneration are often tied up with feeling undervalued or unappreciated by employers.
Behavioural economists can now confidently say that people work harder when they’re happy. A 2015 study of more than 700 people by researchers at the University of Warwick found productivity increased by around 12 per cent among individuals who were “treated” prior to being assigned a task. Incentives included snacks and drinks – the kind of workplace perks that were first associated with tech companies such as Alphabet (US:GOOGL). Those perks aren’t a shortcut to success, but their origin does hint at one reason why many workplaces are now more accustomed to focusing on their staff.
Workers as assets
The capital-intensive industrial companies that dominated stock markets for much of the 20th century were not quite so concerned with employee satisfaction. Some of the earliest management consultants viewed workers merely as tools akin to machines or raw materials. The goal of a management team operating under this paradigm was therefore to extract the maximum amount of labour possible while minimising spending on wages. If a worker wanted to earn more on an assembly line, they’d generally have to demonstrate they could produce more, and were therefore worth more to the organisation.
Rights and benefits such as paid time off and occupational pension schemes didn’t become commonplace in the US and UK until the middle of the 20th century. In an influential 2011 paper on employee satisfaction and equity prices, London Business School professor Alex Edmans noted that attitudes to staff also began changing with the development of human relations theories around this time. In contrast to prior management theories, these models envisioned employees as key assets within an organisation, rather than expendable commodities.
They also argue that job satisfaction can improve individual motivation and employee retention within an organisation – to the benefit of its shareholders. Edmans reached a similar conclusion in his paper. He found that a value-weighted portfolio of the Fortune 100 best companies to work for in America produced excess returns of 3.5 per cent annually from 1984 to 2009. He also found that the companies that made the list reported significantly more positive earnings surprises than companies that didn’t.
Working out how to rise up rankings is easier said than done for companies. In the assembly line era, an offer of additional pay in return for greater output might have been enough to motivate staff. But this carrot and stick approach doesn’t work in a knowledge economy, according to Edmans, who says: “For so many jobs that people do now, you can’t really measure performance. Even with a teacher, you can measure test scores, but we know teachers do far more than prepare students for tests. Because there are so many dimensions that are not measurable, the best way to motivate [employees] is not to pay £1 for every unit they produce, but to make them feel happy and valued. Then they’ll engage in discretionary effort.”
From investors’ perspective, given it has now been more than a decade since Edmans’ paper was published, it would be reasonable to assume that the market has ‘priced in’ employee satisfaction. This would mean the companies that prioritise staff satisfaction no longer outperform in the same way.
But this doesn’t actually appear to be the case. Two years ago, Hamid Boustanifar, an associate professor at France’s Edhec Business School, extended Edmans’ research through to 2020. He found that the same portfolio of companies delivered excess returns of 2 per cent to 2.7 per cent per year across the 36-year period.
These results suggest that investors are still undervaluing employee satisfaction as a metric. Boustanifar suggested that one potential reason is that funds and investors screen stocks for inclusion in their portfolios based on exclusionary or negative traits “rather than positive or best-in-class-screening”. Another possibility is that investors focused on ‘responsible’ businesses tend to look more at environmental and governance factors – the ‘e’ and ‘g’ in the ubiquitous ESG acronym.
“Furthermore, most approaches to ESG investing are predominantly based on ESG scores and easily quantifiable factors,” Boustanifar wrote. “These approaches ignore important qualitative factors such as fairness, respect, pride and camaraderie that are used to measure employee satisfaction.”
Like other intangible assets, the term ‘employee satisfaction’ is nebulous by nature, and is much harder to measure than say a company’s gender pay gap or even its CO2 emissions. However, opinions offered by a company’s employees on anonymous review websites such as Glassdoor can provide some potentially important insights.
One 2019 study led by an academic from Emory University in the US found a relationship between levels of employee satisfaction reported on Glassdoor and a company’s share price return. More specifically, the researchers found that quarterly changes in employer ratings predicted share price returns over the subsequent quarter. The effect was confined to reviews by current, as opposed to former, employees and was stronger when the employee worked in the state where the company is headquartered.
This doesn’t mean investors should start structuring their portfolios based on posts from anonymous staff members. But review sites do offer new perspectives on workplaces. Boutique investment firm Irrational Capital uses information from Glassdoor, as well as its own proprietary data, to create its own ‘human capital’ rating. According to the company, its full data set includes 4,500 publicly listed companies and factors in survey data from 15mn employees.
The resulting scoring system for companies, based on the opinions of its employees, has become the basis for three recently launched ETFs from Chicago-headquartered Harbor Capital. The first, known as the Harbor Corporate Culture ETF (US:HAPI), launched in October 2022 and is made up of 153 companies. Apple (US:APPL), Alphabet and Nvidia are among its top 10 holdings, as are pharma giants Eli Lilly (US:LLY) and Johnson & Johnson (US:JNJ). Since its inception, the fund has delivered a 35 per cent total return to shareholders, outperforming the S&P 500.
Beyond remuneration
For many investors, pay is a sticking point at the moment, and not in the way advocates would have it: wage growth is still on the up, meaning businesses are having to factor in significant increases in staff costs among many others. But remuneration is only one small component of a company’s overall human capital score. Positive feelings around organisational alignment and an emotional connection to the business can also boost a firm’s rating. “Much more important than compensation is the perception of compensation,” says Kristof Gleich, Harbor Capital’s chief investment officer. “If you look at a company that actually pays more money, versus a company where there was a much higher perception of fairness in compensation, the second company would score much higher.”
In any case, the technology sector is well represented across each ETF’s list of holdings, which might leave investors wondering whether there’s a structural advantage at play here. Do the industry’s comparatively safe working conditions and generous salaries lead staff to report high levels of job satisfaction? “When you look at the aggregate economy, the human capital factor score is high among industries that have the least tangible assets on their balance sheets, like technology and software,” Gleich says.
Edmans controlled for industry in his research, meaning that companies with higher levels of employee satisfaction still performed better regardless of which sector they operate in. “Even within a tech company, you could still have a toxic boss, or managers that expect you to be available on your emails all the time,” he says.
More to the point for investors, human capital indices' weighting to these sectors mean funds like those run by Harbor are just proxies for tech indices? While the HAPI ETF is underweight Amazon, its holdings in the two largest US companies – Microsoft (US:MSFT) and Apple – was a combined 10.7 per cent as of mid-August – three percentage points below their weighting in the S&P, and around half that of the Nasdaq. Positions in tech giants such as Nvidia and Alphabet are roughly equivalent to those in the Nasdaq.
Performance also differs slightly: while the Corporate Culture ETF has been in existence for less than two years, the index on which it is based – created by CIBC World Markets for Irrational Capital – extends back to 2020. It outperformed the Nasdaq in a down market last year, and narrowly did so against the S&P 500 over the same period. This year, it is ahead of the main US benchmark but lagging the Nasdaq. So the short-term evidence suggests its risk/return profile sits somewhere inbetween the two.
From an accounting perspective, human capital shares another commonality with tech: its assets aren’t easily recognised by traditional accounting measures.
“If company A does a better job of investing in employee engagement and building a good corporate culture, and company B does the opposite, then company A is clearly positioned to deliver better products and services – whatever industry it’s in,” Gleich says. But if someone were to look at both firms' balance sheets, he says investments in employee satisfaction would most likely appear as upfront costs.
“There’s an accounting inefficiency in that human capital, if done well, is clearly an asset, but it’s booked as an expense every single year,” he said.
However this intangible is accounted for. For individual investors – whose only insights into a company might be its earnings reports and AGM – getting a feel for its corporate culture might seem nearly impossible. After all, figures for pension provision and wage spending don’t actually tell you anything about a workplace. Edmans suggests starting with a look at independent assessments, in which a third-party goes into a company and surveys workers across all divisions and levels. Online reviews could then serve as a helpful adjunct to these structured studies.
However, he argues there’s no substitute for a “boots on the ground” approach, one of which involves a tried-and-tested method for private investors. “A further way of doing this is to go into stores yourself to see how customers and workers are being treated,” he says. Of course, none of these litmus tests will guarantee that a single company will outperform the market.
Yet for now, the human capital factor remains unrecognised, or at least, in the view of its advocates, miscategorised. “There’s a tendency to bucket this into some sort of ESG experiment,” Gleich says. “I think that’s a mistake. I think it’s an investment factor that can generate strong risk-adjusted returns because it’s looking to measure something the market doesn’t do a good job of pricing in efficiently.”
