Can employee satisfaction drive superior stock returns?
Alex Edmans investigates whether the market undervalues employee satisfaction by examining firms from Fortune's "100 Best Companies to Work For in America" in his paper Does the stock market fully value intangibles? Employee Satisfaction and Equity Prices.
He uses Carhart's four-factor model, firm characteristic controls, and extensive robustness tests, to conclude:
- A value-weighted portfolio of Best Companies earns an abnormal return of 0.29% per month (3.5% annually) over the risk-free rate and 2.1% above industry benchmarks.
- Robustness tests show that abnormal returns persist after excluding extreme values and controlling for market, size, value, momentum, and industry effects.
- Firms newly added to the Best Companies list experience immediate positive earnings surprises at quarterly announcements, with abnormal returns averaging 0.36%, which contribute substantially to the portfolio's overall excess performance.
- While initial mispricing exists, the market gradually corrects undervaluation over a four-to-five-year period and abnormal returns decline markedly in the fifth year.
- Firms with significant human capital investments display higher valuation ratios and abnormal returns, supporting the view that employee satisfaction is a crucial yet overlooked component of firm value.
- The abnormal returns are robust across various models, indicating that traditional valuation methods fail to fully capture the value of intangible assets like employee satisfaction.
By considering employee satisfaction, asset managers can capture signals traditional financial ratios overlook. This approach not only supports responsible investing but also enhances returns by identifying undervalued companies.
It however remains challenging to fully disentangle whether high employee satisfaction drives future performance or if inherently strong firms naturally achieve both high satisfaction and superior returns.
Self-selection into the Best Companies list may introduce bias, and unmeasured factors such as management quality might also influence both employee satisfaction and stock performance.