Presentation by Alex Edmans, Professor of Finance at London Business School based on his TEDx talk: The Social Responsibility of Business

1. 1
Professor Alex Edmans, LBS
www.alexedmans.com | @aedmans
based on a TEDx talk, “The Social Responsibility of
Business”, http://bit.ly/CSRTEDx
Does Employee Engagement
Improve Firm Performance?

8. Credit: The M&S Company
Archive

16. The “100 Best Companies to Work
For in America” beat their peers by
2-3%/year over 1984-2009

18. “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

19. ShareholdersEmployees

20. ShareholdersEmployees

21. 21

23. 23
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)

24. 24
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

25. 25
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

35. 1888 2015
£100 ?

36. 1888 2015
£100 £18,500,000

37. 37
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

38. 38
Edmans, Fang, and Lewellen
(2015)
 Vesting equity linked to
 Cuts in investment (R&D, advertising, capital expenditure)
 Just meeting earnings targets
0
100
200
300
400
500
600
700
800
900
[-5,-6) [-4,-5) [-3,-4) [-2,-1) [-1,0) [0,1) [1,2) [2,3) [3,4) [4,5) [5,6)
Frequency
Number of cents above forecast
T1 T3

39. 39
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

40. 40
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

47. 47
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

48. 48
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/