Social Impact Investing: Employees Key?

for social impact investing, are companies with happy companies key?

How well do investment portfolios perform when they are constructed with happy employees in mind?

Back in 1970, Milton Friedman wrote an article for the New York Times Magazine that outlined his views on the social responsibility of business and the basic agency problem it implies:

“What does it mean to say that the corporate executive has a “social responsibility” in his capacity as businessman? … It must mean that he is to act in some way that is not in the interest of his employers. … The corporate exec­utive would be spending someone else’s money for a general social interest.”

In Friedman’s “agency view,” socially responsible managers pursue activities that do not maximize the value of the firm.

There certainly seems to be some evidence supporting the view that a focus on Socially Responsible Investment (“SRI”) can hurt shareholders. Wharton finance professor Chris Geczy [and academic director of the Wharton Wealth Management Initiative and academic director of the Jacobs Levy Equity Management Center for Quantitative Financial Research] authored a study in 2005, “Investing in Socially Responsible Mutual Funds,” which concluded, in part, that:

“The SRI constraint imposes … diversification costs—at least 30 basis points per month. In essence, when compared to the broader fund universe, the SRI universe does not offer funds that come as close to offering the exposures to the size and value factors possessed by portfolios identified as optimal under the Fama-French model.”

It would seem that investors who limit themselves to social impact and SRI funds are hurting their returns.

Yet the academic literature continues to evolve in the SRI space. Today, there is a strain of research that suggests that Friedman’s agency view may be too categorical in its separation of social impact goals and profit. Indeed, could it be that elements of SRI might actually enhance shareholder returns? If so, how could we go about identifying social impact factors that would lead to outperformance?

Alex Edmans, a professor of finance at London Business School and Wharton, has explored this question by focusing on a specific SRI dimension: employee satisfaction. In his paper, “Does the Stock Market Fully Value Intangibles? Employee Satisfaction and Equity Prices,” Edmans shows that portfolios constructed using Fortune’s “100 Best Companies to Work for in America” earned an annual four-factor alpha of 3.5 percent over a 15-year period.

Friedman is surely turning over in his grave. “Spending money on employee satisfaction?! Balderdash!” he might have sniffed.

Yet in today’s economy, this view makes more sense in a world where employees are increasingly viewed as potential creators of firm value, rather than as laborers whose services should be contracted for at the lowest possible wage rate.

Edmans recently gave a TEDx talk relating to his conclusions, and he agreed to have an interview with me, both of which you can find below.



Q: You mention the importance of human capital to firms whose value depends on “quality and innovation,” such as with building new products and client relationships, in areas like consumer goods, retail, financial services and others. In what other types of industries might you expect this to be the case and why? 

EDMANS: One might think that it only matters in innovative industries such as financial services, software and pharmaceuticals. But, interestingly, it matters in low-tech industries also. … Wal-Mart and McDonald’s have increased their wages significantly recently. These industries are also customer-facing, and how customers are treated by Wal-Mart or McDonald’s employees could affect their willingness to return. So, even though these industries in the past might have viewed their employees as commodities (since some of the workers are part-time, or temporary—e.g., a summer job for someone at high school), they’re now recognizing that their employees are assets. It can also be true in non-customer-facing industries. I toured a Toyota factory in Japan once, and they showed how many of the features of the factory came from the employee suggestion scheme.

new social impact investing research from Alex Edmans

Prof. Alex Edmans. Photo credit: Wharton Flickr.

Q: You mentioned in your paper that human capital was not capitalized on the balance sheet. How might you measure a firm’s investment in human capital?

EDMANS: The Best Companies list is one measure of human capital. Glassdoor, which anonymously gathers reviews from employees, is another. Asking employees is the best way, just like measuring customer satisfaction based on product reviews.

Q: Fortune’s results are based on “Great Place to Work Institute” methods, and use credibility, respect, fairness and pride/camaraderie, among others. What other ways might you measure employee satisfaction? Could you measure it without such “grass-roots” employee input? 

EDMANS: The Best Companies is the most respected list out there because it asks the employees themselves. Other data is based on management (e.g., asking them how much they care about their workers), and so the responses may be unreliable. Alternatively, it’s based on observable outcomes. You might measure diversity by whether there’s a woman on the board, but a firm could care nothing about diversity and put a token woman on the board to check the box. Measures based on observables are easy to measure, so the grass-roots analysis is the way to go.

Q: You had a great quote from a sell-side research analyst in your paper. The analyst said (to paraphrase), “Costco invests in employees to the detriment of shareholders.” Then you had another quote from the Costco CEO, who responded, “I believe that in order to reward the shareholder, you have to please your customers and workers.” This raises an interesting question. If it’s true that Wall Street is myopic and may penalize you for investing in your employees, does this suggest that some firms may do better to stay private, with a shareholder base who understands this approach and will give the firm the latitude to make long-term investments in employees and culture?

EDMANS: Going private is one way, but it’s not the only way. You can stay public as long as shareholders look to the long-term and don’t just value the company based on short-term earnings numbers (I go into this in more detail in my TEDx talk). Please see my World Economic Forum post (a copy is here), particularly the section “Sell First, Ask Later”; the underlying paper behind it is “Blockholder Trading, Market Efficiency, and Managerial Myopia” (a copy is here).

Q: You also talked about how underreaction to intangibles is strongest in small firms, but Fortune’s BC list consists of mostly large firms. Are there any other BC lists, of midsize firms, say, that might be worth looking at?

EDMANS: Yes, there’s a list for medium workplaces, and one for small (see A Great Place to Work). However, most of these companies are likely private.

Q: You suggest that the list might be a tradable signal for SRI investors. How does employee satisfaction fit into SRI? Why is it SRI friendly? 

EDMANS: Employee satisfaction is an SRI criterion since treating your employees ethically is responsible. The opposite is sweatshop labor, which exists even today. While it doesn’t exist in the U.S., there are still firms which try to pay their workers as little as possible (hence, the importance of the minimum wage). Mistreatment of workers doesn’t need to involve things as extreme as making them work in a sweatshop, but not giving them on-the-job training or involving them in management decisions. Things like trust in management, camaraderie with your colleagues, opportunities for continuous learning and development are all ethical.

Q: There are new trends in the workplace emphasizing lifestyle and life satisfaction, especially among the emerging millennials, so companies are trying to find new ways to motivate them. What are some new directions suggested by your research? How can you take the next step and get a more granular view on how employee satisfaction affects firms?

EDMANS: It’s not just about quantitative factors like pay and benefits, but also qualitative factors such as described above. Indeed, one reason why the Best Companies list is so thorough [is] that it looks at these qualitative factors as well.

Editor’s note: The original version of this article first appeared on on May 26, 2015.



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