The Causal Effect of Corporate Governance on Employee Satisfaction

Marco Menner and Frederic Menninger are from the University of Konstanz, Germany. This post is based on their recent paper.

Politicians, business lawyers, institutional investors, and academics in the field of finance are currently debating the corporate purpose beyond shareholder wealth maximization. United States Senator Elizabeth Warren has introduced the “Accountable Capitalism Act” in August 2018, which requires changes to the corporate governance of large corporations and forces companies to increase their focus on the well-being of their employees. Business lawyer Martin Lipton has published the corporate governance framework “The New Paradigm” (discussed on this Forum here), which promotes investments in the workforce to ensure long-term and sustainable growth. Investor Larry Fink, founder and CEO of ETF giant BlackRock, has used his annual letter to CEOs to criticize companies for underinvesting in skilled workforces (2015) and has reminded CEOs that companies must benefit all of their stakeholders, including their employees (2018). Academics have confirmed the importance of the workforce. Several empirical studies have found a positive relation between stock returns and employee satisfaction, as well as high monetary and non-monetary societal costs resulting from stress in the workplace.

A clear understanding of the drivers of employee satisfaction is essential when focusing on employees as key stakeholders of a corporation. Otherwise, regulatory changes could lead to unwanted outcomes and fail to achieve the desired effect. In a paper we recently placed on SSRN, The Causal Effect of Corporate Governance on Employee Satisfaction, we use a large dataset provided by the U.S. job search and review site Glassdoor to investigate how corporate governance affects the well-being of the workforce.

The effect of stronger shareholder rights on employee satisfaction is a priori unclear. On the one hand, an increase in employee satisfaction usually occurs at the expense of the company. Stronger shareholder rights that align with the interests of shareholders and managers might therefore lead to a decrease in employee satisfaction. Another possible reason for neglecting the workforce is stock market pressure to deliver short-term results, even if that comes at the expense of long-term shareholder value (i.e., short-termism). On the other hand, the combination of (i) increasing investments in ETFs, (ii) sufficient resources of institutional investors to investigate and appreciate the value of employee satisfaction as an intangible asset, and (iii) institutional investors’ influence on CEOs suggests an improved employee satisfaction.

In order to ensure a causal effect of corporate governance on employee satisfaction, we measure the changes in employee satisfaction around quasi-exogenous shocks to the corporate governance of companies. Specifically, we employ a Regression Discontinuity Design to votes on shareholder proposals in favor of stronger shareholder rights that pass or fail by a small margin. Since the outcome of such a close vote (e.g., a proposal passing with 50.5% of the vote or failing with 49.5% of the vote) is uncorrelated with firm characteristics and cannot be anticipated, that voting result is akin to an exogenous shock and therefore overcomes potential endogeneity issues of cross-sectional regressions. In addition to ensuring causality, the use of shareholder proposals as our instrument has the advantage of practical relevance: the decisions that are up to a vote in our sample are, by definition, aspects of corporate governance that are within the control of shareholders. This allows investors to act on our findings.

To quantify employee satisfaction, we use employee reviews provided by Glassdoor. These reviews reflect the employees’ overall satisfaction with their company and are assigned numerical values between one (low satisfaction) and five (high satisfaction). For each company in our analysis, we compute an employee satisfaction score before and after the annual meeting using the average company-specific overall satisfaction adjusted for the domestic average overall satisfaction value in the respective time period.

Employee satisfaction decreases by approximately 10% when shareholder proposals pass by a small margin compared to when they fail by a small margin. This decrease amounts to approximately one standard deviation of the employee satisfaction measure in our sample. Our finding is robust in a variety of alternative settings. Placebo checks using artificial event dates or thresholds other than the majority do not lead to significant effects, which excludes alternative explanations of our results. Furthermore, companies with proposals that passed by a small margin show no significant pre-existing differences from companies with proposals that failed by a small margin.

Alongside a drop in employee satisfaction, we identify decreases in the employees’ perceptions of firm culture and top-tier management as well as decreases in the company’s number of employees and its capital expenditures. These findings suggest that stronger shareholder rights increase managers’ focus on short-term results and reduce their focus on long-term investments such as their workforce.

In conclusion, we find a negative causal relationship between shareholder rights and employee satisfaction. This insight could help politicians and investors work toward an employee-friendly environment.

The full paper is available here. Comments would be most welcome.

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