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Why ESG investors need to look beyond employee satisfaction and consider institutional context

A large-scale study of publicly-listed firms by Professor Chendi Zhang emphasizes the need for adaptability in ESG investment strategies

30 January 2024

It is often assumed that the happier the employee, the better they perform at work and – by extension – the better their firm performs.

If it were always this simple, then ESG investors – those who make investment decisions based on a firm’s performance in the areas of environment, social responsibility and governance – would have a relatively straightforward time, needing only to establish which firms have a happy workforce to know where to put their money.

In a research paper published in the Management Science journal which builds on work dating back over a decade, my colleagues and I explored and tested this link between employee satisfaction and stock market returns.

We looked at data on employee satisfaction from the Good Place to Work Institute in San Francisco spanning in a large number of publicly-listed firms across 30 countries dating from 1997 to 2021.

We first confirmed earlier results that there was indeed a link between job satisfaction and a firm’s performance in the United States, as companies with high employee satisfaction demonstrated above-average stock returns, commonly referred to as alphas.

However, a more nuanced picture emerged when comparing firms by country and finding that in some places this relationship was far weaker or even turned negative.

What was happening? We cross-analysed our results with information on employment laws using two versions of the OECD Employment Protection Legislation index. Each incorporated factors such as laws protecting workers from dismissal, costs of dismissing workers, prevalence of collective bargaining and rules for hiring temporary workers, such as requirements that pay and working conditions be the same as for full-time workers.

It revealed to us that in countries with fewer regulations around hiring and firing, such as the UK, US, Brazil, Australia, Japan and India, companies with satisfied workers enjoyed higher stock market returns.

Whereas in more highly regulated countries like Denmark, Germany, Sweden and Mexico, the link between employee satisfaction and stock returns diminished.

This might seem counter-intuitive, but think of it like this: Employee satisfaction benefits a firm in three ways – by improving worker recruitment, motivation and retention.

In countries like Denmark or Germany that have lots of worker protections there is, as a result, a stable workforce with not much hiring and firing.

Employee satisfaction will be worth less to a firm if there is less recruitment in the first place, and high satisfaction will have less impact on retaining employees if employees are unlikely to leave their jobs. Lastly, if a job is satisfying then employees will work hard to keep it, but if it’s difficult to be fired these motivational benefits of satisfaction are removed.

What does this mean for investors?

Our research cautions against a one-size-fits-all approach and emphasizes the need for adaptability in ESG investment strategies.

Those ESG investors who use employee satisfaction, a common screen in ESG investing, as a factor in decision-making processes therefore need to evaluate carefully the legal and regulatory environment of the countries in which their target firms operate.

Beyond employee satisfaction, our findings suggest that the value of various socially responsible investment screens – such as a firm’s record on gender diversity, animal rights and environmental sustainability – must not be used in isolation as an investment factor but in conjunction with contextual considerations.

For as we have shown with investing in employee satisfaction, what works in one country may not deliver the same results globally, emphasizing the dangers with portraying the academic evidence for ESG investing as being unequivocal.

Ours is the first paper to study the global performance of a Social factor positively linked to returns. Although the “E” (i.e., environmental) components of ESG are largely quantitative and thus, comparable, such as carbon emissions and water usage, many “S” (i.e., social) components are qualitative and thus, difficult to measure on a comparable scale globally. We provide evidence on a globally comparable measure for an “S” dimension.

Employee Satisfaction, Labor Market Flexibility, and Stock Returns Around the World is authored by Professor Chendi Zhang, Director of the Exeter Sustainable Finance Centre and Associate Dean for Research and Impact for the University of Exeter Business School, and Professors Alex Edmans and Darcy Pu, both of the London Business School, and Lucius Li. It is published in Management Science.


Professor Chendi Zhang Professor Chendi Zhang is Associate Dean for Research and Impact, Professor of Finance and Director of Exeter Sustainable Finance Centre


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