Do Countries Matter More in Determining the Relationship Between Employee Welfare and Financial Performance?

Date01 June 2020
Published date01 June 2020
AuthorChandrasekhar Krishnamurti,Kartick Gupta
Do Countries Matter More in
Determining the Relationship
Between Employee Welfare and
Financial Performance?
Centre for Applied Financial Studies, University of South Australia, Adelaide,
South Australia, Australia
Extant literature suggests that employee-friendly practices inuence corpo-
rate decision-making. Using a bargaining framework, we examine the role of
country-level determinants in inuencing employee-friendly practices and
their impact on value creation. Utilizing a comprehensive sample of 25,483
rm-year observations from 56 countries, we nd that rms domiciled in
countries with weak employment protection and regulations can potentially
benet by voluntarily undertaking employee-friendly practices. Also, in
countries with exible labor market conditions, rm value is enhanced by
undertaking employee-friendly practices. Furthermore, the importance of
employee-friendly practices in value creation is observed strongly in coun-
tries that provide better infrastructure, productivity, and incentives.
JEL Codes: G32; J24; J28
Accepted: 10 August 2018
Firms such as Motley Fool, Optera, Carfax, and Alphabet Inc. provide liberal
facilities to their employees to maintain a satised workplace.
They claim that better treatment of their employees results in lower attri-
tion and higher productivity. Increasingly, rms are undertaking employee-
friendly activities to encourage employees to invest in rm-specic human capi-
and to retain and attract human capital. The emerging literature on human
capital nds evidence consistent with the view that employee satisfaction is
positively correlated with stock returns (Edmans 2011). Human capital is
1 Source:
2 Cambridge dictionary denes human capital as, employees, and all of the knowledge, skills,
experience, etc. that they have, which makes them valuable to a company or economy.
© 2018 International Review of Finance Ltd. 2018
International Review of Finance, 20:2, 2020: pp. 415450
DOI: 10.1111/ir.12231
considered to be a key driver of a rms success and competitiveness (Faleye
and Trahan 2011).
The primary research question of this paper is whether a rms employee-
friendly practices have an impact on rm value. Our work is motivated by Zin-
gales (2000) and John et al. (2015) who posit that nancial literature has paid
little attention to the relationship between employee-friendly practices and rm
performance. We argue that rm-level incentives to undertake employee-
friendly practices is also inuenced by the country-level labor market regula-
tion, exibility of labor markets, human capital infrastructure, and productivity
incentives. It is not clear if investing in employee satisfaction is always value
increasing for the rm. If it were so, then all rms would make this investment.
Organizational capitaldened as intangible capital that is embedded in key
talentis movable across rms (Eisfeldt and Papanikolau 2013). When key tal-
ent has the option to move, rms have incentives to retain them through better
workplace treatment. The marketability of key talent may vary across countries,
making a case for cross-country examination.
This study extends the literature in several new directions. First, we extend
the work of Edmans (2011) and Edmans et al. (2014) which examine the rela-
tionship between employee satisfaction and abnormal stock returns using a
sample of US rms and an international sample composed of rms in 14 coun-
tries. They nd that employee satisfaction is associated with positive abnormal
returns in countries with high market exibility but not in those where it is
low. We extend prior work by examining a more comprehensive set of coun-
tries (56) and therefore contribute to the growing literature by documenting
the effect of country-level determinants on the impact of a rms employee-
friendly practices on its nancial performance. A further distinction is that we
use Tobins Q as a proxy of nancial performance, while Edmans (2011) and
Edmans et al. (2014) use abnormal stock returns. We construct our own rm-
level employee-friendly measure using individual employee practices and label
it as Employee Treatment Index (ETI). Our results indicate that undertaking
employee-friendly practices contributes positively to the rms value creation,
measured by TobinsQ.
Second, we use the bargaining framework to study the impact of country-
level employee protection on the relationship between employee treatment
and rm-level nancial performance. Prior work such as Dasgupta and Sen-
gupta (1993) and Matsa (2010) have used a bargaining framework to explain a
rms capital structure decision in the context of bargaining with employees.
Simintzi et al. (2014) uses a cross-country setting to study the impact of
country-level labor market bargaining power on rm-level leverage. We extend
these studies by studying the association between employee treatment and
rm-level value creation. We argue that the level of employee treatment
depends on the bargaining power of labor. We categorize the bargaining power
of labor into two types. The rst type which we label as hardbargaining
power arises when labor is protected by regulations and institutional support
from trade unions. Saint-Paul (2002) suggests that employees have a strong
© 2018 International Review of Finance Ltd. 2018416
International Review of Finance
bargaining power in countries that provide strong labor protection. In addition
to hard bargaining power, a second type of bargaining power which we label as
softbargaining power may also be a signicant determinant of employee
treatment. In exible labor markets, soft bargaining power is created by the
threat of workers, especially those with a high degree of skills, leaving the rm.
Summing up, better treatment of employees by rms will likely result in
three possible outcomes. First, there will be no improvement in productivity
when the labor has hard bargaining power. The impact on rm value will be
negative since it will take real resources to improve employee treatment. The
second possibility is that employee treatment leads to better productivity, but
employees capture all the gains with none left for shareholders. Finally, there
may be situations in which employee treatment results in improved productiv-
ity and employees and shareholders share the gains from improvement. In this
situation, the value of the rm will increase, resulting in an increase in
When there is hard bargaining, the rst or second situation is most
likely, resulting in no increase in rm value. When the third situation occurs
which is most likely when labor has soft bargaining power, rm value and
therefore Tobins Q are likely to increase. We assume that increases in rm
value, arising from improvements in productivity, are captured entirely by
Third, we examine the role of three different aspects of country-level deter-
minants. The rst aspect is related to a set of country-level regulations and pro-
tections, while the second set of country-level determinants reects the
exibility of labor market conditions. The last set of determinants relates to
country-level productivity and incentives. We posit that country-level soft
infrastructure is an integral part of the environment that sustains the soft bar-
gaining power of labor.
Fourth, we extend the literature by retesting prior ndings in a new setting
using new data following the suggestion of Karolyi (2016), who nds that the
majority of the studies are biased toward the US market and advocates that it is
important to explore other markets where many of the previously documented
results may not be applicable. We take his call and address two issues: whether
unobservable country-level factors are driving the result; and whether the prior
results are robust to alternative modeling specications or data sources. Finally, we
construct an alternate measure of employee treatment from the Asset4 database to
conduct our studies. Chatterji et al. (2014) note that Asset4 employee indicators
aremuchmorecomprehensivethanKinder, Lydenberg, Domini Research & Ana-
lytics (KLD), as the former has many more indicators of employee treatment.
We derive a set of testable hypotheses using the bargaining framework. If
labor is better protected, then they may have higher bargaining power relative
to managers and shareholders. Managers, then, will not be able to extract
3 Following prior literature, we use Tobins Q as a proxy of rm value changes.
4 We ignore any improvements in debt value due to lower risk arising from better treatment of
© 2018 International Review of Finance Ltd. 2018 417
Employee Welfare and Financial Performance

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