Environmental, social and governance (ESG) factors have all grown in importance for investors in recent years. But the S in ESG – the social factor – has, until recently, often played second fiddle to environmental considerations.
This neglect is understandable, because what makes up the social factor – how well companies treat their employees, suppliers and customers – is harder to measure than performance on the environment or in governance. Nonetheless, failing to pay heed to the social factor is a mistake because there appears to be some correlation between social performance and share price performance.
The benefits of happy employees
One way to measure this correlation is by looking at Glassdoor, the website where employees anonymously rate employers. Over the past 10 years, the share prices of companies ranked in the top fifth in Glassdoor ratings have outperformed companies ranked in the bottom fifth by over 6%. Glassdoor provides useful quantitative and qualitative evidence, so it can help open the door to engagement with management on social issues. We used Glassdoor, for example, to start a conversation with a management team about issues employees were raising on the platform. This prompted a productive discussion with senior executives about what they thought they could do to address these issues.
Exhibit 1: Glassdoor versus returns
This glassdoor model is a proprietary neural network, which was trained to forecast future financial performance from content in Glassdoor reviews. The model was trained in an expanding window manner, using 5 million reviews from more than 5,000 unique publicly-traded companies, covering the time period from 2008 to present. For more information please refer to footnote.
Source: J.P. Morgan Asset Management. Past performance is not a reliable indicator of current and future results. Data as at July 2021.
Another example of how employee satisfaction can contribute to a better company is Rentokil Initial, a British pest-control and hygiene company. The company has a strong culture of listening to employees; this has likely contributed to its high employee retention rate of 85%. Importantly, customer retention is equally high at 86%, supporting the idea that happier employees produce more satisfied customers because the workers tend do their jobs better.
The value of customer service
Treating customers well is another social factor that can also have an impact on company performance, as evidenced by the recent issue of travel refunds thrown up by the pandemic. Customers who booked directly with a hotel or airline found it easier to secure a refund than if they had booked through a third party. We believe that this may translate into an increase in direct bookings, which allows us to try to capture and quantify the differences in customer service by feeding these expected new booking trends into our earnings growth estimates.
Diversity in focus
Treating employees and customers well is one way companies are taking the social factor more seriously. The corporate sector, as a whole, also seems to be paying more attention to social factors. For example, since early 2020 there has been a sharp rise in the number of management mentions of diversity and inclusion in the earnings calls of companies in the MSCI All Country World Index.
Exhibit 2: The importance of social issues in ESG investing
Corporate mentions of “diversity”/“inclusion” in earnings calls
Number of mentions for MSCI ACWI companies, four-quarter moving average
Source: MSCI, J.P. Morgan Asset Management. Guide to the Markets - UK. Data as of 30 June 2021.
Studies have started to examine the impact diversity on corporate performance. A 2018 study by McKinsey found that companies in the top quartile for gender diversity on executive teams were 21% more likely to outperform on profitability and 27% more likely to have superior value creation, while companies in the top quartile for ethnic/cultural diversity on executive teams were 33% more likely to have industry-leading profitability1.
Conclusion
We believe increased corporate focus on social factors will ultimately be good for productivity, economic growth and – in the long term – corporate profits and share prices. We see much for investors to celebrate in the future if the social factor is good for share prices.
1Source McKinsey, Delivering through Diversity, January 2019. www.mckinsey.com
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