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Why firms with happy employees beat the competition

Pras Subramanian

Most folks are as happy as they make up their minds to be.

-Abraham Lincoln

Whatever your thoughts on the matter on what is the key to sustained happiness, perhaps not surprisingly the issue of happiness does have tangible effects at the workplace.

Study after study points to unhappy employees leading lives of unproductivity, which hurts company profits. Gallup recently estimated that symptoms of employee unhappiness - high absenteeism, chronic turnover, quality control issues, lost productivity – cost companies an eye-popping $550 billion a year.

Tony Hsieh, CEO of Zappos.com (which sold for a $1.2 billion to Amazon), knew the importance of having happy employees at his company, not just for moral reasons but for profitability concerns as well. In fact, Zappos will pay new employees $2,000 to quit if they aren’t completely happy upon starting a new position with the company. Incidentally Amazon will pay new employees $5,000 to quit if they are unhappy.

But is there evidence that overall happiness of employees can actually make a company more profitable? That’s what Alex Edmans, associate professor of finance at the Wharton School discovered when examining stock market returns of companies and correlating them with measures of employee happiness.

Edmans discovered that firms listed in “100 Best Companies to Work For in America” have outperformed their industry peers in annual stock market growth by two to three percentage points. In the attached video, Edmans explains the methodology for finding a correlation between employee happiness and stock market return was quite simple.

“What I looked at was the list of 100 best companies to work for in America, which is luckily published in Fortune magazine,” he says. “The advantage of this list is that it’s been available since 1984, so this is a long period of time which includes both booms and recessions.” He looked at the returns to the companies on this list and compared them to other similar firms in the same industry or with similar characteristics to isolate the impact of employee satisfaction rather than other factors.

According to Edmans, there are many discrete factors that contributed to employee happiness. “Employee satisfaction is not something that can be reduced to one variable. This is why the best companies list is so well respected, its highly sophisticated.” Edmans notes the study looks at 57 questions of employees, across a number of different dimensions such as pride and camaraderie, fairness and equality, and the effectiveness of management communication. “So it’s not just extrinsic things such as pay or benefits, but many other things such as equality and communication,” he says.

What he discovered was a surprising, long-term trend. “Over this 30 year period that I studied, firms on the [best companies] list beat peer firms by two to three percentage points per year.” In the investment world, finding that extra two to three percentage points of performance on top of the market is extremely difficult. In fact, traders and fund managers refer to this excess performance as ‘alpha.’ Seemingly, companies that make it a point to keep their employees happy may actually have ‘alpha’ built into their DNA.

Incidentally, Edmans acknowledges that there is a “chicken and egg” problem here. In other words, is it the fact that the company employees are happy because the company is profitable already (and thus has generous benefits, for example), or that happy employees are producing results that make the company profitable?

Edmans believes he’s controlling for this situation by looking at stock returns, as opposed to company profit, “because if employee satisfaction was the result of good performance, rather than the cause of good performance, then the profits of the company would already be in the stock price today, and you should not expect higher returns going forwards. So by looking at employee satisfaction today, and future stock returns, that tries to get around the issue of causality.”

Not only did companies on the list of happy employees outperform their peers, but Edmans discovered that these companies beat analyst expectations when reporting quarterly earnings, suggesting Wall Street itself hadn’t properly taken into consideration the added performance, or alpha if you will, that happy employees provide to corporate top and bottom lines.

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