Companies that opted to retain their staff and take measures to support their suppliers during the coronavirus market crash have been rewarded for this by institutional investors. According to research by State Street Associates.
The research arm of the US asset manager and custodian bank State Street investigated the impact of measures taken by companies to protect employees and suppliers on their share price. It also looked at the amount of money that institutional investors invested in those companies during the coronavirus crash (defined as the period between 19 February and 23 March). The investigation was carried out among 1005 US-listed companies, including those in the S&P 500 index.
As some companies were of course already more vulnerable to a crisis than others, the investigation corrected for factors such as valuation, profitability, size (small caps are often more vulnerable than large companies) and sector.
Walmart
Companies that were associated with, among other things, the dismissal of employees, late payment of suppliers or the termination of contracts in news articles during the coronavirus crisis receive a negative ‘sentiment score’. Companies that for example, according to news reports, did not fire any staff, provide sufficient protection against the virus in the workplace and make efforts to support their suppliers, on the other hand receive a positive ‘sentiment score’.
‘An example of the latter is a large American supermarket chain [Walmart] that decided to pay its suppliers faster,’ says Bridget LaPerla (pictured), a researcher at State Street Associates.
The study’s most important conclusion? ‘Our data showed that companies taking measures to accommodate their staff and suppliers saw higher inflows from institutional investors and also suffered less steep price declines than companies that did not do this,’ says LaPerla. ‘The effects were even stronger if they received a lot of media attention.’
Each increase of one standard deviation in a company’s sentiment score translated into a higher stock market return of 1.5% to 2% during the market crash. The treatment by companies of their employees turned out to be the most important factor. ‘If there was extra media attention for the actions of companies, the additional return even rose to 3.6%.’
However, negative publicity does not seem to affect all companies. Amazon, for example, regularly featured negatively in the news because it did not offer employees in its distribution centres sufficient protection against infection with coronavirus. The company also dismissed employees who organised protests to address these problems. Nevertheless, the company is the best performing share in the S&P 500 index, having risen by more than 35% year-to-date.
Sign of strength
La Perla indeed admits to being somewhat surprised by the outcome. After all, shareholders tend to generally appreciate companies cutting costs, especially when their revenues are falling such as during the current crisis.
We had expected a conflict of interest between shareholders and employees during this crisis, but this did not happen. By rewarding companies that decided to spare their employees and suppliers, investors have in fact subordinated their own interest of short-term profit to the interests of other stakeholders.
A possible explanation is that investors see a lack of immediate austerity measures as a sign of strength, according to LaPerla: ‘Investors were eagerly looking for companies that were able to weather the crisis. They were looking for signals that confirmed this, such as good care for staff and suppliers.’
Conversely, investors may have seen quick and drastic cuts as a sign of trouble. Indeed, there also appears to be a link between negative sentiment and return. LaPerla: ‘On average, negative sentiment about a company’s response to the corona crisis leads to extra negative returns and a poorer performance than the sector average during the market crash.
‘Cuts paralyse companies’
Finnish consultancy Wörks also concluded in a separate study that substantial cutbacks in a crisis often do not lead to better results in the long term. Its research looked at the effects of cutbacks during recessions on the future success of companies between 1980 and 2015.
The research showed that companies that cut back most on their personnel costs and other operational expenses have the lowest chance of outperforming competitors in subsequent years.
More than one third of the companies that made less than average cutbacks in the years after the crisis recorded at least 10% higher turnover and profit growth than their competitors. Of the companies that make the most cuts, only one in nine manage to do so. ‘By cutting both personnel and operational costs, companies become paralysed in the longer term,’ explains Wörks.
State Street wants to extend its own research to other stock markets, as well as investigate a longer time period. After all, most companies have only announced austerity measures and/or redundancies in April or May, or even not yet at all. ‘In a follow-up study, we want to further explore the question of what exactly were the characteristics of companies that led to their outperformance during this crisis,’ says LaPerla.