Why Do Banks Favor Employee-Friendly Firms? A Stakeholder-Screening Perspective
Qian, C., Crilly, D., Wang, K. & Wang, Z.
Published in Organization Science, April 2020
“The fundamental problem isn’t lack of capital. It’s lack of trust,” the Former U.S. Labor Secretary Robert Reich once said. “And without trust, Wall Street might as well fold up its fancy tents.”
So how is this precious commodity, trust, created? A study by Dr Zheng Wang, Associate Professor in the Department of Accountancy, and co-authors, has an answer. They examine how a firm’s favourable treatment of one group of stakeholders (employees) can elicit trust from another group of stakeholders (creditors).
“Our research indicates that firms which treat employees favourably are charged lower interest rates by their creditors,” says Wang.
When banks extend loans, their risk not only pertains to firms’ financial capability, but also arises from the intention of creditors to repay. Even well-performing firms may harm their creditors, for instance by engaging in restructuring and transferring debt to spun-off divisions. Banks can obtain valuable information from how firms treat employees to infer their intention to honor their financial obligations.
“Firms with favourable employee treatment are perceived to have more integrity in keeping contractual commitments and to show greater benevolence to other stakeholders,” says Wang.
Intent denotes a firm’s unobservable motivation to behave appropriately in exchange relationships and can only be inferred by creditors. Firms build reputations over time through the costly action of granting favourable employee treatment. These hard-earned reputations are at risk if employers are found to treat any stakeholder group poorly.
Wang and co-authors also conducted experiments by recruiting financial professionals to make loan decisions. They found that strong financial metrics were necessary, but insufficient, for obtaining low-cost loans. Employee treatment acts as a cue for both quality (future performance prospects) and intent (integrity and benevolence).
“Perceptions of good intent are more important in translating favourable employee treatment into banks’ willingness to lend at low interest rates than perceptions of quality,” Wang concludes.