Workplace sexual harassment and related misconduct—a toxic boys'-club atmosphere—led to three recent cases against McDonald's, its management and board. And studies have shown that workplace sexual harassment can have substantial adverse “psychological, health, and job-related consequences” for employees, often resulting in “higher employee turnover, lower employee productivity, increased absenteeism, and increased sick leave costs.” But what is the impact for shareholders? A study in the Journal of Business Ethics, “ How Much Does Workplace Sexual Harassment Hurt Firm Value?”, looked at just this question. Earlier studies of the impact of workplace sexual harassment looked at the short-term impact on the market, but this study analyzed the “longer-term effect on firm value starting from the date when harassment risk affects employee morale.” The study found that sexual harassment led to much greater damage—manifested in significant reductions in stock performance and profitability—than previously realized: the stock prices of the group of companies with the highest levels of pervasive harassment underperformed those of an equivalent group with low levels of harassment by about 17%. The study also showed that these “high-SH” companies experienced a decline in operating profitability and an increase in labor costs. One of the paper's co-authors told Corporate Secretary, “[f]inancial analysts and investors often undervalue intangibles such as the effect of a toxic work environment…But [workplace safety] is indicative of all sorts of other underlying issues, including poor control systems and overall bad governance, which can directly impact employee performance, company performance and stock market value.”
SideBar
You probably remember the string of McDonald's cases—all of them arising out of workplace misconduct at McDonald's, none even grazing the topic of employment law. In January, the SEC announced settled charges against McDonald's and its former CEO Stephen Easterbrook, arising out of McDonald's disclosure about the termination of Easterbrook without cause “for exercising poor judgment and engaging in an inappropriate personal relationship with a McDonald's employee in violation of company policy.” The SEC alleged that Easterbrook made “false and misleading statements to investors about the circumstances leading to his termination in November 2019.” In addition, the SEC charged that McDonald's disclosures related to Easterbrook's separation agreement were deficient in failing to disclose that the company “exercised discretion in terminating Easterbrook ‘without cause,'” allowing Easterbrook to “retain substantial equity compensation.” When McDonald's discovered that there were more inappropriate relationships with employees, it sued Easterbrook in Delaware Chancery Court seeking recovery of the compensation Easterbrook was paid under his separation agreement. The clawback settlement was reportedly valued at more than $105 million. (See this PubCo post.)
Then, in In re McDonald's Corporation, plaintiff stockholders sued derivatively, alleging that David Fairhurst, who formerly served as Executive Vice President and Global Chief People Officer of McDonald's, consciously ignored red flags and thus breached his fiduciary duties as an executive officer “by allowing a corporate culture to develop that condoned sexual harassment and misconduct,” not to mention engaging in some pretty extensive workplace misconduct himself. The defendant moved to dismiss the oversight claim under Rule 12(b)(6), contending that officers do not have Caremark duties, and, even if they did, that the plaintiffs failed to allege sufficient facts to state a claim against him. VC Laster begged to differ. He held that officers do have Caremark duties: according to the court, Fairhurst “had an obligation to make a good faith effort to put in place reasonable information systems so that he obtained the information necessary to do his job and report to the CEO and the board, and he could not consciously ignore red flags indicating that the corporation was going to suffer harm.” In addition, the complaint alleged that Fairhurst himself “engaged in inappropriate conduct with female employees and exercised inadequate oversight in response to risks of sexual harassment and misconduct at the Company and its franchises.” Based on allegations in the complaint, the court believed that it was “reasonable to infer that Fairhurst knew about and played a role in creating the Company's problems with sexual harassment and misconduct, which led to the external signs that took the form of employee complaints and a ten-city strike.” (See this PubCo post.)
And, earlier this month, we saw a new decision out of Delaware regarding the derivative Caremark litigation against the company's directors alleging that they ignored red flags about the company's culture that condoned workplace misconduct. This time, however, the court dismissed the complaint against the directors, holding that the directors did not ignore the numerous red flags. According to the court, the record showed that, even if the Board's efforts were not entirely successful, the directors “responded to the red flags regarding the toxic culture that was developing at the Company,” including holding several meetings about these issues and the numerous steps the company was taking, elevating the issues to the importance of an enterprise risk and terminating Easterbrook and Fairhurst. Because of their effort, it was “not possible” to infer that they acted in bad faith. As a result, the Caremark claim against the directors for breach of the duty of oversight failed to state a claim on which relief could be granted. (See this PubCo post.)
As noted above, earlier studies of the market impact of sexual harassment have focused on the effect of public reports of toxic culture scandals, where research showed an immediate decline in shareholder value of 0.6-1.5% of market cap. Because companies and victims are often discouraged from disclosing sexual harassment, the authors concluded that relying on public announcements was likely to “severely understate the prevalence of sexual harassment.” The authors suspected that the toxic culture probably went undetected long before announcements in the press. The key was to devise a way to estimate the incidence of workplace harassment prior to media exposure, which would allow the authors to measure the effect of sexual harassment on firm value over a prolonged period, rather than a short event window.
To that end, the authors measured “high harassment risk through employee complaints of harassment problems in online job reviews” from current and former employees. The authors performed textual analysis on 1.65 million reviews published between 2011 and 2017, covering nearly 1,100 companies, looking for reviews that contained the words “sex” and “harass.” The authors controlled for the overall employee satisfaction score and, to minimize the potential for excessive impact of individual reviewers, limited the sample to companies with at least 200 reviews. The authors then calculated an annual sexual harassment score for each company, characterizing a company with SH scores in the top quantiles (the 99th, 98th or 95th percentile) as high-SH, indicating severe sexual harassment problems.
Measuring stock market performance over a one-year period starting from the date of the high-SH classification, the authors found that the SH measure correlated with a “strong reduction in firm value.” Over the 6.5-year study period, a “portfolio of high SH firms generated a 157% lower value-weighted cumulative stock return than an equivalent portfolio of low-SH firms. Further, high-SH firms generate value-weighted, annualized risk-adjusted returns (‘alpha') ranging from –7.7% to –20.7%.” The authors estimated the annual shareholder value loss to be $0.9 billion to $2.2 billion per high-SH company. In addition, examining the two years before and after the year of high-SH classification, the authors found a negative impact on operating performance, with high-SH companies showing a “large decline in operating profitability (measured by ROA or ROE) over the five-year period. [They also found] that labor costs rise significantly after firms are identified as high-SH firms. In contrast, this decline is not mirrored in low-SH firms—their ROA, ROE, and labor costs remain constant over the same period.”
Finally, the authors characterized the magnitude of adverse change in firm value for high-SH companies as “striking” and “not limited to the short-term announcement window. It may even surprise corporate executives, which helps to explain why they do not do more to stem toxic work environments.” The study, they concluded, supports the use of corporate governance resources to curb sexual harassment, and reflects the importance of ESG and CSR in finance.
What to do? Could part of the answer be found in board and management gender diversity? In this paper from two of the same authors, “Does Board Gender Diversity Reduce Workplace Sexual Harassment?,” the authors used the same type of analysis (textual analysis of online job reviews) over the same study period (2011 through 2017) to examine “whether board gender diversity creates positive social impact through the lens of workplace sexual harassment,” or, more specifically, “whether board gender diversity contributes to a reduction in workplace sexual harassment, or whether firms engage in ‘fem-power washing,' [think “green-washing”] that is, the successful, but false, use of gender-equality CSR policies for corporate branding, where the falseness of the claim originates from the lack of concrete actions implemented towards the proclaimed goal.”
The authors concluded that board gender diversity did make a difference—as did gender diverse managements: an increase of one female director was associated with a 20.71% decrease in sexual harassment—averaging things out, the authors calculated that this percentage decrease translated into “an average reduction of 116 sexual harassment incidents per year for the average firm.” Instead of fem-power washing, the authors found that companies with “higher proportions of female board members display improved corporate social policies.” That is, “the mechanism for this reduction in sexual harassment appears to be related to organizational policies—board gender diversity is associated with an increase in positive social policies, and improving these policies leads to reduced sexual harassment. In sum, we find no evidence of fem-power washing, that is, the apparent adoption of policies favoring workplace gender equity, without concrete actions to implement said goals.” In addition, the authors found that the “positive social externalities associated with female directors also extend to others forms of female leadership: [they found] that firms led by female CEOs and firms with higher percentage of female executives also experience decreases in SH.”
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