Current research has focused primarily on the impact of aggregate ESG scores, sustainability scores (E) and governance (G) scores on investors and the capital market. There is not much research on the impact of the social dimension (S) on investors as well as the association between human capital and the financial performance of firms. The social dimension score is a proxy for a firm’s human capital resources. Investing in human capital serves as a useful strategy for fostering a culture of integrity, transparency, and social responsibility at all levels of an organization. One of the objectives of this paper is to examine the association between the social dimension score of firms and abnormal stock returns surrounding two unique events that had implications on the human capital disclosures and policies adopted by a firm. A second objective is to investigate the financial performance of firms during the pandemic from the lens of their human capital. The pandemic challenged firms to contend with workforce related issues at a time when sales declined precipitously, and employees faced significant health-risks. Research related to the “S” score is of particular importance in the current anti-DEI environment. My results will provide a market-based assessment of the relevance of this metric to capital market investors.
I initially analyzed the abnormal returns, my proxy for investor reaction, surrounding two announcement events. Did investors react differentially to these announcements based on the social dimension score of firms? Next, I examined the financial performance of firms during the pandemic and analyzed whether there is any association between the social dimension score and the return on net operating assets (RNOA). Did firms with higher social dimension scores perform better during the pandemic?
The first event I examine is an amendment to Regulation S-K by the Security Exchange Commission (SEC) announced on August 26, 2020, and effective November 9, 2020, requiring firms to provide a description of the company’s human capital resources and any human capital measures or objectives that the company focuses on in managing the business. For this long-window event study, I estimate buy-and-hold-abnormal returns (BHAR) for 1783 U. S. firms from August 26, 2020, to November 9, 2020 using the CRSP dataset. The firms are restricted to retail, manufacturing and service industries. I estimate a fixed-effects regression and adjust for cross-sectional dependence using industry clustered standard errors. I obtain ESG scores from the S & P Global ESG scores dataset. I control for the climate risk profile of the company using the environmental dimension score and include the governance score to account for the same. My initial results indicate that companies with higher social dimension scores were significantly and positively associated with BHAR indicating that investors rewarded companies with better human capital resources and better management of human capital. These firms benefitted from the disclosure of their human capital policies when the SEC’s promulgated these amendments. I need to further examine if there are any confounding events in this period for the sample firms to test the robustness of the results.
The second event was the Supreme Court’s ruling in Students for Fair Admissions, Inc. v. President and Fellows of Harvard College decided on June 29th, 2023. This ruling spawned a whole set of anti-DEI legislations across states and put the corporate world on notice about human capital policies. Florida and North Dakota enacted anti-DEI legislations for educational institutions on July 1, 2023, and Texas and Utah followed a year later. I examine the ten-day cumulative abnormal returns starting with the announcement date. I estimate a fixed effects regression and adjust for cross-sectional dependence using industry clustered standard errors. Like in the first event, I control for the climate risk profile of the company using the environmental dimension score and I include the governance score to control for the same. The results demonstrate a significant negative association between the cumulative abnormal returns and the social dimension score of sample firms indicating that investors perceived firms with higher social scores as being more politically risky investments subsequent to the Supreme Court decision. This is in contrast to the results obtained in the first event where investors rewarded firms with better human capital resource management. These mixed results motivate the next analysis which examines whether better management of human capital improves financial performance.
My final test is a cross-sectional study of the association between the financial performance of firms during the pandemic and human capital resources as proxied by the score on the social dimension. The sample firms are restricted to the retail, manufacturing and service industries. I estimate the RNOA for each firm over the period 2020 to 2022. I adjust these using an industry average RNOA and then standardize firm-specific RNOA using the standard deviation of RNOA in the industry. By doing this, I scale down and normalize any industry-specific differences in RNOA. Using a fixed-effects estimation, I test whether there is any association between RNOA and the social dimension score. I adjust for cross-sectional dependence using industry clustered standard errors. In the regression, I include variables that control for the firms’ profit margin, sales growth and market share. I also control for a firms’ inventory turnover as a proxy for their supply chain efficiency during the pandemic. I include the firms’ environmental score and governance scores. My results indicate a significantly positive association between a firm’s social score and standardized RNOA. The results suggest that firms with higher social scores and more depth in their human capital resources performed better during the pandemic.
Our results suggest that investors value the disclosure of the human capital management policies of a firm and initially rewarded firms with better human capital management. During the pandemic, firms with greater depth in their human capital resources performed better financially. However, subsequent to the 2023 Supreme Court decision, the social score served as a proxy for political risk and firms with higher scores were penalized by investors. This explains the current trend of firms shuttering their DEI programs.