Want an Innovative Culture? Be Kind to Your Creative Thinkers

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Bottom Line: Companies with employee-friendly policies produce more patents, which shareholders highly value and result in long-term financial benefits.

For large companies, innovation is essential. Introducing new products or services is a key driver of long-term economic growth and, ideally, a distinct competitive advantage. But successful innovation requires human capital, that most precious of resources — and keeping talented researchers and engineers happy and productive is no easy task.

Getting the best out of employees being paid to come up with breakthrough ideas isn’t necessarily as straightforward as offering the higher salaries or performance bonuses that might motivate more bottom-line-oriented workers. Indeed, it’s widely recognized that tending to creative egos and coaxing moments of inspiration out of them requires a wider, more subtle type of personnel management — which is another way of saying, “treat employees well.” There are many ways companies try to nurture their brightest thinkers and make them feel at home in an organization: allowing them a louder voice in corporate decision making, instituting flexible schedules and family-friendly policies, offering attractive health benefits and retirement plans, strengthening safety protocols, and cultivating a more inclusive and diverse workplace, for example.

Management lore offers plenty of anecdotal evidence to suggest that treating employees well is something that deserves more than just lip service, and that it helps attract, retain, and stimulate skilled workers. For example, 3M’s 15 percent initiative, introduced in 1948, encourages employees to use a chunk of their work time to pursue their own innovative projects. It has generated a number of popular products, among them the Post-It. More recently, Google’s 20 percent time policy, which allowed its employees to spend 20 percent of their paid time working on their own ideas, has been widely credited with contributing to the development of such products as Gmail and Google Earth.

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But broadly speaking, do companies that are especially nice to their RD personnel really reap the benefits in their innovation activities? The authors of a new study put the theory to an empirical test and came up with a resounding yes.

To conduct their analysis, the authors began with the KLD Socrates database, which contains ratings for publicly listed firms on a wide variety of employee treatment metrics, such as those discussed earlier, based on company reports, government filings, data from watchdog groups, media accounts, and direct communication with company representatives.

Economists have long used patent activity as a proxy for a firm’s innovative performance. Accordingly, the authors combined several databases to track all patents granted to U.S. public firms from 1992, the first year included in the Socrates database, through 2011. But, the authors argued, because a simple count of patents fails to account for their technological and economic significance, the study also tabulated the number of citations each received in other patent applications, as citations are regarded as a reliable proxy for the influence and importance of a particular invention.

To ensure they were isolating the effects of employee-treatment policies, the authors controlled for a number of factors that can also affect innovation activity — including a firm’s size, age, ownership structure, managerial experience, capital expenditure, return on assets, sales growth, debt load, cash holdings, RD investment, and the level of industry competition, unionization, and MA intensity.

Overall, the authors found, companies with higher employee-treatment ratings produced more patents, which in turn were cited more frequently in subsequent patent filings.

Do companies that are especially nice to their RD personnel really reap the benefits in their innovation activities?

But patents aren’t worth much unless they can be converted into new products, processes, or services that represent a commercial leap forward for a firm. The authors therefore measured the stock market’s reaction, over a three-day period, to the awarding of patents. This was meant to capture unbiased shareholder opinion about the economic viability of a new invention. After adjusting for market conditions and idiosyncratic stock-return volatility, the authors report that firms that treat their employees better not only generated a higher number of patents, but that those patents are much more valued by shareholders.

In a further step, the authors explored how employee treatment can have an impact on a firm’s long-term financial performance, which they measured by the growth rate in a company’s return on assets over the five years following a patent registration. Employee-friendly firms had much stronger long-term operating performance, they found.

To strengthen their findings, the authors also repeated their analysis using firms that made Fortune’s list of the “100 Best Companies to Work For,” another commonly used proxy for employee satisfaction. When compared with a group of control firms that had similar characteristics but were not included on the Fortune list, the best companies to work for also boasted a higher and more valuable innovative output.

So why does treating employees better result in more effective and valuable innovation efforts? Delving deeper, the authors found that more generous employee policies result in increased inventor productivity, higher retention rates of skilled employees, and more efficient teamwork.

“Employees are crucial to corporate innovation, and firms that offer employees a greater voice motivate employees to participate more actively and creatively in the innovation process,” the authors write. “By offering their employees satisfying workplaces, firms can also recruit and retain talented people who play key roles in innovative activities.”

Source: Be Nice to Your Innovators: Employee Treatment and Corporate Innovation Performance, Chen Chen (Monash University), Yangyang Chen (The Hong Kong Polytechnic University), Po-Hsuan Hsu (The University of Hong Kong), and Edward J. Podolski (Deakin University), Journal of Corporate Finance, Aug. 2016, vol. 39