Companies with substantial competitive advantages have always had to guard against employee complacency. With employees now a top priority for ESG advocates and regulators, it’s more important than ever for investors to discern how a company balances protecting employees and encouraging employees.

Investors beware: Since the Great Quit, the ESG movement and other social forces have made employee well-being a top priority in corporate America. Securities regulators are considering requiring disclosure of corporate investment in human capital.

These trends can add value as they promote employee satisfaction and productivity. But companies and regulators must be careful not to overdo their concern or pamper themselves. Investors should watch for regulatory and workforce enthusiasm amid these trends. Rewarding and caring for employees is desirable and valuable. Encouraging workers to take it easy, to let it go, to be lazy or to settle for the status quo is not.

When companies generate extraordinary profits, voters naturally make claims. For employees, higher salaries and bonuses are sought, along with other material comforts. It can also be natural for employees to relax and rest on their laurels. Managers and other leaders must be careful to prevent this from degenerating into complacency. They must find ways to care for their people without letting them become lazy or smug.

Finding that balance can be difficult, as a short list of historic legions of fallen giants attests: AIG; Arthur Anderson; Hit video; Border Books; Compaq computer; Kodak; Toys “R” Us and Xerox. Everyone’s rise and fall has a distinct story, but a common feature is a certain comfortable arrogance among the workforce.

External pressure – demanding customers, savvy competitors – can motivate a corporate culture and improve performance. While many investors probe the pricing power associated with monopolistic firms, it may be wiser to look for healthy competition. Ruthless rivals can kill businesses, but rational rivals can foster a culture of product innovation and customer service that increases sales and profits.

In the absence of external pressure, due to pricing power and other competitive advantages, a firm may need to generate its own internal pressure. This has always been difficult in fields that emphasize human capital and cultivate a culture of caring, and will increasingly be so in a world focused on employee comfort. In all these environments, the internal pressure must be in a productive form and channeled towards a worthwhile objective.

Holding contests, offering rewards or inducing other forms of rivalry are healthy when offered in the spirit of achieving a collective goal in which all employees can claim a stake. . Positive goals, such as improving customer satisfaction ratings, outweigh negative goals, such as aggressively targeted cost reduction.

Many companies use baseline ratios or key performance indicators (KPIs) to reflect these aspirations for optimal internal pressure when setting rewards or penalties and promoting accountability. These can produce clear and current feedback as an effective external market substitute. Employees who don’t receive such feedback can easily slip into comfortable patterns that stunt innovation and creativity.

Decentralizing a business into smaller business units also helps. Companies as diverse as Amphenol APH,
Berkshire Hathaway BRK.A,

Constellation Software CSU,
Danaher HRD,
Kelly Partners Group Holdings KPG,
and Mettler Toledo MTD,
illustrate various approaches to decentralized operations. Some distribute almost all responsibilities as deeply into the organization as possible (Amphenol is at this extreme) while others centralize only certain functions, such as capital allocation (Berkshire is at this extreme).

But everyone recognizes that autonomy motivates people, without hindering or pampering them. The key is to maintain a balance between autonomy and control. Pure autonomy risks anarchy and pure control suffocates. Unleashing the power of autonomy requires that rulers and their troops they command have a high degree of control over their own commercial fate. To promote the likelihood of desired business outcomes, they need to be incentivized to adopt certain ways of thinking in exercising that control.

Methods vary as businesses are unique, but a nudge is better than a mandate. Leaders must listen to feedback signals and monitor how strategy and culture are working, given authority arrangements and organizational structure. In response, they use “communicate to influence” rather than “command and control” to generate the desired changes. Suction could be called intelligent autonomy – neither unbridled discretion nor excessive control, neither too much comfort nor too little.

Investors should incorporate such corporate culture analysis into their investment process. They should look for companies whose employee engagement improves both employee satisfaction and productivity. Finding this balance has always been essential for companies with pricing power and other competitive advantages that can induce complacency. It will now be critical for all businesses in an increasingly labor-intensive world.

Lawrence Cunningham is a public company director and founder of Quality Shareholders Group, a boutique that facilitates relationships between long-term focused shareholders and the companies that want to attract them. He is the author of many books and is well-famous for “Warren Buffett’s Essays: Lessons for American Business.” Cunningham is a director and shareholder of Constellation Software, a director of Kelly Partners Group and a shareholder of Berkshire Hathaway.

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