The Holler

Investing in the future of intangibles: the value of human capital and the CIBC Human Capital Index

Episode Summary

Helen Hayes in conversation with renowned behavioral economist, Dan Ariely Ph.D., Irrational Capital.

Episode Transcription

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Helen Hayes: Welcome to The Holler. I am your host, Helen Hayes. Please join me each week as I speak with industry experts and research analysts from around the world to bring you emerging trends and ideas that are impacting how we invest in global markets.

Dan Ariely: You know, a lot of companies, I don't think on purpose, but they're actually doing things to hurt the human capital factor. Think about bureaucracy, what is really bureaucracy from the perspective of the people who are experiencing it?

Helen Hayes: Welcome to today's episode of The Holler. I'm delighted to be joined by Dan Ariely. Also joining me on the line is my colleague Bill Bamber, MD and Global Head of Structuring at CIBC. Dan Ariely is a leading Behavioural Economist, entrepreneur and investor. He's the author of six books, including The Honest Truth About Dishonesty, and has a weekly column in The Wall Street Journal called Ask Ariely. He's delivered over six TED Talks with a combined 20 million views. Professor Ariely also teaches at Duke University and is a founding member of the Center for Advanced Hindsight. He's an expert in all things within the topic of irrationality. His investment firm, Irrational Capital, identifies and quantifies the nuanced relationship between companies and their employees. They invest in human capital factors that are linked to long term stock price performance. I kind of think of it as the G in ESG taken to a much more heightened level. They believe that the lack of measurement tools for these intangible assets may represent a new opportunity for investment selection. I quote, investing and understanding in properly motivating human capital is one of the best drivers of growth. Dan, welcome to The Holler. I'm really pleased you're able to join Bill and I today. How are you?

Dan Ariely: I am very well and lovely to be here with you.

Helen Hayes: It's a rainy day in Toronto. But again, I know that you mentioned that you're calling us from North Carolina. So welcome. Let's start out really at the beginning. You've spent so much of your professional life researching what motivates people, especially around work. What are some of the key themes you've discovered, Dan?

Dan Ariely: Ok, so maybe I'll tell you this in kind of two chapters.

Helen Hayes: Sure.

Dan Ariely: So chapter one of my research life was looking at one company at a time. So I would go to a company and we would do some research together on how to motivate people. And the conclusion, by the way, was it was always very easy to find ways to improve motivation. It was kind of painful to realize how easy it was. And the reason it was so painful is that if it's so easy, it must mean that people are not really spending a lot of time on it, because it's not that I'm all of a sudden able to see lots of things that people are not able to see. But I will just come into it, and almost in every company we'd find low hanging fruit on how to increase motivation. Now, some things were surprising, but some things were easy. So let me give you an example from this kind of chapter one of motivation, and I'll tell you about the study we did with Intel, the chip manufacturer. This was in one of their production facility. And in that production facility, people worked on for four days off for four days. And the people at Intel thought, their intuition was, that when people come back from four days off, you need to kind of get them going in a quick way. So they gave people a target, let's say, thirteen-hundred computer chips and a bonus. Thirty dollars if you make it. And that was the process. So you have four days off, you come back and they said, here's your target. Thirteen hundred computer chip and the bonus. Thirty dollars if you make it. Zero if you don't make it. 30 dollars if you make it. And for me this was a really interesting setup because you have the first day of the work week, the first day of the four days work week where you have a target and a bonus, but you also have the days when you don't have a target and a bonus. And one of the things that is very, very important for companies to understand is goodwill. And goodwill is what happens when I'm not paying you directly and not measuring you directly and not looking at it directly. So here we had a chance to see what happens on the first day and what happened on the three other days. So we tried lots of things. We tried a control condition with nothing. We tried the standard condition, which was 30 dollars. We tried a condition of sending people a voucher for a pizza. And we tried a compliment. So the way it worked is people would come back on the first day, a quarter of the people were told nothing. That's the control condition. A quarter of the people were told if you reach thirteen hundred computer chips, we'll give you 30 dollars. A quarter of the people told if you reach a thirteen-hundred computer chips, we'll give you a voucher for pizza worth 30 dollars. And a quarter of the people were told if you achieve thirteen hundred computer chips, you'll get a text message from the boss saying, nice job. By the way, this was not the compliment I would design, but there are limits to what you can do. So that's what we did. And here's a question to you. I'll ask you to predict what you think happened. So On that day when people came in, which method do you think worked the best, the money, voucher for pizza or the compliment?

Helen Hayes: The compliment.

Dan Ariely: So first of all, the good news is they all worked better than the control condition.

Helen Hayes: OK?

Dan Ariely: The money condition was about 6% better than the control condition and the pizza and the compliment were 1% better than that. But here's the real question. What happens in the next day? Remember the next day and the next three days? Actually, there's no money and there's no target. And what we saw was that the money condition went up by 6%. But on the second day, it went down by 12%. And the next day it went slightly up and slightly up, almost catching up to the control condition. But in total, Intel lost about 5% of productivity by giving people a bonus. And, you know, you can ask, how come? How can giving people money change motivation for the worse? And the reality is that we see lots of those things. As an intuition, imagine that I ask you to help me change a tire on my car. I said, look I have a flat tire. Would you help me out?

Helen Hayes: I'd be the wrong person to ask but OK.

Dan Ariely: But think about your willingness to help. Now, what would happen if I said, would you help me change a tire on my car? I'll give you five dollars. Is your motivation now going up or going down? And it's actually for the vast majority of people going down, because when I just ask you for help, you think of it as part of your, you know, part of your definition of being a human being in this world, helping other people. The moment I give you five dollars, I'm basically telling you this is what you're worth to me. I'm not interested. Give me a thousand, we can talk. And by the way, we saw this happening with the No Child Left Behind in the US, where you increase salaries of teachers as a function of how well their kids did and motivation went down. We see it in all kinds of places, including in Intel. So the money motivation, basically it was 30 dollars. And on that day people work to try and get the 30 dollars. But the next day they said to themselves, oh, this is really what I'm worth to you? 30 dollars? Not that interested. Now that's I told you, that's what happened to the money condition, what happened to the compliment condition. And remember, it was a very, very mild compliment. It was a compliment over text message. But what happened was there was an overall improvement. It went up by 7% on the first day and it went down slowly over the next three days. But overall, creating a huge benefit. And what happened with the pizza condition, it was somewhere in the middle. And I speculate that if the pizza was more like a real pizza with, you know, crust and a smell, it would have been much better. And if it was more transactional, you know, good only for Tuesday, but not with anchovies or whatever, it would have been worse. So the point of this is to say that motivation works in stranger ways than we think. And sometimes the thing we think would motivate people actually end up backfiring. OK, so that's chapter one. And I told you, I went to lots of companies and we did lots of experiments like this. You know, I have lots of those to describe. And basically what we found is that you can always go and change motivation for the best. Chapter two for me was really interesting. In chapter two is really the founding of Irrational Capital. And when I met David, who is my partner, he asked me the question of can we do it at the level of the stock market? And I said, I think so, but we need to get good data. And we started getting data about how companies were treating employees, how employees perceived how the company treated them, and how did that affect their performance in the stock market. Now, in some sense, it's trivial. Because, you know, every CEO stands on a stage and say, my people is the best thing I have. It's the most important asset I have. And it's kind of obvious, right? What's the engine of growth for any company? It's people. People are creating ingenuity and savings and designing new things. I mean, there's no question that that's the engine of growth. But the question is, do companies know how to treat that resource and are they treating it in the best way to maximize the performance of this? And we got lots of data from lots of places going back to 2006. And we started asking the question of saying if we had this data in 2006 and 2007 and so on, could we have invested in a way that would beat the S&P 500? So the first thing we did was we look at each one of the dimensions that we have. What's a dimension? Quality of coffee. So we can ask, for example, if we only had quality of coffee with investing based on that yield companies who are beating the S&P 500. And the answer, by the way, is no. If you look at companies who invest in quality of coffee, that doesn't seem to matter. The quality of furniture doesn't seem to matter. Salary, by the way, doesn't seem to matter. But fairness in salary matters a lot. And we find that autonomy matters a great deal. You know, there's something really interesting that lots of companies are asking people to try new things, right? Innovation. Companies punish people who make a mistake, not a stupid mistake, but, you know, try something that didn't work out. So we find that a sense of autonomy, a sense of appreciation. Companies where people feel that if they make an honest mistake, if they try a project because they think it would work, but eventually it doesn't work, they would still, they would not get punished. So we find lots of those things. It turns out to be a big deal. So if we take from 2006 to 2019, the data we have and we invest based on those attributes of autonomy, trust, appreciation, perception of fairness and so on, the return on those companies without looking at anything like P/E ratios. We don't look at anything outside of that. We just look at human capital. The return is slightly more than seven percent a year. I hope you agree. It's quite amazing.

Helen Hayes: Yeah, it's amazing.

Dan Ariely: And we also find, we also did something on gender. And, you know, very sadly, we find it in most companies, most women are mistreated compared to men on almost everything. And what we found is that that gap basically has a huge, huge negative effect on companies because, you know, like salary, I told you salary doesn't matter. Maybe women's salary wouldn't matter that much, but there are some things you get used to like if you think about quality of furniture or you think about your salary, you don't think about it that much. But if it feels unfair, for example, if the fairness promotion is unfair or salaries unfair, that's not something you can stop thinking about. And what we find is that all of these notions of unfairness keep on having a negative effect on the women. So, for example, if we look at the companies that we had in our data set and we look at how do the 20% companies who are treating women in the best way do, they do about 5% a year over the S&P 500. So there are things that are just general for everybody and then there are things that are about fairness and so on. So we got another big data set in which we looked at what happened during Covid. You know, Covid is a tough period. And we found two important things. The first one is that everything we found from before Covid was even more important during Covid. And why? Think about kids in school. If you have kids in school, the teacher can basically force them to study, right? The teacher can say, you know, put your phone down, focus, read and the teacher has some control. When the teacher is teaching over Zoom, the kids could just turn them off. So all of a sudden, the role of what we call good will and intrinsic motivation is becoming much higher. If somebody is working from home, we have much less control over them. So all of a sudden it's more at their discretion of whether to work harder or not. And the other thing is it's not easy to work from home. There are all kinds of things that happen making it harder to do your work. So you need more motivation and more intrinsic motivation. And in general, we find that the companies, if you look at, you know, somewhere at the end of March, the stock market was at its bottom. If we look at the period from the end of March to September, the companies who did well in terms of treating their employees had the 3x return during that period on the stock performance. You look at the companies who basically showed people appreciation and helped them see the direction of the company and created trust and created a safe environment to share ideas. All of those things helped tremendously. And the most important driver, by the way, was showing appreciation. We think about somebody working from home, where is their engine of motivation, where's it coming from? And the companies who show the appreciation and caring did much, much better.

Helen Hayes: Dan, you've talked a lot here I think about human capital and the whole concept of the human capital factor. And what's been amazing through this period of the last, let's call it nine months of the pandemic has been this intangible that has come to the forefront. So whether we're talking about it from what you've described in human capital factor, and when we think about what I mentioned earlier around ESG, is there anything else you want to mention around human capital and that main factor? But I'd be really curious to talk about ESG because, you know, when I talk to clients, this has been one of the surprise, I shouldn't say winners, but people have recognized from a value and purpose position what's important in their lives and what's important in terms of investments. And I'm just wondering when we think about the human capital factor and from an investing perspective, how we should position it around ESG?

Dan Ariely: So, first of all, it turns out that companies who treat their employees better also are good on other measures that are ESG, right? There are some things that we should do because it's morally the right thing to do. So you can ask yourself, you know, should you invest in companies that pollute the world or should you take yourself out of that? And that's a value proposition from a moral perspective. The thing about treating your employees well is that it's both a moral thing to do and it's a financially reasonable thing to do. And actually, I think that most of the, according to our analysis, most of the benefit that people see in investing in ESG from a financial perspective, doesn't come from the ESG itself. It comes from treating your employees well. Because if you think about, it's really important to be nice to the environment, don't misunderstand me, right? If you say would being good to the environment translate into higher performance? Not necessarily. The only way it translates into higher performance is that if now the employees feel more connected to the goal of the company. So there are two important things here. One is that I think that treating employees right is both morally correct and financially rewarding. But the second thing is that when companies do things, they need to understand that the only way that those things will become whatever ESG it is, whatever version or action, the only way that it will become valuable for the shareholders if it goes through employee motivation. So I think that's really the engine that is so important. And I think it's kind of a shame that we haven't included human capital in a more fundamental way in ESG. Hopefully there's time to change it and include human capital in there as well.

Helen Hayes: Yeah, you know, it's funny when you do think about diversity, which you've touched on, you've talked about purpose and alignment and that whole authenticity, which is so important, right? People have to believe morally that they're aligned from a perspective of what the corporate goals are, but just internally, their direct boss, the fabric of the culture. And you know, you so well describe what I think is an important part of ESG from a perspective of companies. But when we think about your human capital factors and when you look at companies, how sticky are the companies that have these high human capital factors? Does it change a lot or is there a correlation that you think about when you view a company that has a very good culture and it's really embodied in the fabric of the company, they treat people well. As they grow, does that change, Dan?

Dan Ariely: Yeah, we find that it is something that needs continuous care. It's not something that you set it up once and it stays there. And, you know, a lot of companies, I don't think on purpose, but they're actually doing things to hurt the human capital factor. Think about bureaucracy, what is really bureaucracy from the perspective of the people who are experiencing it? It's basically a sense of lack of trust. Before Covid, I was at a company and they very happily showed me a new app that they pull out for their employees, for all the rules and regulations of what they can and can't do when they take guests for dinner. So, you know, nobody's taking guests for dinner now. But, you know, and you are supposed to go to dinner with these people and take your app out and figure out, yes, I could do a drink, but only up to five dollars. And not this and this this. And if you think about what it is, yes, it does make everything more easy to reach and you're less likely to make a mistake. But it also tells you that nobody trusts you. If you're in a place that the beer cost 50 cents more, that's OK. And all of a sudden you change the game. Now, again, good will. You know, if we have a job that is really, really simple, like somebody has to organize a chair in a row, OK, organize the chairs in a row and you can measure and you can see and you can react to it. But most jobs and especially the jobs we care about are in the knowledge economy. And that means that most of the things are happening between people's ears, right, it's our brains, and we can't control that. And we don't see how hard people work. I can sit in front of my computer and do nothing for work and I can be in the shower and think just about work. And because of that, because of that switch, even before Covid, the importance of people having ownership of their job, feeling that they're not working for money, like, you know, if I work just for money. OK, so I'm a university professor and I have what is called tenure, which basically means that unless I do something illegal, I have a job for life. Now, in principle, the economic theory would say that I should stop working, right? Here I have a job for life, people pay me, like, why would I do anything, right? If I hated work, I should just stop. But the reality is that on the day that I got tenure, I actually changed my view of the institution and became more committed. I didn't say all of a sudden, oh, you know, thank you very much ,I'm gone. Instead, I said, you know what? Now that I have this security, I can figure out what from all the things I could do would give the most value to the institution. All of a sudden, it aligned my incentive. Think about getting married. The moment you get married, you should say, oh, it's going to be harder for that person to leave me. Let's be nastier to them. Let's be more selfish. Like if you think we just tied the knot, you can't leave me, I don't need to be as nice to you anymore. No, most people wake up the next day and say I'm extra committed to this relationship because now we have, we're looking forward in a mutual way, in a longer time horizon. And that's actually what happens for lots of companies that give people assurance, saying, I'm not here for another, every month I'm going to examine what I'm here. I'm here for years. And all of a sudden when they say, oh, my future is tied with this institution and I'm going to be here for years, changes completely my outlook. Now, I'm willing to do more long term projects. I'm doing things that are good for the institution. So things do change and that's really what we want. But a lot of the things we do is actually the opposite. We're treating people in a too transactional way. I love human resources. I think it's such an important function. But in most companies, they treat them so badly, they're just like one level above compliance, they're treating them as, instead of an R&D function, like I would love to see people in human resources continuously exploring how to increase motivation. Instead, they're just dealing with rules.

Helen Hayes: Dan, when we talk about these intangibles, because I think your work is, it's so fascinating, right? When we run through the list of intangibles, I think we've talked a little bit about management and leadership. You've talked about trust and autonomy, pride and psychological safety a little bit. And I wondered some more about psychological safety. What do you mean by psychological safety? Is it back to the example that you just talked about as tenure or should we think about it in a different way?

Dan Ariely: No. Psychological safety. So think about a kid. So imagine you have a young kid, four year old kid, and you go with them to the playground. And you say, go ahead and go to the swing. Now, the question is, is this kid going to the swing or they checking to see that you haven't left? And that's called the kids who just go to the swing and know that you're there to protect them, that's called secure attachment. And psychological safety is basically that principle for adults, right? It's basically say, I know that my company has my back. Now, you know, if you're in manufacturing, there's also a physical safety. But outside of that, a lot of it is saying, I know you have my back and we have a long term aligned interest here. You're not going to try and catch me, make mistakes. I don't have to document everything. You know, that I care about the mutual goal, the goal of the company. The company knows that I care about them. And I don't have to justify everything. I don't have to make sure that you're behind me. I don't have to be afraid that if I make a mistake, you'll turn your back to me. I kind of know where I am supposed to go. And I know you're giving me trust to go that way. That's an amazingly empowering thing. Right now, people can go and innovate and improve and do all kinds of things.

Helen Hayes: Is there, Dan, a real life example of human capital factor at play that's very exciting to you? We've touched on a number of topics within this concept of human capital factor, but is there anything that's really evolved or something that perhaps we should all be thinking about?

Dan Ariely: So the first one to realize is the role of employee benefits in all of this. If we have an employee benefits, our temptation is to write down on people's paycheque how much we paid for their employee benefit. So imagine that I pay a thousand dollars of your health care and I'm sending you your paycheque. And it's tempting for me to say, hey, you know, by the way, I paid a thousand dollars a year. And it turns out that that's a bad idea. Why is it a bad idea? Imagine you came to my house for dinner one day and you were going to buy a bottle of wine and you were going to buy an expensive bottle of wine, maybe one hundred dollars. And you came to the door and you say, Dan, here's one hundred dollars worth bottle of wine, just so you know, I spent one hundred dollars on it. How will that be effective or not?

Helen Hayes: No.

Dan Ariely: By the way, it's also not a good idea for you to give me just a hundred dollars and say you know, I didn't know what wine you want and here's one hundred dollars. Go ahead and buy yourself the best bottle of wine you can. The reality is that when you come to my house for dinner, we're trying to create a social relationship, not a financial one. You see, with the financial relationship, you open the books and close the books. You worked for me, I paid you. We're even. When we do favours, we don't really close the books. It's a very different calculus. The moment you do a favour to somebody, you basically are creating openness for mutual higher level of involvement. It doesn't happen that you say, oh, you know, I helped you two weeks ago, move your apartment now you help me for 30 minutes we're even. It's a much more delicate thing than that. And it's basically creates mutual appreciation in agreement and so on. And companies can do it in the same way. Companies can create appreciation, loyalty. It doesn't come from saying, oh, this was a thousand dollars. I could give it to you in cash or I could do it this way. So that's one topic. And the other topic that is shocking to me, how badly we do on it is appreciation. Appreciation is so important. And as I said, even more important during Covid and I sometimes feel that people behave as if they have like a hundred compliments to give in their lifetime. And when these are over, they'll die. We can't waste them. We have to think of it as a scarce commodity. No, you know, we have lots of compliments to give. We don't have to be so careful on them, but people act as if it's a very scarce commodity and we can give lots of compliments and it's fine. Those, I think, are the two surprising ones. The other big one is encouraging people to take risk. And that's very tough, but very, very important.

Helen Hayes: Bill, when we think about the work that you've done with Dan and his team, and I wonder if you just spend a few minutes talking about the index you've created and how investors can think about being able to access this whole philosophy from a standpoint of a product in the market?

Bill Bamber: Thank you and thank you, Dan. This is a fascinating topic. And Helen, thank you for hosting this discussion. When we first encountered Dan and Irrational Capital's research, we found it incredibly compelling. And what we have done here is sought to codify their research and methodology into an index. That index we have the historical data reconstructed going back to early 2014. The index symbol on Bloomberg is CIBCHCT, HC for human capital and T for total return. That's a total return version. The price return version is a P at the end. So the index is fully constructed. It's public now on Bloomberg, as mentioned. Institutional investors with whom we have interests on can access very easily by a total return swap. And we are working with a number of potential asset management counter parties to create various regional funds and ETFs, both in Canada and the US and potentially Europe. And that work is underway and hopefully will be live in the not too distant future. So for now, it's very much accessible via total return swaps or if an institution would like to track it themselves. The baseline version that we have created rebalances on an annual basis. The universe is US S&P 500 Large Cap US Equities in essence. And so we can also discuss licensing of the IP and the index methodology in order to track the index. So happy to engage with any interested parties.

Helen Hayes: Well, that's great. Dan, this has been an absolutely fascinating conversation. I would say that last week I had a call with our Head of Investment Banking talking about intangibles in terms of IP and companies, and I think I can absolutely align with the thinking around these intangibles when it comes to human capital. And I think the work that you're doing is absolutely amazing. So thank you so much for your time. If you're interested in receiving more information about the HCT index, please reach out to your CIBC representative. To learn more about Dan Ariely and his team at Irrational Capital, please reach out to the website Thank you for listening.

Helen Hayes: Please join us next week for more insights from industry experts and up to date research calls from across our Global Markets platform. I'm your host, Helen Hayes, and this is The Holler.

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