Why Do Banks Favor Employee-Friendly Firms? A Stakeholder-Screening Perspective

Abstract

We investigate why employee-friendly firms often benefit from lower costs of debt financing. We theorize that banks use employee treatment as a screen to assess firms’ trustworthiness, which encompasses not only confidence in firms’ ability to perform well but also the belief that they will act with good intent toward their creditors. We integrate screening theory and stakeholder theory to explain the—oftentimes unintended—consequences that firms’ actions toward employees have on their relationships with other stakeholders. An analysis of U.S. firms between 2003 and 2010 shows that favorable employee treatment reduces the cost of bank loans, and this relationship is stronger when banks cannot infer firms’ intent from their relations with stakeholders other than employees. A policy-capturing study provides further support that employee treatment serves as a screen for intent. We discuss the implications of our stakeholder-screening perspective as a novel way to understand the second-order, unintended effects of a focal stakeholder relationship on firms’ relations with other stakeholders.