Firm performance

How the ‘butterfly effect’ can hurt business performance

Companies should develop appropriate HR risk management strategies to mitigate the impact of unplanned employee departures.

Strategic human capital is a company’s most valuable resource. Established research leans toward the theory that strategic human capital (employees with valuable, non-substitutable knowledge, skills, and abilities) can provide companies with sustainable competitive advantage. As a result, companies are led to believe that in order to gain competitive advantage, they must attract and retain strategic human capital (valuable employees).

Therefore, much research has been conducted to find out what factors govern employee departure decisions and how their departures affect company performance. However, the question remains: does leaving an employee lead to poor business performance, or does poor business performance lead to leaving an employee?

Our research provides clear evidence that employee departures To do negative impact on company performance and, more importantly, this impact is magnified by the strength of the employee-company relationship. In addition, our results revealed a third contributing factor to employee departure decisions: the “butterfly effect” of uncontrollable external events (accidents and disasters).

We looked at the aftermath of the Fukushima nuclear accident (caused by the tsunami that followed the March 11, 2011 earthquake in Japan). We sampled 9,564 data points across the United States over six years. Our sampling period covered the three years before the Fukushima nuclear disaster and the three years after. Our treatment group consisted of 797 companies located within 80 km of an operating nuclear power plant in the United States. Our control group consisted of 797 equal companies located 160-240 km from an operating nuclear power plant in the United States.

Factors beyond our control

Our research demonstrates that no matter how much companies invest in their employees, they cannot guarantee that their employees will not decide to leave due to external circumstances. The catastrophic accident in Fukushima caused massive panic and overreaction among the public. In addition, intense media coverage kept the American public’s attention on the devastating consequences of this unfortunate accident and tarnished the image of nuclear energy. This led to a widespread loss of confidence in the safety of nuclear reactors and generated a sense of outrage and fear. This has led to mass departures of employees from companies based thousands of miles near US nuclear power plants.

We found that some companies were negatively impacted by these employee departures, while others were not. A deeper analysis of each company’s HR strategy revealed a direct correlation between the amount companies invest in their employees and the impact on performance after employees leave. Our results revealed that ROA decreased for companies that had invested more time and resources in their employees. In other words, the more a company invests and bases its competitive advantage on its employees, the greater the negative impact of an employee leaving.

Strategic human capital requires extensive research and attention

Companies cannot own and control their human resources in the same way that they can control their other resources. In other words, employees are free to leave their employer at any time.

Therefore, companies invest heavily in resources and strategies designed to foster an environment in which they can build strong relationships with their employees and retain them. This positive environment promotes motivation, commitment, efficiency and innovation. In other words, it improves business performance.

Employee departures have the potential to create a downward spiral for businesses in many ways. For example, the loss of a single high-value employee can disrupt established routines and prevent remaining employees from doing their jobs effectively. This can lead to low morale and a general feeling of anxiety. This in turn sends negative signals to external stakeholders and customers, and reduces confidence in the company’s capabilities. Potentially, the resulting poor performance can lead to new employee departures.

Consequently, much research has been directed towards identifying the factors that influence employee departures. These studies have generally focused on two distinct areas. First, the influence a company has on employees (rewards and incentives, job satisfaction). Second, the theory that employee departures are triggered by emotional events that cause them to judge their jobs negatively. However, our research shows that an additional factor influencing employee departures has not been recognized: the “butterfly effect” of external events beyond the control of the company.

Moreover, our results clearly show that the more a company invests in building and maintaining strong relationships with its employees, the more it will be negatively affected by employee departures. This is because high-value relationships cannot be easily replaced – if an employee leaves, the company must reinvest time and resources into developing an equivalent relationship.

Investing in people for a sustainable competitive advantage

Existing research focuses on the benefits of strong employee-company relationships, but leaves the downsides of this relationship largely unexplored. While there is no doubt that investing in employee-company relations is critical to business success, our research clearly demonstrates that there are factors beyond our control that affect whether this investment benefits to the performance of a company or compromises it. Ten years after the Fukushima event, this research is even more relevant in light of Covid-19 and the millions of employee departures since the start of the pandemic.

Employees are our most valuable resource and we must certainly continue to invest in them. However, our research highlights the need to approach this valuable resource more strategically. Going forward, companies need to consider how unforeseen external risks can be assessed and managed in advance, and develop appropriate risk management and succession strategies to mitigate their impact.

Ithai Stern is Associate Professor of Strategy at INSEAD.

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