Cross-Validation of Customer and Employee Signals and Firm Valuation

Abstract

Previous studies have separately shown that a firm needs to rely on its customers and employees to achieve superior performance. In this study, the authors draw on signaling theory to develop and empirically test a cross-validation argument. They argue that how a firm treats one stakeholder group will be interpreted by investors in conjunction with how the firm treats another stakeholder group. Investors use consistency in stakeholder group treatment as a signal of complementarity in a firm’s investments, which can improve the likelihood of competitive advantage. Specifically, the authors propose that a firm’s achievements (lapses) directed at customers have a stronger positive (negative) impact on investors’ valuation of the firm if they are validated by its achievements (lapses) directed at employees, and vice versa. Applying a multilevel model to a large sample of firms across various industries (1994-2010), they find evidence to support these arguments. In addition, they find that cross-validation is more crucial for firms with a narrow than a broad business scope.

Keywords: signaling theory, achievements and lapses, business scope, stakeholder