Organizational Higher Purpose, Employee Effort, and Firm Financial Performance

I use an optimal contracting framework to address mixed empirical evidence on the impact of organizational higher purpose pursuit on the firm’s financial performance. Some empirical papers show that the authentic pursuit of a purpose that transcends the usual profit maximization goal leads to higher profits, which is theoretically puzzling since the pursuit of purpose often involves financial sacrifice (or else all firms would do it). Other papers show that the pursuit of purpose-driven initiatives can diminish firm profits. I develop a theoretical model in which there are firms that are purpose driven and those that are not, but all firms are observationally indistinguishable a priori. All employees are purpose-driven. Employees provide labor, motivated by optimal wage contracts designed by firms that provide capital. The model generates the following results: (1) Both the utility that employees attach to the pursuit of organizational higher purpose and the utility some firms attach to it lead to higher employee effort, but when the identities of firms are shrouded and the equilibrium is pooling in employee wages, the pure profit maximizers always do better financially. I also identify conditions under which purpose-driven firms do better financially than pure profit maximizers in a separating equilibrium. (2) When the equilibrium is separating in wages, purpose-driven firms pay higher wages than what they pay in a pooling equilibrium, but purpose-driven firms may pay higher or lower wages than pure profit maximizers in a separating equilibrium. (3) A separating equilibrium generates higher expected pecuniary output as well as a higher sum of pecuniary payoffs and purpose-linked utilities than a pooling equilibrium, but a sufficiently high social stigma associated with not being purpose-driven can induce firms to invest in shrouding their identities, generating inefficiencies. (4) Strengthening corporate governance designed to serve shareholders can lead to higher productive effort by purpose-driven employees.