Pricing Organizational Friction: Evidence from the "S" in ESG

Environmental, social, and governance (ESG) ratings continue to suffer from methodological fragmentation and low cross-agency correlation, especially for the social (S) and governance (G) pillars. Although existing studies document a link between employee welfare and equity returns, they provide little theoretical insight into the causal mechanisms connecting organizational friction to long-term firm risk and performance. This paper develops a structural ESG framework based on the Life-Value Reflow (LVR) model. The framework distinguishes two core constructs: the reflow signal-to-noise ratio (SNR), a slow-moving state variable that measures organizational health and the distribution of value to employees; and Organizational Friction Momentum (OFM), a short-run accounting proxy for shocks to bureaucratic efficiency. Using a curated panel of ten mega-cap U.S. firms over 2008–2021, we first show that a decline in SNR—measured through natural language processing of Glassdoor employee reviews—strongly predicts higher future 12-month tail risk. Because these firms are among the most resilient and heavily scrutinized in the market, this finding provides a conservative lower-bound estimate of the broader effect. We then test the framework at scale using Residual OFM, constructed from audited financial statements for a comprehensive panel of U.S. equities (2021–2025). After orthogonalizing OFM to standard profitability and investment factors, we find that it generates a significant Fama-French five-factor alpha of 1.38% per month (t-statistic = 2.33) and an annualized equal-weighted long-short return of 11.5%. Consistent with limited attention, the return spread is stronger among less liquid stocks. Impulse response analysis further reveals a delayed price correction that peaks around six months. In addition, OFM predicts elevated future crash risk, suggesting that investor underreaction to gradual changes in firm efficiency leaves markets exposed to latent structural downside risk. Overall, the framework offers a tractable, accounting-based proxy for organizational friction that predicts tail risk and generates economically meaningful abnormal returns. It provides a structural approach to corporate sustainability that avoids much of the subjectivity inherent in conventional ESG ratings.