April 2, 2013

Doing Good: Bad for the Bottom Line?

It’s long been a truism that good corporate citizenship cuts into profits. Not so, according to new research. Investors and managers who take a long-term view find that doing good can pay off where it counts: in ROI and stock price.

Betsy Wiesendanger
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Being an ethical corporation costs money. It’s hard to dispute that the broad range of measures dubbed “sustainable practices” — anything from monitoring suppliers’ factories to implementing recycling programs — is laudable and necessary. But doing good can be bad for the bottom line. Or, to use a favorite phrase of economists, it destroys shareholder wealth.

Not so fast, says Robert Eccles, professor of management practice at Harvard Business School. He and two coauthors examined the financial performance of 180 US companies over an 18-year span, comparing 90 that voluntarily adopted environmental and social policies with a matched set of 90 who didn’t. The surprising result: High-sustainability companies significantly outperformed their counterparts on several measures, including ROI, return on assets, and stock price.

The data have important implications for investors and corporate strategists, says Eccles. “It would be logical to assume that high-sustainability firms would underperform because their labor costs were higher — they provided more benefits and training,” he says. These firms might also pass up valuable business opportunities that didn’t fit into their sustainable mission.“But a more long-term view reveals that, in fact, shareholder value is created, not destroyed, when companies invest in process and product quality and safety,” he notes.

Eccles presented his findings at a conference on long-term investing held in December 2012. The conference was organized by Chazen Senior Scholar Patrick Bolton and sponsored by the Committee on Global Thought at Columbia University.

The Good, the Bad, and the Sustainable

Eccles and his coauthors, Ioannis Ioannou of London Business School and George Serafeim of Harvard, examined 775 US firms to determine the degree to which each had comprehensive, coherent policies related to the environment, the communities they operate in, and their products and customers. They then constructed a sustainability index and ranked each firm on 27 criteria, including environmental standards, such as emission reduction and water efficiency; community policies include adherence to business ethics and diversity in hiring; and product and customer measures include programs to promote product safety and minimize negative impact on customer health.

They then compared the 90 highest-scoring companies with the 90 lowest-scoring. The result: High-sustainability firms demonstrated outsized returns by several measures. An investment of $1 in a high-sustainability firm in 1993 would have grown to $22.60 by the end of 2010, compared with only $11.70 for low-sustainability companies. In addition, high-sustainability firms had higher return on equity and return on assets.

The research adds a twist to a fundamental business debate: What is the objective of a corporation? Neoclassical economics and several management theories assume that a firm’s goal is profit maximization subject to capacity constraints. But the story is more nuanced that that, says Eccles.

Variations on a Theme

“Does a company have to create value for shareholders to sustain its existence? The answer is obviously yes,” he says, adding, “There is, however, substantial variation in how corporations actually compete and pursue profit maximization.” One firm may pay lip service to sustainability and eco-friendly practices for the sake of good PR, a practice known as greenwashing, he notes. Others may make such policies a pillar of the organization’s mission by, for example, tying executive compensation to meeting sustainability metrics.

The upshot is that profit and being socially responsible needn’t be mutually exclusive. In fact, his data show that they can go hand in hand if investors and managers look beyond quarterly returns. And although his research focused only on US corporations, Eccles says that anecdotal evidence points to a link between sustainability and profitability in corporate entities across the globe.

“If you look at corporate strategy from the risk side — say, environmental or governmental issues — or on the opportunity side, such as creating new revenue streams, these investments just don’t make sense if you’ve got a very short-term orientation,” he says. “But a company can create value for shareholders over the long term, and do so in a way that creates a sustainable society.”

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