Over the last few decades – if not longer – a persistent belief has arisen that addressing social and environmental issues will come at a cost to businesses. In educating senior business leaders on the strategic implications of sustainability related risks and opportunities, I’m often amazed at how frequently I hear comments along the lines of:
“We clearly need to take action on social and environmental issues, but shareholders will have to accept lower returns as a result.”
Or things like:
“If we choose to follow a sustainable purpose, we should be proud about demonstrating our commitment by accepting a lower rate of return relative to our competitors.”
I believe that there is a very real risk that, if not critically evaluated, this view could drive business leaders back to business-as-usual practices as soon as the health impacts of COVID-19 begin to fade. The good news is that there is a growing body of evidence that indicates that creating value for a broader set of stakeholders does not come at a cost to shareholders, but typically leads to better and more resilient financial returns over the longer term.
It seems 2015 was something of a golden year for research publications in this area – a sign of changing times, perhaps. In this year, an academic study published in the Journal of Sustainable Finance & Investment reviewed over 2,000 empirical studies and concluded that “the business case for ESG [Environmental, Social and Governance] investing is empirically very well founded”.
Meanwhile, Harvard research that looked at the financial performance of 2,307 firms from across various sectors found that:
“…firms with good performance on material sustainability issues significantly outperform firms with poor performance on these issues, suggesting that investments in sustainability issues are shareholder-value enhancing. Further, firms with good performance on sustainability issues not classified as material do not underperform firms with poor performance on these same issues, suggesting investments in sustainability issues are at a minimum not value-destroying.”
Also in 2015, Caroline Flammer, Associate Professor of Strategy & Innovation at Boston University, looked at 2,729 investor proposals and identified all of those related to social and environmental issues that were tabled between 1997 and 2012. Her study focused only on those proposals passed by a small margin (e.g. 50.1%). These ‘close call’ proposals are equivalent to the random assignment of sustainability priorities to a business. This is because acting on the proposal remained voluntary and shareholders could have very easily voted narrowly against them (e.g. if only 0.1% voted the other way).
This study concluded that the adoption of such proposals led to a signiﬁcant increase in shareholder value of 1.77% (the additional value was derived largely from improved labour productivity and sales growth). The random assignment of ESG priorities within these companies demonstrates that there is a causal link between acting on social and environmental issues and the delivery of higher financial returns.
In a 2011 paper, Alex Edmans, Professor of Finance at London Business School, analysed the performance of businesses listed in Fortune’s 100 Best Companies to Work For in America over the period 1984 to 2009. He found that “firms with high levels of employee satisfaction generate superior long-horizon returns, even when controlling for industries, factor risk, or a broad set of observable characteristics” (these companies beat industry benchmarks by 2.1% per year). With the vast majority of corporate value in western countries now being based on intangible assets – 80% by some estimates – it is not surprising that treating employees well pays off.
Indications are that the strength of sustainable investing still holds true since the arrival of COVID-19. For instance, in May 2020, the global institutional investor BlackRock released a study which concluded that:
“Consistent with prior BlackRock research, financial research across market cycles supports our view that sustainable strategies do not require a return trade-off, have important resilient properties, and can offer investors better risk-adjusted returns.”
As with many things, the above views can be contested. Particularly in a world where one can still make good returns from ‘sin stocks’ that fund things like tobacco, gambling and arms. However, with the world rapidly waking up to the social and environmental implications of economic and corporate practices, it is hard to imagine that business as usual will be able to survive untouched. Indeed, many leading businesses have already taken substantive steps forward and have set bold targets that they will have to deliver on over the next ten years.
The reality is that most people don’t only care about maximising returns, but also value personal and societal wellbeing. Research by academics at the Chicago Booth School of Business has shown that investors – who are effectively paying now to have a stake in the future – care about the sustainability performance of companies independently of financial performance. The authors were able to isolate investor preferences after Morningstar, a leading financial research website, unexpectedly published sustainability ratings for more than 20,000 US mutual funds in March 2016. The financial performance of these funds did not change, but investors were able to respond to the sustainability-related information that was provided.
The researchers found that “being categorized as low sustainability resulted in net outflows of more than $12 billion while being categorized as high sustainability led to net inflows of more than $24 billion.” This is strong evidence that investors are not only concerned about maximising wealth, but also care about their future wellbeing and the quality of the world that they will retire into.
In an earlier blog, I explored how corporate thinking has evolved over time and how there has been a growing shift from a focus on maximising shareholder profits to exploring ways in which companies can create value for a broader set of stakeholders (where the environment and society are clear stakeholders, in the sense that they impact on a company’s ability to create, preserve or erode economic, environmental and social value).
This year has seen a doubling in the number of businesses committing to net zero emissions and there have been strong calls for companies to redefine and strengthen their social contracts. Thankfully, if the evidence presented here is anything to go by, businesses can continue to respond to environmental and social challenges in earnest, in the knowledge that this should enhance rather than hinder their longer-term financial performance and resilience.
Oscar Wilde wrote that a cynic is someone who knows the price of everything and the value of nothing. The ongoing distancing, disruptions and damages caused by the COVID pandemic have enlivened a debate that has quietly been gathering momentum since the 2008 financial crisis: what does society value and what does it mean to create value for society? Will 2020 be remembered as the year in which corporate concerns about ‘value’, in its broadest sense, reached a tipping point? Let’s hope so.