A new study answers an elusive question – does investing in companies known for sustainable business practices result in better returns than investing in conventional companies?
The study finds that yes, investing in sustainable corporations yields significantly better results both on stock and accounting performance. But like sustainability itself, those results are realized over a longer time frame.
The outperformance is stronger for companies that sell directly to individuals rather than other companies – where they compete on the basis of brand reputation, and where products significantly depend upon extracting large amounts of natural resources.
The key is how long the policies have been in place and how well they’ve permeated a company’s culture. Companies that long ago adopted environmental and social policies – "High Sustainability Companies" – exhibit fundamentally different characteristics than traditional firms that have never adopted these policies, conclude the researchers from Harvard and London Business Schools.
High Sustainability Companies are much more likely to take a long-term view of their business. Their boards of directors are responsible for sustainability and they link top executive incentives with clear environmental and social metrics. Moreover, they are more likely to have organized procedures for engaging with stakeholders and to measure and disclose nonfinancial information.
"Our overarching thesis is that organizations voluntarily adopting environmental and social policies represent a fundamentally distinct type of the modern corporation that is characterized by a governance structure that takes into account the environmental and social performance of the company, in addition to financial performance, a long-term approach towards maximizing inter-temporal profits, and an active stakeholder management process," the authors say.
The research compares 90 High Sustainability companies – those with a substantial number of environmental and social policies in place since the early to mid-1990s, before sustainability was trendy – with 90 comparable firms that adopted almost none of these policies. Researchers tracked the financial performance of the two groups for an 18-year period through the end of 2010.
Examples of environmental policies include carbon emissions targets, green supply chain policies and energy and water efficiency strategies. Social policy metrics include diversity and equal opportunity targets, work-life balance, and health and safety. The authors also examined corporate citizenship commitments, business ethics, human rights standards, product risk, and customer health and safety.
How Companies Perform
Investing $1 in the beginning of 1993 in a value-weighted portfolio of High Sustainability firms would have grown to $22.6 by the end of 2010, based on market prices. In contrast, a similar investment in a value-weighted portfolio of Low Sustainability firms would have grown to only $15.4 by the end of 2010.
Using Return-on-Equity (ROE) accounting metrics, that $1 would have grown to $31.7 in book value by the end of 2010 for a High Sustainability portfolio, compared to $25.7 for Low Sustainability firms.
Using Return-on-Assets (ROA) analysis, the $1 investment would have grown to $7.1 in assets for High Sustainability firms, compared to only $4.4 for a portfolio of traditional firms.
An equal-weighted portfolio of High Sustainability firms also outperformed a portfolio of traditional firms.
Culture of Sustainability
The authors posit that the evolution of a "culture of sustainability," where environmental and social performance is considered equally important to financial performance, forged a different kind of long term corporate model with its own values and beliefs.
It takes about three years for High Sustainability companies to outperform their counterparts, and it continues to rise after that. "These sustainability issues take time to bed in and it’s difficult to see differences over a 1-2 year time horizon. But we see clear outperformance after three years and that increases over time."
Executive compensation in traditional firms is based on short-term metrics, and only on financial ones. That encourages managers to make decisions that deliver short-term performance at the expense of long-term value creation. Consequently, a short-term focus on creating value for shareholders alone may result in a failure to make the necessary strategic investments to ensure future profitability.
"Firms in the High Sustainability group may outperform traditional firms because they are able to attract better human capital, establish more reliable supply chains, avoid conflicts and costly controversies with nearby communities, and engage in more product and process innovations to be competitive under the constraints that the corporate culture places on the organization."
The authors conclude, as so many other studies do, that adopting strong environmental and social practices enhances performance, rather than impedes it. The argument against adopting such practices is often the "high cost" when in fact the opposite is true. Low Sustainability companies face much higher costs over the long run, even if they have strong short term results.
Although the study focuses on large US companies where extensive data exists, the authors say the same could be true for smaller companies. The research findings show tangible value to individual and institutional investors that have long-term return horizons that integrate environmental, social and governance (ESG) factors into their stock selection.
Rona Fried, Ph.D. is CEO of SustainableBusiness.com
You can read the full study here, which was conducted by researchers at Harvard and London Business Schools: The Impact of a Corporate Culture of Sustainability on Corporate Behavior and Performance
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