by Michael Connor

Wall Street analysts who issue “buy” and “sell” recommendations on publicly-held companies are increasingly awarding more favorable ratings to firms with corporate social responsibility (CSR) practices, according to a new academic study.

Stock ExchangeThe study – The Impact of Corporate Social Responsibility on Investment Recommendations by Ioannis Ioannou, an Assistant Professor at the London Business School and George Serafeim, an Assistant Professor at the Harvard Business School – examined how social performance ratings for companies affected the recommendations of “sell side” analysts in the United States.

“Sell-side” analysts typically work for brokerage firms and issue research and recommendations that are generally made public. (“Buy-side” analysts typically work for mutual funds, pension funds or other large investors; their research is generally not made public.)

The study examined data on 4,109 companies over a 16-year period.  It found that from 1993-1997 a company’s CSR strength had a “significant negative impact” with sell-side analysts.  Since 1997, however, the perception has become more positive.

“As time goes by, CSR strategies are perceived to be value-creating, potentially more legitimate, thus uncertainty about future cash flows and profitability is reduced and, analysts assess CSR initiatives more accurately,” the authors write.

The authors suggest several reasons why CSR strategies might affect sell-side analysts’ recommendations. “If CSR affects a firm’s long-term financial performance by creating (or destroying) value for a broad range of stakeholders, including customers, employees and competitors, then the resulting changes in financial performance will have a direct impact on analysts’ recommendations,” they write.

Another reason, according to the authors, is the rapid growth of socially responsible investing.  They report that in 2007 mutual funds investing in socially conscious firms had assets under management of more than $2.5 and $2 trillion dollars in the U.S. and Europe respectively. Socially conscious funds in Canada, Japan and Australia held $500 billion, $100 billion and $64 billion respectively. Funds in the U.S., U.K. and Canada grew by $400 billion, $600 billion and $400 billion respectively, between 2001 and 2007, according to the study.

Companies with “higher visibility” receive more favorable recommendations for their CSR strategies, the study found, while “analysts with more experience, broader CSR awareness or those with more resources at their disposal, are more likely to perceive the value of CSR strategies more favorably.”

While “the issue of whether CSR strategies result in value creation is by no means decided,” according to the study,  perceptions of Wall Street analysts should be considered carefully by company management.

The authors write: “Top executives and managers interested in implementing CSR strategies in their organizations should be aware that negative analysts’ reactions, and subsequent value destruction in capital markets is a real possibility when they initially attempt to implement such strategies.  Managers should particularly focus on communicating the value of CSR strategies to the investment community. Highlighting short term costs but also long-term benefits could mitigate difficulties that investors may face in understanding the value generated through such activities and might expedite the adjustment of their valuation models to these new CSR-augmented business models.”

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