by Michael Connor

A new study by researchers at Harvard Business School and London Business School concludes that companies which have voluntarily embraced a sustainable business culture over many years “significantly outperform their counterparts over the long-term, both in terms of stock market and accounting performance.”

Stock Market Screen_000005720299XSmallThe study compares a portfolio of 90 “High Sustainability” organizations that have adopted a substantial number of environmental and social policies since the early to mid-1990s with a similar number of “Low Sustainability” companies that have adopted almost none of those policies.  Financial performance of the two groups is tracked for an 18-year period through the end of 2010.

“We document that sustainable firms are fundamentally different from their traditional counterparts with respect to their governance structure, the extent of stakeholder engagement, the extent of long-term orientation in corporate communications and investor base, and the measurement and disclosure of nonfinancial information and metrics,” the study says. “This is an important finding because it suggests that the adoption of these policies reflects a substantive part of corporate culture rather than purely greenwashing and cheap talk.”

The study – The Impact of a Corporate Culture of Sustainability on Corporate Behavior and Performance – was authored by Robert G. Eccles, Professor of Management Practice at Harvard Business School; Ioannis Ioannou, Assistant Professor of Strategic and International Management at London Business School; and George Serafeim, Assistant Professor of Business Administration at Harvard Business School.

Performance Metrics

The authors report that an investment of $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, the study finds that an investment of $1 in the beginning of 1993 in book value of equity in a value-weighted portfolio of High Sustainability firms would have grown to $31.7 by the end of 2010, compared to only $25.7 for Low Sustainability firms.

Using Return-on-Assets (ROA) analysis, a $1 investment would have resulted in assets in a value-weighted portfolio of sustainable firms growing to $7.1 over an 18-year-period, 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, according to the financial analysis.

Culture of Sustainability

At companies with sustainable business policies, the authors write, boards of director “are more likely to be responsible for sustainability and top executive incentives are more likely to be a function of sustainability metrics.”  In traditional firms, the study says, executive compensation based on short-term metrics “may push managers towards making 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 might 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 in order to be competitive under the constraints that the corporate culture places on the organization,” the study says.

The study concludes:

Overall, we find evidence that firms in the High Sustainability group are able to significantly outperform their counterparts in the Low Sustainability group. This finding suggests that companies can adopt environmentally and socially responsible policies without sacrificing shareholder wealth. In fact, the opposite appears to be true: sustainable firms generate significantly higher profits and stock returns, suggesting that developing a corporate culture of sustainability may be a source of competitive advantage for a company in the long-run. A more engaged workforce, a secure license to operate, a more loyal and satisfied customer base, better relationships with stakeholders, greater transparency, a more collaborative community, and a better ability to innovate may all be contributing factors to this potentially persistent superior performance, even in the very long term.

In their final analysis, the authors pose several questions that are left unanswered: “What is the optimal degree of a culture of sustainability under various circumstances? Since sustainability involves tradeoffs, both across financial and nonfinancial objectives, and between nonfinancial objectives themselves, the firm cannot optimize across all of them. Choices need to be made.”   And, “since the choices a firm makes are dependent on the overall societal context, how will a culture of sustainability evolve as society evolves?”

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