A recent study involving a survey of over 1000 CEOs found that 93% of them believe that sustainability will be important for the future success of their business. These views may be based on strong evidence from studies that have contributed to strengthening the link between company performance and “doing the right thing”. However it should not be forgotten that a moral, and in some cases legal expectation towards business to do the right thing exists independently of financial incentives.
Cost and risk reduction
These days the consequences of irresponsible business behaviour can be significant. For example BP’s bill for settlements of state and federal claims for environmental damages and damages to impacted communities for the Deep Water Horizon spill reached nearly USD 54 billion this June. The Volkswagen scandal involving emissions rigging of vehicles contributed to their stock plummeting a third of its value in less than a week and estimated costs associated with recalls as well as penalties that will have to be paid are being reported at USD 35 billion.
A recent study by Vigeo showed that corporate social responsibility (CSR) related sanctions for companies are also quite common. Nearly 20% of companies in a sample of over 2,500 were found to be subject to such sanctions between 2012 and 2013, amounting to penalties upwards of EUR 95.5 billion
Beyond actual legal liabilities poor business conduct can also result in delays and opportunity costs for companies. For example where companies do not adequately communicate and engage with stakeholders it frequently leads to delays in operations, misapplication of staff time, and lost opportunities in instances where companies want to expand operations, renew contracts or otherwise. A study by Harvard found that the costs attributed to delays arising from community conflict can cost a mining project with capital expenditure between USD 3 million and USD 5 billion on average, or USD 20 million per week in NPV (Net Present Value) due to delayed production.
Additionally, reputational costs stemming from poor business conduct increasingly can hurt the bottom line and scare off investors. Today divestment campaigns from companies with poor environmental and social records are a common tool to encourage better behaviour.
Competitive advantage, reputation and legitimacy.
Responsible business practices, in addition to avoiding costs, can help to build a positive corporate culture and image. This in turn can influence the retention of employees, help increase productivity as well as boost brand appeal and thus increase market strength.
In a study of the ‘’100 Best Companies to Work for in America’’, Prof. Edmans of the London School of Business found that those companies generated 2.3-3.8% higher stock returns per year than their peers over a period of 27 years.
More broadly, a cross-sector Harvard Business School study by Prof. Serafeim and others tracked performance of companies over 18 years, found that “high sustainability” companies, those with strong environmental, social and governance (ESG) systems and practices in place, outperformed “low sustainability” companies as measured by stock performance and in real accounting terms. (High sustainability include companies which include a substantial number of environmental and social policies that have been adopted since the early to mid-1990s; Low-Sustainability Companies include comparable firms that have adopted almost none of these policies.)
Firms with better sustainability performance were also shown to face significantly lower capital constraints. A study by Babson College and IO Sustainability found that CSR practices have the potential to reduce the cost of debt for companies by 40% or more and increase revenue by up to 20%. Likewise a recent meta study by the University of Oxford found that 90% of the studies on cost of capital show that sound sustainability standards lower the cost of capital of companies. Furthermore the study found that 88% of research showed that solid responsible business practices result in better operational performance. And 80% of the studies show that stock price performance is positively influenced by good sustainability practices.
Shared value creation
In a Harvard Business School article Professors Porter and Kramer coined the term ‘’shared value creation,’’ defining it as generation of economic value in a way that also produces value for society by addressing its challenges. A shared value approach reconnects company success with social progress. Firms can create shared value in three ways: (1) by reconceiving products and markets; (2) redefining productivity in the value chain; and (3) building supportive industry clusters at the company’s locations.
Porter & Kramer describe the societal and business benefits of providing products to meet societal needs and serve disadvantaged communities and developing countries. For example, a service developed by Thomson Reuters providing weather and crop pricing information for farmers earning under $2,000 reached subscription by an estimated 2 million farmers and contributed to increasing income in more than 60% of them. In another example Nespresso created shared value by investing in their suppliers, resulting in higher incomes and fewer environmental impacts among coffee growers, while increasing Nespresso’s supply of reliable quality coffee beans.
Delayed recognition of the business case for RBC
While a significant and growing body of empirical evidence is pointing to the fact that responsible business makes good business sense this understanding has yet to be internalized in the mainstream. In the first place information challenges continue to exist because certain benefits of RBC such as strong corporate culture or good will are difficult to isolate and quantify. However there is reason to believe that these data gaps will be overcome as increased information regarding RBC is collected.
Another reason is that intangible assets, whether they be related to RBC or other intangibles in general, are not usually immediately reflected by financial markets as their value is only realized in the long term. In order to make sure these values are recognized in financial markets, and thus adequately prioritized at the level of companies themselves, organizational changes will have to be made.
There is growing evidence that responsible business conduct pays off for business which affirmatively answers the question that companies can indeed do well by doing good. However in order to ensure that responsibility is embedded within corporate DNA, a move towards organizational and incentive structures prioritizing long term growth over short term gains will have to be made.