Robert G. Eccles, Ioannis Ioannou, & George Serafeim, The Impact of a Corporate Culture of Sustainability on Corporate Behavior and Performance, Harvard Business School Working Paper 12-035 (2012), available at SSRN.
Progressive corporate law scholars have tended to ignore business or economics research as potential support for their normative claims. When seeking interdisciplinary insights they have generally looked elsewhere. This is not surprising, given that business and economics scholarship often reflects assumptions about corporate law that progressives reject, in particular a shareholder primacy orientation that prioritizes shareholder wealth maximization while disregarding social costs. For progressives, business and economics scholarship may also bear the taint of its embrace by mainstream corporate law scholars, many of whom have a strong law-and-economics, empirical perspective that draws them naturally to finance, accounting, and management literature.
Those interested in corporate social responsibility (CSR) and the problems of managerial and investor short-termism should not overlook the paper reviewed here. Robert Eccles, Ioannis Ioannou, and George Serafeim (professors at Harvard, London, and Harvard business schools respectively) make an important contribution to debates among corporate law academics about CSR as an alternative to shareholder primacy. Their paper also has significant relevance to those who are concerned about the costs of shareholder primacy’s current incarnation as an obsession with quarterly earnings and their effects on share prices. The authors present a sophisticated, empirically grounded demonstration of the economic advantages enjoyed by corporations that have chosen to invest in stakeholder relationships and to pursue a long-run approach to wealth creation. Because these companies are shown to outperform financially their more traditionally-minded, shareholder-primacy, short-term-oriented rivals, CSR advocates can assert a ‘business case’ for their belief that corporations should attend to the well-being of nonshareholding stakeholders, including employees, customers, local communities where the firm operates, and those who are affected by its impact on the environment. The business case also lends support to critics of short-termism who have no particular interest in CSR.
A persuasive ‘business case’ for CSR is important because until now the large body of empirical research investigating its efficiency has yielded distinctly mixed results. Further, the ‘ethical case’ for CSR gains limited traction among investors and managers seeking to maximize financial returns. Progressives do need to bear in mind the limits of the business case: it justifies investment in stakeholder well-being only to the extent that there is a financial payoff. Nevertheless, there is no doubt that companies genuinely embracing a stakeholder orientation create more social value than those that do not, even if their motivation is primarily economic.
Eccles and his colleagues identify 90 corporations that adopted a range of social and environmental policies in the early 1990s. These are referred to as the ‘High Sustainability’ (HS) firms because they invest in and nurture valuable stakeholder relationships in order to create financial gains sustainable over the long run. They integrate these policies into their business models rather than merely paying lip service to CSR as a marketing strategy. The authors then match these firms with 90 others, each closely comparable to its HS counterpart in sector, size, capital structure, operating performance, and growth potential. The second group – the ‘Low Sustainability’ firms – pursue a traditional commitment to profit and share price maximization, disregarding externalities where cost-effective to do so. Their short-term orientation discourages even stakeholder expenditures that promise long-term payoffs because of the immediate negative impact on accounting results.
Having constructed these two sets of firms, the authors draw on third-party proprietary databases that analyze the extent to which particular companies have embraced various sustainability practices and policies. The point is to assess the extent to which the corporate culture of the firms that embarked on a sustainability path truly is different today from that of their traditional, LS counterparts. The authors find substantial, often dramatic differences. As to governance, for example, HS firms are much more likely to assign explicit responsibility to the board of directors or a specially tasked board committee to advise and to monitor senior management on sustainability issues. The compensation of senior executives is more often linked to environmental and social metrics, in addition to the more typical financial ones.
Because a commitment to sustainability requires stakeholder engagement in order to understand needs and expectations and develop effective responses, HS firms tend to adopt mechanisms that are unusual at LS firms. These include processes for facilitating and collecting expressions of concern, such as grievance mechanisms, and for reporting responses to stakeholder issues to the stakeholders themselves and to the public. HS firms ‘are more focused on understanding the needs of their stakeholders, making investments in managing these relationships, and reporting internally and externally on the quality of their stakeholder relationships.’ (P. 17.)
Commitment to sustainability also requires a long temporal horizon because development of robust stakeholder relationships requires trust based on effective cooperation over time. It also requires expenditures that reduce earnings in the short-term – such as employee training, infrastructure investments in developing countries, and customer service – while generating payoffs only in the future. Eccles and his co-authors find evidence of a long-term orientation among HS firms in comparison to their LS counterparts by analyzing the language used in conference calls with stock analysts. They also find higher percentages of shares owned by ‘dedicated’ or patient shareholders as opposed to ‘transient’ or high portfolio turnover investors. As with internal governance and stakeholder engagement, the point here is that the companies that embarked on a sustainability path in the early 1990s had by 2010 developed distinctive cultures that set them apart from their LS counterparts in a number of significant, substantive ways. The differences go far beyond mere ‘greenwashing’ or ‘cheap talk.’
Having shown in detail the significant cultural differences between the HS and LS firms, Eccles and his colleagues then compare their financial performance, using both share price and accounting metrics. These findings are likely to draw the greatest interest and attention. The cumulative stock market performance of the HS firms from 1993 through the end of 2010 is significantly stronger: $1 invested in a value-weighted HS portfolio would have grown to $22.6, versus $15.4 for a LS portfolio. Equal-weighted portfolios would have yielded similar differences. Accounting measures likewise indicate superior performance. Using return on assets as the metric, $1 invested in a value-weighted portfolio of HS firms would have grown to $7.1 compared to $4.4 for a LS portfolio. Similar results are derived using return on equity. The authors’ conclusion is a bold one: ‘companies can adopt environmentally and socially responsible policies without sacrificing shareholder wealth creation. 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.’ (P. 30.)
The implications of this study for corporate law are important. It often seems as if corporate law progressives and mainstream law-and-economics proponents talk past each other with no basis for engagement. It is as if those concerned about the social costs of corporate activity have nothing to say to those focused on maximization of shareholder wealth. A persuasive, empirically grounded business case for CSR can change that because it allows corporate law progressives to justify attention to nonshareholder considerations in economic rather than purely ethical terms. The duties of directors and senior officers therefore might more readily be defined as embracing a range of stakeholder interests, rather than in terms of shareholder primacy. The case for management’s ability to deploy defensive measures against hostile takeovers may also be strengthened. Takeovers can threaten long-run business strategies for the sake of short-term shareholder gains. However, this paper also suggests the need to interrogate target management claims. All firms are not equal with respect to genuine commitment to long-run, sustainable business models.
The results presented in this paper also have important implications beyond the divide between proponents of CSR and shareholder primacy. At the moment, a shareholder empowerment agenda enjoys strong support in legal academic as well as business circles. The idea is that shareholders should be better able to pressure management to act in their interests. I have written elsewhere about the propensity of many large institutional shareholders, including public and private pension and mutual funds, to focus their investment strategies on short-term, quarter-to-quarter gains. This is a function, in the case of pension funds, of their current legal obligations to their beneficiaries and, in the case of mutual funds, of competition for investor dollars. The paper under review here warns us that empowering these shareholders could threaten business strategies capable of creating long-run economic value that exceeds what can be realized from a focus on quarterly profits. Shareholder empowerment, in other words, would yield financial as well as social costs. Beyond its value as a response to the shareholder rights activists, this paper also lends strong support to arguments for proactive law reform aimed at curbing short-term investment and management horizons. In sum, here is a paper, empirically grounded and produced by business school researchers, that should be of great interest to corporate law scholars skeptical of shareholder primacy or concerned about short-termism.