The impact of CSR on corporate behaviour and performance – by London Business School Professor Ioannis Ioannou

Dr. Ioannis Ioannou
Strategy and Entrepreneurship Area
London Business School

An important problem
Economist Joseph Stiglitz recently announced
that he believes climate change is the most
important issue facing the U.S. economy Joseph Stiglitz, Economist
today. Certainly, climate change is a serious
global issue, but how exactly will it affect the
U.S. economy? What follows are some
statistics on climate change’s impact on the
U.S. economy, gathered primarily from non-
governmental organizations that deal with
climate change issues.
http://www.huffingtonpost.com/2013/01/08/joe-stiglitz-climate-change-economy_n_2432744.html

Statistics
• Climate change is projected to cost the average U.S. household
$1,250 per year by 2020, $1,800 per year by 2040 and $2,750 per year
by 2080.
• Climate change will likely cost the U.S. economy $3.8 billion per year
by 2020, $6.5 billion per year by 2040 and $12.9 billion by 2080.
• The U.S economy may be held back by 2% of GDP over the next 20
years because of climate change.
• Failure to act on climate change already costs the world economy 1.2
trillion dollars in lost prosperity each year, according to one study.
• Lost prosperity associated with rising temperatures and carbon-related
pollution could double costs to 3.2% of world GDP by 2030.


Statistics
• Climate change is a leading global cause of death, responsible for an
estimated 5 million deaths each year.
• From 1980 through 2011, U.S. weather disasters caused losses of
$1.06 trillion.
• In 2011, the United States broke the record for the most billion-dollar
weather disasters in a year.
• Due to climate change, the timber industry is expected to suffer from
an increased prevalence of pests, slower growth rates for trees and
more frequent wildfires, resulting in a decrease in revenue of $1 billion
to $2 billions per year.


Why Sustainability?
Strategy: superior sustainable performance
Increasing pressures for Expectations for companies to
companies to be perform not only in terms od
sustainable not only in profitability (i.e. shareholder
terms of capacity to produce returns), but also in terms of
profits but also within their social and environmental
social and environmental performance…
context…

RESEARCH AGENDA

CAPITAL MARKETS

ANTECEDENTS LONG-TERM
AND DETERMINANTS SUSTAINABILITY VALUE CREATION

“The impact of CSR on Investment Recommendations”, with G.
Serafeim (HBS), working paper CAPITAL MARKETS

“CSR and Access to Finance”, with B. Cheng (HBS) and G.
Serafeim (HBS) Strategic Management Journal, forthcoming

“Do Actions Speak Louder than Words? The case of CSR”, with O.
Hawn (Duke, working paper

“Understanding the Cognitive Gap Between Companies and
Investment Analysts”, with D. Crilly (LBS), working paper

“What drives Corporate Social Performance? The Role of National-
level Institutions”, with G. Serafeim (HBS), Journal of International
Business Studies, forthcoming

“The consequences of Mandatory Corporate Sustainability
Reporting”, with G. Serafeim (HBS), working paper

“The consequences of a Culture of Sustainability Reporting”, with
R. Eccles (HBS) and G. Serafeim (HBS), working paper

“Pay for Environmental Performance: The effect of Incentive
ANTECEDENTS Provision on Reducing Carbon Emissions”, with R. Eccles (HBS),
AND DETERMINANTS X. Li (HBS) and G. Serafeim (HBS), working paper

“Understanding the Cognitive Gap Between Companies and
Investment Analysts”, with D. Crilly (LBS), working paper

The impact of a Corporate Culture of
Sustainability on Corporate
Behavior and Performance
with George Serafeim (HBS) and Robert Eccles (HBS)

MOTIVATION METHODS FINDINDS IMPLICATIONS

MOTIVATION

The Role of the Corporation in Society
Neo-classical view: To maximize profits subject to capacity constraints

This is equivalent to maximizing the market value of all claims of capital providers in the
absence of market failures (Jensen 2001)

However, firms, as far as neoclassical economics is concerned are ‘black’ boxes

In reality they differ significantly in how they are trying to achieve this objective:

 Stakeholder vs. shareholder focus
 Inter-temporal trade-offs
 Externalities
 Ethics

MOTIVATION

A Corporate Culture of Sustainability
Environmental and social performance are important, in addition to financial performance.
Some organizations are voluntarily integrating social and environmental issues into their
business model and strategy.

Typically, values, preferences and beliefs are coded in corporate policies.

Culture is “the specific collection of values and norms that are shared by people and
groups in an organization and that control the way they interact with each other and with
stakeholders outside the organization” (Hills and Jones, 2001)

MOTIVATION

Increasing Interest in Corporate Sustainability
Corporations
UN Global Compact – Accenture CEO study (2010): 93% of the 766 participant
SEOs worldwide, declared sustainability as an “important” or “very important” factor
for their organizations’ future success (Ioannou and Serafeim, 2011)

Employees
A BT study in the UK found that 44% of young professionals said they would
discount an employer with a bad reputation.

80% of respondents would prefer working for a company that has a good reputation
for environmental responsibility (Insync surveys, 2008)

ESG performance is the third most important driver of employee engagement
overall, and an organization’s reputation for social responsibility is an important
driver for both engagement and retention (Towers Perrin, Global Workforce Study
2007-2008)

MOTIVATION

Customers
A recent 5,000 people survey by Edelman revealed that nearly two thirds of those
interviewed cited “transparent and honest business practices” as the most important
driver of a firm’ reputation (Cheng, Ioannou and Serafeim 2011)

Investors
Global Socially Responsible Investing (SRI) market grew at an annual rate of 22%
since 2003. The SRI sector would grow to $26.5 trillion AUM by 2015, representing
15% of the global total (Eccles, Serafeim and Andrews, 2011)

In recent years, investment recommendations are more optimistic for companies
with good ESG performance (Ioannou and Serafeim, 2010)

Large market interest in the level of a company’s degree of transparency around
ESG performance (Eccles, Krzus and Serafeim, 2011)

MOTIVATION


CorporateRegister.com – External reporting on sustainability performance (Eccles, Serafeim and Andrews, 2011)

MOTIVATION

Research Questions
Characteristics of Sustainable Organizations
 Does the governance structure of sustainable organizations differ from traditional
firms and, if yes, in what ways?
 Do sustainable organizations have better stakeholder engagement?
 Do sustainable organizations have longer time horizons?
 How do their information collection and dissemination systems for nonfinancial
data differ, if at all?

Performance implications
 Could meeting other stakeholders’ expectations come at the cost of creating
shareholder value?
 In general, what are the performance implications for sustainable organizations
characterized by the above structural elements

METHODS

Back to 1993
In 1993, Firm A and Firm B were statistically identical in
terms of:

 Industry membership
 Total Assets
 Return on Assets
 Leverage
 Turnover
 Market to Book

METHODS

Corporate policies
Except that firm A had an explicit emphasis on employees,
customers, products, the community and the environment as
part of their business model.

In other words, Form A had adopted several corporate
policies that reflected an integration of social and
environmental issues whereas Firm B had not.

Sample construction
Match each firm A with another firm B that has adopted
almost no environmental and social policies throughout the
1990s and 2000s.

Exact matching on subsector and matching with closest
neighbor on Size, ROA, MTB, Asset Turnover and Leverage
in 1993.

METHODS

Sample construction
Firms with an explicit emphasis on employees, customers, products, the community and
the environment as part of their business model.

Adopted policies for many years to allow for such policies, in turn, to reinforce the norms
and values upon which a sustainability culture and integration are based.

Adopted policies prior to CSR becoming widespread, less likely to have measurement
error by including firms that are either ‘green-washing’ or adopting these policies for PR.

Introduce a long lag between our independent and dependent variables – mitigate the
likelihood or biases that could arise from reverse causality.

METHODS

Fast forward to 2009
We chose 90 such pairs from the United States,
representing in total 180 of the largest US corporations.

Key question: What happened in 2009?

Remember: in 1993, these pairs of companies looked
almost identical on everything except corporate policies
relating to Sustainability.

FINDINGS: ARE HIGH SUSTAINABILITY ORGANIZATIONS DIFFERENT?

Corporate Governance
Boards of directors perform a monitoring and advising role and ensure that management
is making decision ins a way that is consistent with organizational objectives.

Top management compensation plans align managerial incentives with the goals of the
organization by linking executive compensation to key performance indicators that are
used for measuring corporate performance.

Prediction 1a: High Sustainability forms are more likely to have
a board review the sustainability performance of the
organization.

Prediction 1b: High Sustainability firms are more likely to link
executive compensation to sustainability metrics.


Corporate Governance


Stakeholder engagement
Engagement is necessary for understanding these stakeholders’ needs and expectations
in order to make decision about how best to address them (Freeman, 1984; Freeman,
Harrison, and Wicks, 2007).

Prediction 2: High Sustainability firms have better stakeholder
engagement practices.


Stakeholder engagement


Time Horizon
Integrating environmental and social policies in the business model and operations
requires a long-term perspective.

Incurring short-term costs while expecting long-term benefits
 Providing positive externalities and internalizing negative externalities
 Building good stakeholder relations as part of a corporation’s’ strategy takes time
to materialize, is idiosyncratic to each corporation, and depends on its history;
such relationships are based on mutual respect, trust and cooperation and such
tied take time to develop (Choi and Wang, 2010)

Prediction 3: High Sustainability firms are more long-term
oriented.


Long Term Time Horizon


Measurement of Non-Financial Information
Performance measurement is essential for management to determine how well it is
executing on its strategy and to make whatever corrections are necessary (Kaplan and
Norton, 2008)

Reporting on performance measures to the board is an essential element of corporate
governance, so that the board can form an opinion about whether the management is
executing the strategy of the organization well.

Quality, comparability and credibility of information is enhance by internal and external
audit procedures which verify the accuracy of this information or the extent to which
standards are being followed.

Prediction 4: High Sustainability firms are more likely to collect
non-financial data.


Supplier Standards


Disclosure of Non-Financial Information
External reporting of performance is how the company communicates to shareholders
and other stakeholders how productively it is using the capital and other resources they
have provided to the corporation.

Prediction 4: High Sustainability firms are more likely to
disclose non-financial data.


Disclosure of Non-Financial Information

IMPLICATIONS: WHAT ARE THE PERFORMANCE IMPLICATIONS FOR HIGH SUSTAINABILITY ORGANIZATIONS?

Implications for Financial Performance
High Sustainability firms might underperform because they:
 Experience high labor costs by providing excessive benefits to their employees
 Pass valuable business opportunities that do not fit their values and norms
such as selling products with adverse environmental consequences
 Deny paying bribes to gain business in corrupt countries where bribe payments
are the norm

High Sustainability firms might outperform because they:
 Are able to attract better human capital
 Establish more reliable supply chains
 Avoid conflicts and costly controversies with nearby communities
 Engage in more product and process innovations


Buy-and-Hold Stock Returns, Value-weighted Portfolio


Buy-and-Hold Returns, Return on Equity (ROE)


Buy-and-Hold Returns, Return on Assets (ROA)


Abnormal Stock Returns
Four-factor model based on Fama-French (1992) and Carchart (1997)

Annual abnormal performance is higher for the High Sustainability group compared to the Low Sustainability group by 4.8%
(significant at less than 5% level) on a value-weighted based and by 2.3% (significant at less that n 10% level) on an equal
weighted-base.


Performance and Sectoral Membership

Conclusion
High Sustainability firms are characterized by:

 Distinct governance mechanisms which directly involve the board in
sustainability issues and link executive compensation to sustainability
objectives;
 A much higher level of and deeper stakeholder engagement, coupled with
mechanisms for making it as effective as possible, including reporting;
 A longer-term time horizon in their external communications, which is matched
by a larger proportion of a long-term investors;
 Greater attention to nonfinancial measures regarding employees; a greater
emphasis on external environmental and social standards for selecting,
monitoring and measuring the performance of their suppliers;
 A higher level of transparency in their disclosure of nonfinancial information and
 Superior accounting and stock market performance in the long-term.

Conclusion
Given changing societal expectations (Paine, 2004), we believe hat
increasingly more and more firms will integrate environmental and social
issues in their strategy and business model.

Significant opportunities for future research:
 Conditions under which companies adopt a culture of sustainability?
 Mechanisms by which such cultures get created?
 Can sustainability destroy shareholder value under certain conditions?
 Are sustainable firms less likely to cut back on R&D investments, lay off
employees and consolidate suppliers in down economic cycles? Are they less
likely to provide quarterly earnings guidance?
 What determines materiality?

Thank you!
Questions and Feedback much appreciated
@iioannoulbs
www.ioannou.us

The impact of CSR on corporate behaviour and performance – by London Business School Professor Ioannis Ioannou

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The impact of CSR on corporate behaviour and performance – by London Business School Professor Ioannis Ioannou