Industry Market Trends

"High-Sustainability" Companies Perform Better Over Long Run

May 01, 2012

You might thFord headquartersink a sustainability program requires a great deal of effort: measure your environmental impact, buy renewable energy, conserve water, plant a lot of trees on your campus, etc. (Photo: Ford Motor Co.'s world headquarters. Credit: Jeff Powers, CC BY-ND 2.0.)

But according to researchers in a Harvard Business School working paper, the long-term benefits outweigh the short-term pain. Robert Eccles and George Seraeim of Harvard Business School, with Ioannis Ioannou of London Business School, studied 180 companies and compared the financial performance of what they call "high-sustainability" and "low-sustainability" companies. They found that high-sustainability companies foster a culture that often results in longer-term profitability and stakeholder value. In fact, the researchers concluded, high-sustainability companies "significantly outperform their counterparts over the long term, both in terms of stock market and accounting performance." (See "The Impact of a Corporate Culture of Sustainability on Corporate Behavior andPerformance," Nov. 25, 2011)


The High-Sustainability Company: A Different Animal

Eccles notes that a growing number of companies in recent years "have integrated social and environmental policies in their business model and operations, on a voluntarily basis." These policies, he proposes, reflect an underlying company culture where environmental and social performance are important. Eccles writes:

"Organizations voluntarily adopting environmental and social policies represent a fundamentally distinct type of the modern corporation that is characterized by a governance structure that takes into account the environmental and social performance of the company, in addition to financial performance, a long-term approach towards maximizing inter-temporal profits, and an active stakeholder management process."

GE headquartersIn the study, Eccles and colleagues identified 90 high-sustainability companies that, since the early 1990s, have adopted governance structures that take into account environmental and social performance and exhibit "a substantial number of environmental and social policies that have been adopted for a significant number of years." Then they identified 90 low-sustainability companies that operate in the same sectors as the high-sustainability ones and have similar size, capital structure, growth opportunities and other characteristics. These companies implemented almost none of the sustainability policies identified among the high-sustainability group. Eccles reports that the high-sustainability companies had an average $8.6 billion in assets, while the low-sustainability companies had about the same, $8.2 billion. (Photo: GE headquarters in Fairfield, Conn. Courtesy of GE.)

The high-sustainability companies, Eccles found, are characterized by a distinct type of company culture in terms of "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 non-financial information and metrics," which suggests that "the adoption of these policies reflects a substantive part of corporate culture rather than purely 'greenwashing' and cheap talk."

The researchers found that companies with a high-sustainability culture are more likely to:

  • Judge success according to long-term metrics
  • Place responsibility for sustainability at the board level and establish a special board committee dedicated to sustainability
  • Include environmental and social metrics and external perception (such as customer satisfaction) as factors when deciding executive compensation
  • Establish a formal process for engaging stakeholders (such as employees, customers and suppliers) and set metrics around the company's relationships with stakeholders
  • Measure and disclose "more data related to non-financial performance."


Does It Pay to Be Sustainable?

The researchers found that high- and low-sustainability companies differ significantly in their financial performance. Eccles writes:

"We track corporate performance for 18 years and find that sustainable firms outperform traditional firms in terms of both stock market and accounting performance. Using a four-factor model to account for potential differences in the risk profile of the two groups, we find that annual abnormal performance is higher for the High Sustainability group compared to the Low Sustainability group by 4.8 percent (significant at less than 5 percent level) on a value-weighted base and by 2.3 percent (significant at less than 10 percent level) on an equal-weighted base. We find that sustainable firms also perform better when we consider accounting rates of return, such as return-on-equity and return-on-assets."

Analysis revealed that a dollar invested in 1993 in a value-weighted portfolio of sustainable firms would have grown to $22.60 by 2010, versus only $15.40 for traditional firms.

The study found that that the performance difference was more pronounced between companies that sell to consumers than between companies that sell to other businesses. (Photo: Siemens headquarters in Munich, Germany. Credit: Teo Romera, CC BY-SA 2.0.)

Siemens headquarters

Eccles spotlights the dichotomy between the long-term thinking of the high-sustainability companies and the short-term thinking that more characterized the low-sustainability companies and its effect on company performance. According to the article:

"[E]xecutive compensation incentives that are 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. Importantly, such a short-term approach to decision making often implies a negative externality being imposed on various other key stakeholders. In other words, short-termism is incompatible with extensive stakeholder engagement and a focus on stakeholder relationships."

Eccles thinks his group's research suggests that companies "can adopt environmentally and socially responsible policies without sacrificing shareholder wealth creation." In fact, the higher returns for sustainable firms suggest that a corporate culture of sustainability might in the long term serve as a competitive advantage:

"A more engaged workforce, a more 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 in the long-term."