Alpha for ‘high sustainability’ companies after 3 years, says major Harvard/LBS research report

A financial premium for ‘high sustainability’ companies can be perceived after three years and continues to rise after that, according to a significant new report by Harvard Business School and the London School of Business. The findings of the research show tangible value to institutional investors with long-term return horizons that integrate environmental, social and governance (ESG) factors into their stock selection. The report, titled: “The Impact of a Corporate Culture of Sustainability on Corporate Behaviour and Performance” is co-authored by Robert Eccles, Professor of Management Practice at Harvard Business School, George Serafeim, Assistant Professor of Business Administration at Harvard Business School, and Ioannis Ioannou, Assistant Professor of Strategic and International Management at London Business School. From a sample of 180 US-based companies, the research finds that high sustainability companies significantly outperform similar low sustainability companies over the long-term in both stock market and accounting performance. Tracking performance over 18 years, the research finds that investing $1 in the beginning of 1993 in a value-weighted (equal-weighted) portfolio of sustainable firms would have grown to $22.6 ($14.3) by the end of 2010, based on market prices, compared to $15.4 ($11.7) in a portfolio of low sustainability firms. The research report suggests that a corporate culture of sustainability has created a distinct type of corporation that performs better on both financial and social metrics.Speaking to Responsible-investor.com, Serafeim said: “These sustainability issues take time to bed in and it’s difficult to see differences over a 1-2 year time horizon. But we see clear outperformance after three years and that increases over time.” The academics said the research was designed to test the hypothesis of a performance difference for a ‘sustainable company’, which they said referred to firms that have a clear strategic focus on ESG issues, but without any a priori positive or negative connotation. They said traditional or ‘low sustainability’ companies referred to those without such developed policies. Examples of the environmental policy markers used for the research included carbon emissions reduction action, green supply chain policies and energy and water efficiency strategies. Social policy metrics used included diversity and equal opportunity targets, work-life balance, health and safety improvement, and favouring internal promotion. Policies related to community included corporate citizenship commitments, business ethics, and human rights criteria. Other measurements related to customers included product risk, and customer health and safety. The research aimed to iron out ‘greenwashing’ effects by looking at actual corporate policy implications via interviews with corporate executives. It identified 90 companies that by the late 2000s had adopted almost 50% of the ESG reference policies and then matched each of these with low sustainability companies that had on average, adopted only 10% of the same policies by the late 2000s to create a 180 firm universe. The
matching was done to compare like-for-like companies as far as possible and to avoid sustainability initiatives being linked to resources. The research found that the market price outperformance was also borne out on a ‘return on equity’ and ‘return on assets’ basis. The professors posited that the evolution of a “culture of sustainability” within certain companies, where environmental and social performances – in addition to financial performance – were important, had forged a new corporate model with explicit values and beliefs. They said ‘high sustainability’ companies were more likely to make executive compensation a function of ESG metrics, to engage better with customers and stakeholders and be long-term oriented. Notably, they said such companies tended to have more long-term investors and communicated more long-term information to sell-side and buy-side analysts: “Information is a crucial asset that a corporation needs to have for effective strategy execution by management as well as the effective monitoring of this execution by the board. We find that sustainable firms are more likely to measure information related to key stakeholders — such as employees, customers and suppliers — and to
increase the credibility of these measures by using auditing procedures. We also find that sustainable firmsdo not only measure but they also disclose more data related to non-financial information; this is consistent with these companies communicating important strategic dimensions and how well they perform in strategy execution. Importantly, we show that this type of corporate behaviour results in significant variation in corporate performance.” Serafeim said the geography of the study had probable implications for the financial results: “The fact that this is a US sample could mean, for example, that the US has been lagging behind on sustainability issues, which over time are having an impact on consumer trends and thus prices. The reason we chose the US is that the quality of the data is very good, and better data in other countries might also uncover similar results. However, it could also be that these findings are very country specific: you might underperform in China with a sustainability strategy, for example.” Ioannou said the research could be extended to emerging markets, but that data sourcing for sustainability issues was difficult. He said there was also a large cap bias to the research because of the nature of sustainability take-up amongst larger firms, but that this meant research into the potential for small- and medium-sized firms could be very interesting.
Link to full report