HOW SUSTAINABILITY CAN DRIVE FINANCIAL OUTPERFORMANCEMARCH 2015
UPDATED VERSION

Arabesque Partnners

“Momentum building.”
Paul Polman
Chief Execu ve Oﬃcer
Unilever“I am delighted that this report shines a light on the importance of sustainability forshareholders; values in business matter for investors. At M&S we have put Plan A, our
ethical and sustainability program, right at the heart of our business. It makes perfectbusiness sense as well as being the right thing to do. Our rela onship with our customers,
employees, suppliers and society is built on 130 years of trust; it is a vital part of our brand.
Furthermore the work we have done on sustainability provided a net financial benefit tothe business of around £145 million last year through eﬃciencies in energy consump on,
packaging, less waste etc.”
Robert Swannell
ChairmanMarks & Spencers“This report adds to the increasing body of evidence that companies withsustainable business models deliver improved financial returns, and that investors
taking sustainability into account can deliver improved investment performance.
Investors and companies take note.”
Jessica Fries
Execu ve Chairman
The Prince’s Accoun ng for Sustainability Project“A truly important study, showing how financial performance goes hand in hand with good
governance, environmental stewardship and social responsibility.”
Georg Kell
Execu ve Director
UN Global Compact

“This report strips bare the misplaced myths around sustainable investment, clearly
demonstra ng that ESG can add significant value for companies and investors.”
James Giﬀord
Founding Execu ve Director
Principles for Responsible Investment“Increasing a en on is being paid to extra financial statement factors in determining thevalue and the quality of companies. This report is what every person interested in the ESG
field and every investor should have on their desk – it is clear, comprehensive (wonderfulreference materials), free of jargon and above all persuasive as to the need to take into
account the impact of ESG elements.”
Robert A.G. MonksFounder of ISS, Hermes Lens Focus Fund, Lens Fundand GMI (formerly The Corporate Library, now part of MSCI ESG Research)“I welcome and recommend this report as a suppor ng study for all Japanese investors
and corporate execu ves who proac vely address ESG issues and stakeholder dialogues
following the recent introduc on of the Japanese Stewardship Code.”
Masaru Arai
Chair
Japan Sustainable Investment Forum“This report shows the solid eﬀect of corporate sustainability prac ces on companies’ costof capital, opera ng and stock performance. Such convincing findings may be groundbreaking in the sense that the study may contribute to ending the hesita ons related tobenefits of or at least reluctance to ESG issues.”
Ibrahim Turhan
Chairman & CEO
Borsa Istanbul“The report shows that shareholder engagement is an eﬀec ve way to invest responsibly,
and that it enhances long-term corporate performance, and ul mately shareholder value.”
Rob Bauer
Professor of Finance
Maastricht University

“Thanks to the leadership of some companies we now have a wealth of evidence suppor ng
the idea that corporate financial performance should not be at odds with the interests ofother stakeholders.”
George Serafeim
Associate Professor of Business Administra on
Harvard Business School“The integra on of environmental, social and governance factors into corporate and investment
decision making has been gathering momentum over the last decade. This well-researchedreport succinctly highlights one of the key drivers underpinning this shi : sustainability andfinancial performance are linked. This piece eloquently explores why, now more than ever,sustainability should be on the agenda of senior execu ves and investment professionals alike.”
Michael Jantzi
CEO
Sustainaly cs“I welcome this report, which provides a good survey of research into the economic benefitsof corporate sustainability. Importantly, it suggests that owners of the business are key
to good corporate governance and that ac ve ownership can contribute to financial andinvestment performance.”
Colin Melvin
CEO
Hermes Equity Ownership Services“From The Stockholder To The Stakeholder highlights the increasing global awareness of
ESG issues among a broad range of stakeholders and emphasizes the business case for the
integra on of ESG into all aspects of business.”
Philipp Aeby
CEO
RepRisk AG

Arabesque Partn
ners
The Smith School of Enterprise and the Environment

Arabesque Asset Management was established in Juneis a leading international academic programme

2013 through a management buy-out from Barclays Bank

focused upon teaching, research, and engagement

PLC, which developed the technology from 2011 to 2013

with enterprise on climate change and long-termin coopera on with professors from the universi es ofenvironmental sustainability. It works with social

Stanford, Oxford, Cambridge and Maastricht. Arabesqueenterprises, corporations, and governments; it seeks

and the Fraunhofer Society, a leading German semi-

to encourage innovative solutions to the apparent

governmental think-tank and shareholder of Arabesque,challenges facing humanity over the coming decades;

entered into a strategic research partnership in 2014.

its strengths lie in environmental economics and policy,
enterprise management, and financial markets andArabesque oﬀers a quan ta ve approach to sustainable

investment. The School has close es with the physicalinvesting. It combines state of the art systematicand social sciences, including with the School of

portfolio management technology with the values ofGeography and the Environment, the Environmental

the United Na ons Global Compact, the United Na ons

Change Ins tute, and the Saïd Business School.

Principles for Responsible Investments (UN PRI), andbalance sheet and business activity screening. The
integra on of ESG research into a sophis cated por olio
management delivers a consistent outperformance.
Led by founder and CEO Omar Selim, Arabesque isheadquartered in London and has a large research hub
in Frankfurt, together with an Advisory Board of highly
respected industry leaders and academics. Arabesque
Asset Management Ltd is regulated by the UK Financial
Conduct Authority (FCA). Arabesque (Deutschland)GmbH is based in Frankfurt with a focus on research,
programming and advisory.
For further information on Arabesque’s approachto sustainable investment management pleasecontact Mr Andreas Feiner on +49 69 2474 77610 orandreas.feiner@arabesque.com.

1.

Introduuction10

2.

A Businness Casee foor Corrporate Sustainability

11

2.1

Risk

13

2.2

Performancce

16

2.3

Reputation

18

3.

4.

5.

Sustainnability annd the Cost of Capital

22

3.1

Sustaina
ability annd the Cost of De
ebt

22

3.2

Sustaina
ability annd the Cost of Eq
quityy24

Sustainnability an
nd Operrational Perform
man
nce

29

4.1

Meta-Sttudiies onn Sustain
nability29

4.2

Operatioona
al Perfformancce and the ‘G’ Dimensio
on

30

4.3

Operatioona
al Perfformancce and the ‘E’ Dimensio
on

31

4.4

Operatioona
al Perfformancce and the ‘S’ Dimensio
on32

Sustainnability annd Stockk Pricess37

5.1

Stock Prricess andd the ‘G’’ Dimenssion
n

37

5.2

Stock Prricess andd the ‘E’’ Dimenssion
n

38

5.3

Stock Prricess andd the ‘S’’ Dimenssion
n

39

5.4

Stock Prricess andd Aggreggate Susstainnabbility Sco
ores

40

6.

Active Ownersh
hip

46

7.

From thhe Stockhhold
der to the Sttakehold
der

48

8.

Biblioggraphy50

7

OMAR SELIM
CEO, ARABESQUE ASSET MANAGEMENT

We now live in a world where sustainability has entered mainstream. That much isevident from the fact that over 72% of S&P500 companies are repor ng on sustainability,
demonstra ng a growing recogni on of the strong interest expressed by investors.
This report, en tled From the Stockholder to the Stakeholder, aims to give the interested
prac

oner an overview of the current research on ESG.

In this enhanced meta-study we categorize more than 200 diﬀerent sources. Within it, we finda remarkable correla on between diligent sustainability business prac ces and economic
performance. The first part of the report explores this thesis from a strategic management
perspective, with remarkable results: 88% of reviewed sources find that companies
with robust sustainability prac ces demonstrate be er opera onal performance, which
ul mately translates into cashflows. The second part of the report builds on this, where 80%of the reviewed studies demonstrate that prudent sustainability prac ces have a posi ve
influence on investment performance.
This report ul mately demonstrates that responsibility and profitability are not incompa ble,but in fact wholly complementary. When investors and asset owners replace the ques on“how much return?” with “how much sustainable return?”, then they have evolved from astockholder to a stakeholder.

8

Sustainability is one of the most signiﬁcant trends in ﬁnancial markets
for decades.

This report represents the most comprehensive knowledge base on
sustainability to date. It is based on more than 200 academic studies,industry reports, newspaper articles, and books.

90% of the studies on the cost of capital show that sound sustainability
standards lower the cost of capital of companies.

88% of the research shows that solid ESG practices result in better
operational performance of ﬁrms.

80% of the studies show that stock price performance of companies ispositively inﬂuenced by good sustainability practices.

Based on the economic impact, it is in the best interest of investors andcorporate managers to incorporate sustainability considerations into
their decision making processes.
Active ownership allows investors to inﬂuence corporate behavior andbeneﬁt from improvements in sustainable business practices.

The future of sustainable investing is likely to be active ownership bymultiple stakeholder groups including investors and consumers.

9

Sustainability is one of the most significant trends in•financial markets for decades. Whether in the form of

implementing active ownership policies into
investors’ por olios

investors’ desire for sustainable responsible investingThis report aims to support decision makers by providing(SRI), or corporate management’s focus on corporate

solid and transparent evidence regarding the impact

social responsibility (CSR), the content, focusing onof sustainable corporate management and investment

sustainability and ESG (environmental, social andprac ces. Our findings suggest:governance) issues, is the same. The growth of the UN•

1

Global Compact, the United Na ons backed Principles forbe er opera onal performance and are less risky

Responsible Investment (UN PRI),2 the Global Repor ng
3

Initiative (GRI), the Carbon Disclosure Project (CDP),•

4

investment strategies that incorporate ESG issues
outperform comparable non-ESG strategies

the Sustainability Accoun ng Standards Board (SASB),5
6

companies with strong sustainability scores show•

7

the American and European SRI markets and the fact

active ownership creates value for companies
and investors

that more than 20% of global assets are now managed

Based on our results, we conclude that it is in the best8

in a sustainable and responsible manner, all bear strong

economic interest for corporate managers and investors

testament to sustainability concerns. However fromto incorporate sustainability considera ons into decision-

an investor’s perspective, there exists a debate about

making processes.

the benefits of integra ng sustainability criteria into theinvestment process, and the degree to which it results in a

We close the report with the suggestion that it is in

posi ve or nega ve return.9

the long-term self-interest of the general public, as
beneficiaries of ins tu onal investors (e.g. pension funds

This report inves gates over 200 of the highest quality

and insurance companies), to influence companies toacademic studies and sources on sustainability to assess

produce goods and services in a responsible way. By doing

the economic evidence on both sides for:so they not only generate be er returns for their savings•

a business case for corporate sustainability

and pensions, but also contribute to preserving the world•

integra ng sustainability into investment decisions

they live in for themselves and future genera ons.

1
2
3
4
5
6
7
8
9

For more informa on on the UN Global Compact, see: www.unglobalcompact.org.
Background informa on on the United Na ons backed Principles for Responsible Investment (UN PRI), see: www.unpri.org.
See Global Repor ng Ini a ve’s website for further informa on: www.gri.org.
See www.cdp.net for more informa on on Carbon Disclosure Project.
For the SASB’s mission statement, see www.sasb.org.
Forum for Sustainable and Responsible Investment (US SIF) (2014).
Eurosif (2014).
Global Sustainable Investment Alliance (GSIA) (2013).
See, for example, Milton Friedman’s view on the social responsibili es of firms (Friedman, 1970) versus R. Edward Freeman’s perspec ve on how firms cantake into account the interests of several stakeholders (Freeman, 1984). Subsequently, similar arguments are also made in Jensen (2002). A discussion about
the arguments in favor or against the business case can be found in Davis (1973).
10In 2013, Accenture conducted a survey of 1,000

a longer me horizon to make business decisions would

CEOs in 103 countries and 27 industries. They foundpositively affect corporate performance in a numberthat 80% of CEOs view sustainability as a means toof ways, including strengthening longer-term financial

gain competitive advantages relative to their peers.10

returns and increasing innova on.15

Furthermore, the study found that “81% of CEOs believe
There is however an increasing focus on longer-term

that the sustainability reputation of their company is
11

important in consumers’ purchasing decisions”. On thethinking: a recent ini a ve, founded by the Canada Pension

contrary, they found that only 33% of all surveyed CEOs

Plan Investment Board (CPPIB) and McKinsey, is bringing

think “that business is making suﬃcient eﬀorts to address

together business leaders from corporations, pension

global sustainability challenges”.12

funds, and asset managers to promote longer-term
corporate and investment management.16 More broadly,

One reason for this imbalance between acknowledging

numerous corporate leaders are taking decisive steps tothe importance of sustainability and ac ng on it is pressure

implement a longer-term horizon within their companies.

from the financial markets’ focus on short-termism. 13ThisFor example, under the leadership of its CEO, Paul Polman,

clearly emerges from another survey conducted on

Unilever has stopped giving earnings guidance and hasbehalf of McKinsey & Company and the Canada Pension

moved away from quarterly profit repor ng in order toPlan Investment Board (CPPIB), in which 79% of C-leveltransform the company’s culture and shi management’s

execu ves and board members state that they personallythinking away from short-term results.17

feel “pressure to deliver financial results in two years orless”. 14Tellingly, 86% of them note that this constraint is in

Our research demonstrates that there is a strong business

contrast to their convic ons, where they believe that usingcase for companies to implement sustainable management

10
11
12
13
14
15
16
17

Accenture (2013).
Accenture (2013: 36).
Accenture (2013: 15).
See Barton and Wiseman (2014).
Bailey, Bérubé, Godsall, and Kehoe (2014: 1).
See Bailey, Bérubé, Godsall, and Kehoe (2014: 7).
See Bailey, Bérubé, Godsall, and Kehoe (2014). More informa on can be found at www.FCLT.org.
See CBI (2012) and Igna us (2012).
11

practices with regard to environmental, social, andby taking into account the needs and demands of major

governance (ESG) issues.18 In other words, firms can ‘dostakeholders can a company create financial and societal

19

value.24

well while doing good’. However, it is impera ve that theinclusion of ESG into strategic corporate management isbased on business performance.20

In doing so, companies are required to appreciate thetrade-oﬀs that exist between financial and sustainability

Sustainability is further important for the public image of aperformance. Firms are required to implement sustainablecorpora on, for serving shareholder interests, and for the

management strategies that improve both performance21

pre-emp ve insurance eﬀect for adverse ESG events. To

measures (for instance through substan al product andput it another way: good ESG quality leads to compeve

process innovation).25 To achieve this, companies areadvantages,22 which can be achieved through a broader

required first to iden fy the specific sustainability issues

orienta on towards stakeholders (communi es, suppliers,that are material to them. As recent research by Deloi e

23

points out, “materiality of ESG data – like materiality for

Clearly management cannot meet all demands of all

any input in investment decision-making – should be

stakeholder groups at the same me. Rather, we suggest

related to valua on impacts”.26 Table 1 shows a selec onthat by focusing on profit maximiza on over the mediumof ESG issues that, depending on the individual company into longer term, i.e., shareholder value maximiza on, andques on, can have a material impact.

customers and employees) as well as shareholders.

TABLE 1: SELECT
T ION OF MAT
T ERIAA L ESGG FACTORS
S 27

18
19
20
21
22
23
24
25
26
27

ENVIRONMENTAL (“E”)

SOCIAL (“S”)

GOVERNANCE (“G”)

Biodiversity/land use

Community rela ons

Accountability

Carbon emissions

Controversial business

An -takeover measures

Climate change risks

Customer rela ons/product

Board structure/size

Energy usage

Diversity issues

Bribery and corrup on

Raw material sourcing

Employee rela ons

CEO duality

Regulatory/legal risks

Health and safety

Execu ve compensa on schemes

Supply chain management

Human capital management

Ownership structure

Waste and recycling

Human rights

Shareholder rights

Water management

Responsible marke ng and R&D

Transparency

Weather events

Union rela onships

Vo ng procedures

For business case arguments of corporate social responsibility and sustainability, see for example, Davis (1973), Hart (1995), Porter and Kramer (2002, 2006),
Porter and van der Linde (1995a, 1995b).
A term used in the CSR context by David Vogel (2005: 19) and by Benabou and Tirole (2010: 9) to describe the ‘win-win scenario’ of CSR. Corpora ons adopt
superior CSR standards to make the firm more profitable.
For a study on execu ves’ percep ons of CSR and its business case, see Berger, Cunningham, and Drumwright (2007). See, for example, Davis (1973), Godfrey(2005), and Godfrey, Merrill, and Hansen (2009).
See, for example, Davis (1973), Godfrey (2005), and Godfrey, Merrill, and Hansen (2009).
Hart (1995), Hart (1997).
Kurucz, Colbert, and Wheeler (2009).
Jensen (2002), Porter and Kramer (2011). A similar statement has also been made by Smith (1994).
Eccles and Serafeim (2013).
Hespenheide and Koehler (2012: 5).
The data has been synthesized from several sources, including MSCI (2013), UBS (2013), Bonini and Goerner (2011), Sustainability Accoun ng Standards
Board (2013), Global Repor ng Ini a ve (2013a), and the academic papers reviewed in this report. Table in alphabe cal order.
12

The materiality of environmental, social and governancedeeply rooted in the organiza on’s culture and values.

(ESG) issues diﬀers substan ally between industries. For

Companies must reframe their iden ty into organiza ons

instance, resource-intensive industries such as miningthat are open to sustainability and encourage innova on

have a diﬀerent exposure to environmental and social

to increase productivity. Only once this is done can a

28

factors than for example the commercial real-estate

corporate culture be changed into a realm in which

sector.29 The Global Repor ng Ini a ve (GRI) compiled a‘transforma onal change’ can occur.33

comprehensive overview about sector diﬀerences withregard to ESG issues. Over a period of ten years, the Global

A selec on of case studies show that successful companies

Repor ng Ini a ve (GRI) has worked with a number ofwhich build a compestakeholders to identify the most material ESG issues

ini a ves have a clear responsibility at the board level,30

ve advantage from sustainability

in different sectors resulting in the G4 Sustainability

clear sustainability goals that are measurable in quan ty

Repor ng Guidelines.31

and me, have an incen ve structure for employees toinnovate and external auditors which review progress.

Amongst others, there are three major ways how

Such companies are able to benefit from their sustainability

sustainability through the integra on of environmental,

programmes over the medium to longer-term.34

social and governance (ESG) issues can lead to acompeve advantage: 32

2.1 RISK

1. Risk:- Company specific risks-

External costs

An analysis of corporate fines and settlements

2. Performance:- Process innova on-

demonstrates the financial impact of neglecting
sustainability and ESG issues. In Table 2, we show the ten

Product innova onlargest fines and se lements in corporate history, which
together amount to $45.5bn.35 In the financial sector,

3. Reputa on:- Human capital-banks have paid out $100bn in U.S. legal settlements

Consumers

alone since the start of the financial crisis,36 and global

Corporate managers should realize that the criticalpharmaceutical companies have paid $30.2bn in fines

condition for translating superior ESG quality into

since 1991.37

competitive advantage is that sustainability has to be

28
29
30
31
32
33
34
35

36
37

See, Miranda, Burris, Bingcang, Shearman, Briones, La Vina, and Menard (2003).
World Green Building Council (2013). For an academic discussion of this issue, see also Eccles, Krzus, Rogers, and Serafeim (2012).
See Global Repor ng Ini a ve (2013a).
Global Repor ng Ini a ve (2013b).
Similar to the model developed by Kurucz, Colbert, and Wheeler (2009) and the United Na ons Global Compact Value Driver Model (PRI-UN Global Compact,2013).
Eccles, Miller Perkins, and Serafeim (2012).
See Loew, Clausen, Hall, Lo , & Braun (2009) for the collec on of case studies on sustainability in firms from Germany and the USA.
Own research. The University of Oxford and Arabesque are running a database where a neglect of environmental, social and governance (ESG) issues led to
payments in excess of USD 100mn through fines or se lements. The analysis of currently 136 cases shows that the sectors which have been most aﬀected arefinancials, pharmaceu cals, energy, technology and automobiles which represent 90% of all fines and se lements.
McGregor and Stanley (2014).
See Almashat and Wolfe (2012).
13

CASE STUDY ON RISK: BRITISH PETROLEUM
BP’s Deepwater Horizon 2010 oil spill in the Gulf of Mexico is the most high-profile recent
example of how environmental risks can have meaningful financial consequences. Indeed,
the company suﬀered not only financially, but also from a reputa onal and legal perspec ve.
The total costs to BP are hard to es mate with accuracy. The Economist es mates $42bn inclean-up and compensa on costs38 whereas the Financial Times es mates that the clean-up
costs alone may amount to $90bn.39
BP’s share price lost 50% between 20 April 2010 and 29 June 2010 as the catastrophe
unfolded. In the wake of the disaster, a peer group of major oil companies lost 18.5%. Since
the disaster, BP’s share price has underperformed the peer group by c. 37%.40 Astute ESG
investors would have avoided inves ng in BP at the me of the oil spill. Notably, two years
before the spill happened there was severe cri cism of the company’s performance inenvironmental pollu on, occupa onal health and safety issues, nega ve impacts on local
communi es and labour issues, according to RepRisk.41 Addi onally, MSCI excluded BP (in2005) from their sustainable equity indices a er the Texas City explosion42 and a perceived
lack of ac on from BP on health and safety issues.43

FIGU
U RE 1: B P’S SHAA REE PRICC E COMPPARED T O O T HE
E R OIL M A JORS

Cumulave Stock Returns (USD)

Normalized Performance

250

200

150

100

50

0
2010
BP p.l.c.

38
39
40
41
42
43

2011
Chevron

2012

2013

Total S.A.

Royal Dutch Shell

The Economist (2014), p. 59.
Chazan and Crooks (2014).
Own calcula ons, based on data from Factset. As of March 2015.
Cichon and Neghaiwi (2014).
See the website of the BP’s Texas City Explosion for further details.
Based on personal communica on with MSCI’s research team on August 20, 2014.

14

2014

2015
ExxonMobil

TABLE 2: LARGESS T FINES ANN D SEE TTLEMENTS COO NCERNING ESG
G ISS
S UES (MARR C H 2015
5)
COMPANYYEAR

SECTOR

COUNTRY

IN USDMN

CAUSE

SOURCEBank of America

2014

Financials

USA

16,650Financial fraud leading up to and during the financial crisis

U.S. Department of
Jus ceJP Morgan

2013

FinancialsUSA

13,000Misleading investors about securi es containing toxic
mortgages

U.S. Department of
Jus ceBNP Paribas

2014

Financials

France8,970

Illegally processing financial transac ons for countries subject
to U.S. economic sanc ons

U.S. Department of
Jus ceCi group

2014

Financials

USA

7,000

Misleading investors about securi es containing toxic
mortgages

U.S. Department of
Jus ceAnadarko

2014

EnergyUSA

5,150

Fraudulent conveyance designed to evade environmental
liabili es

U.S. Department of
Jus ceBP

2012

EnergyUK

4,500

Felony manslaughter: 11 people killed; Environmental crimes:
oil spill in the Gulf of Mexico; Obstruc on: misstatement of theamount of oil being discharged into the Gulf

U.S. Department of
Jus ce, Securi es

GlaxoSmithKline

2012

Pharmaceu cals

UK

3,000

Unlawful promo on of certain prescrip on drugs; Failure toreport certain safety data to the FDA; False price repor ng
prac ces

U.S. Department of
Jus ceCredit Suisse

2014

Financials

Switzerland

2,800

Helping U.S. taxpayers hide oﬀshore accounts from the IRS

U.S. Department of
Jus cePfizer

2009

Pharmaceu cals

USA

2,300

Misbranding Bextra (an an -inflammatory drug that Pfizer
pulled from the market in 2005) with the intent to defraud or
misleadU.S. Department of
Jus ceJohnson &Johnson2013

Pharmaceu cals

USA

2,200

Oﬀ-label marke ng and kickbacks to doctors and pharmacists

U.S. Department of
Jus ceAnother risk for companies may be external costs (externali es).44

at $7.3tn represen ng 13% of global economic produc on.47

These can aﬀect produc on processes either directly or throughAn analysis of the World Economic Forum comes to similar

disrup ons in the supply chain which may depend on unpriced

conclusions and identifies water and food crises, extreme

natural capital assets such as climate, clean air, groundwater

weather events as well as a failure of climate change mi ga on

and biodiversity. In the absence of regula on, unpriced naturaland adap on amongst the ten global risks of highest concern incapital costs usually remain externalized (i.e. are not paid for in

2014.48

the produc on process) unless events (for example droughts45
or floods46) cause rapid internalization along supply chains

Neglec ng sustainability issues can have a substan al impact

through commodity price fluctua on or produc on disrup on.

on a company’s business opera ons over the medium to

One report es mates the annual unpriced natural capital costs

longer term, or suddenly jeopardize the survival of a firm

44
45
46
47
48

See the OECD’s defini on of externali es: “Externali es refers to situa ons when the eﬀect of produc on or consump on of goods and services imposes costs
or benefits on others which are not reflected in the prices charged for the goods and services being provided.” (OECD, 2014)
See, for example, Ernst & Young (2012).
See, for example, Knight, Robins, and Chan (2013).
Trucost (2013).
World Economic Forum (2014).
15

altogether (tail-risks).49 Risk reduc on is a major outcome

A’ to source responsibly, reduce waste and help communi es,of successfully internalizing sustainability into a company’s

thereby saving the firm $200mn annually.58

strategy and culture.50 Properly implemented, superior
A recent study by PricewaterhouseCoopers claims thatsustainability policies can mi gate aspects of these risks by51

promp ng pre-emp ve ac on. Examples include risks from“sustainability is emerging as a market driver with theli ga on as well as environmental, financial and reputa onal

poten al to grow profits and present opportuni es for value

52

risks. The result is a lower vola lity of a company’s cashflows

crea on — a drama c evolu on from its tradi onal focus

as the impact of nega ve eﬀects can be avoided or mi gated.

on eﬃciency, cost, and supply chain risk”.59 In that respect,

Sustainability ac vi es therefore play an important role in asustainable product innova on can have a substan al impact

firm’s risk management strategy.53

on a company’s revenues. Revenues from “Green Products”
at Philips, a diversified Dutch technology company, reached
EUR 11.8bn represen ng a share of 51% of total revenues.

2.2 PERFORMANCE

Philips’ “Green Products” oﬀer a significant environmental
improvement on one or more “Green Focal Areas”: energy

In an ar cle in the Harvard Business Review, Michael Porter

eﬃciency, packaging, hazardous substances, weight, recycling

and Claas van der Linde claim that pollution translates

and disposal and life me reliability.60 Another innova ve

to inefficiency. They argue that “when scrap, harmfulcompany, LanzaTech, has come up with a microbe as a natural

substances, or energy forms are discharged into the

biocatalyst 61 that can capture CO2 and turn it into ethanol forenvironment as pollu on, it is a sign that resources havefuel.62 The firm has a partnership with Virgin Atlan c, whobeen used incompletely, ineﬃciently, or ineﬀec vely.”54 In

believe that such innova on will assist the airline in mee ng

one example, they examine 181 ways of preven ng waste

its pledge of a 30% carbon reduc on per passenger kilometre

genera on in chemical plants, and find that only one of themby 2020.63“resulted in a net cost increase”.55 In other words, process
innova on more than oﬀsets costs in 180 out of 181 cases.56

Moreover, research by the auditing company Deloitte

For this reason, many companies are implemen ng long-argues that “sustainability is firmly on the agenda for leading

term sustainability programs and reaping resul ng benefits.

companies and there is growing recogni on that it is a primary

For example, Coca-Cola has reduced the water intensity

driver for strategic product and business model innova on.”64of their produc on process by 20% over the last decade.57

This can create a posi ve impact on financial performance.65

Another example is Marks and Spencer who introduced ‘Plan
49
50
51
52
53
54
55
56
57
58
59
60
61
62
63
64
65

See, for example, Schneider (2011) who argues that poor environmental performance can threaten the company’s long-run survival. See also Husted (2005)
for a discussion of how corporate social responsibility could be seen as a real op on to firms which can reduce the significant downside risks corpora ons are
exposed to.
Kurucz, Colbert, and Wheeler (2009).
This risk reduc on feature of ESG has also been documented by Lee and Faﬀ (2009), who show that firms with superior sustainability scores have asubstan ally lower idiosyncra c risk. Similar findings are provided by Oikonomou, Brooks, and Pavelin (2012). The insurance value of CSR against risks has also
been stressed by Godfrey (2005), Godfrey, Merrill, and Hansen (2009), and Koh, Qian, and Wang (2014).
See, for example, Bauer and Hann (2010). Addi onally, Karpoﬀ, Lo , and Wehrly (2005) show that the market punishes viola ons of environmental regula on.
In par cular, they conclude that on average, stock prices decrease by 1.69% in cases of alleged viola on.
See, for example, Minor and Morgan (2011).
Porter and van der Linde (1995a: 122).
Porter and van der Linde (1995a: 125).
Porter and van der Linde (1995a).
Coca-Cola Company (2013).
Marks and Spencer Group Plc (2014).
PricewaterhouseCoopers (2010: 2).
Philips (2014).
Lanzatech (2014).
Wills (2014).
Virgin (2012).
Deloi e Global Services Limited (2012: 1).
Porter and Kramer (2006) and Eccles, Miller Perkins, and Serafeim (2012) stress this. Greening and Turban (2000) also point out that superior CSR prac ces
can be a compe ve advantage in that firms can more easily a ract the best and most talented people for their workforce, which then poten ally translates
into higher produc vity and eﬃciency, and in the end be er opera onal performance. Also, Hart and Milstein (2003) argue that corporate sustainability is a
crucial factor for the long-term compe veness of corpora ons.
16

CASE STUDY ON PERFORMANCE: WALMART
An example of a company implemen ng long-term sustainability measures to increase overall
eﬃciency and opera onal performance is Walmart. Wan ng to take the lead in a sector-wide
evolu on towards sustainability, Walmart set goals of becoming totally supplied by renewableenergy, having zero waste and selling products that sustain people and the environment
back in 2005.66 Since then, commitments have been renewed and ini a ves were widened.
Such ini a ves include: the Walmart Sustainability Expo first organized in 201467, a suppliersustainability index68 and the lis ng of commitments online, indica ng if they have been
completed or whether they are on track69.
Over the 2012 fiscal year, Walmart saved about 231 million dollars by means of eﬃcient waste
management and recycling; an es mated 150 million dollars were saved over 2013 throughrenewable energy projects and a zero waste program.
As an example of Walmart’s eﬀorts, greenhouse gas (GHG) emissions in terms of sales are shownin Figure 2.70

FIGURE
E 2: WALL MA
A RT GHG EM
M ISSIONN S V ERSS US SALL ES

GHG per sales

60
50
40
30
20
10
0
20
006
2006

20
007
2007

20
008
2008

20
009
2009

20
010
0
2010

20
011
2011

20
012
2
2012

GHG emissions per sales (metric tonnes CO2 per 1 mio $)Walmart realizes that sustainability is also a means to an end in safeguarding low prices andsa sfying consumers. Increasing opera onal eﬃciency71 through sustainability programs allows
Walmart to achieve a compeve advantage over its main compe tors.72 Walmart further

emphasizes that there is a business case for corporate sustainability,73 mo va ng others to follow
in their footsteps.74

66
67
68
69
70
71
72
73
74

Louie (2012).
McCullough (2014).
Mayer (2013).
Walmart (2014).
Own calcula ons, based on data from Walmart (2014).
See for example Kahn and Kok (2014) who look into Walmart’s environmental performance in California.
Clancy (2014).
Seligmann (2014).
McCullough (2014).

17

By incorpora ng ESG issues into a corporate sustainability

Inferior ESG standards can pose a threat to a company’s

framework, corpora ons will ul mately be able to realize cost

reputa on. For example, Barilla Pasta President Guido Barilla’s

savings through innova on, resource eﬃciency, and revenuecomment in 2013 that he’d never consider showing gay families

enhancements via sustainable products, which ceterisin his adver sements resulted in a consumer boyco .83 Barillaparibus should lead to margin improvements.75

was heavily cri cized in social media with over 140 thousand
consumers signing a pe on against buying Barilla’s products.84
Another example is a recent report by The Guardian on slavery in

2.3 REPUTATION

Thailand’s shrimp industry which started a discussion on labour
condi ons in Thailand.85 As a direct result of the issues raised,

Research points to the importance of corporate reputa on as an

global supermarket chains reacted publicly to avoid business76

input factor for persistent value maximiza on. Human capital

fallout, engaging with the local producers to improve labour

is one of the core resources that companies leverage in orderworking condi ons.86 Other widely reported examples include

to operate and deliver goods/services to customers.77 Good

Foxconn87 and the tragic tex le factory collapse in Bangladesh in

reputa on with respect to corporate working environments

2013.88 Transparency on a company’s supply chain is not always

can also translate into superior financial performance and help

complete and consumers, investors, and other stakeholders aregain a compe ve advantage.78 This has also been pointed out

o en required to approximate the quality of a company’s supply

by Alex Edmans, Professor of Finance at the London Businesschain. However, responsibility for such issues at the board level,

School. In his study on the relationship between employeetransparent goals, and external auditors who monitor progress,sa sfac on and corporate financial performance, he argues thatare good indicators that a company is managing ESG risks.

“a sa sfying workplace can foster job embeddedness and ensure

Furthermore ac ve par cipa on in mul lateral sustainability

79that talented employees stay with the firm”. Furthermore, heini a ves can indicate the level of importance sustainability

claims that “a second channel through which job sa sfac on

issues represent to a company.89

can improve firm value is through worker mo va on”.80 An
independent way to ascertain the reputa on of a company interms of workforce a rac on can be found in external surveys
such as Fortune’s Best Companies To Work For81 and on moregranular regional lists like Great Place To Work.82

75
76
77
78
79
80
81
82
83
84
85
86
87
88
89

Eccles and Serafeim (2013), Porter and van der Linde (1995a, 1995b).
See, for example, Roberts and Dowling (2002).
Eccles and Serafeim (2014).
Edmans (2011, 2012).
Edmans (2012: 1-2).
Edmans (2012: 2).
The annual lists of the best companies to work for are published on Fortune’s website at: h p://fortune.com/best-companies.
For more details consult the website of Great Place To Work: h p://www.greatplacetowork.com.
Adams (2014).
Moveon.org Pe ons (2014).
Hodal, Kelly, and Lawrence (2014) and Wa s and Steger (2014).
Lawrence (2014).
Economist (2010).
Butler (2013).
Exemplary ini a ves are, for example, Roundtable on Sustainable Palm Oil (h p://www.rspo.org), UN Global Compact’s The CEO Water Mandate (h p://ceowatermandate.org), Sustainable Food Laboratory (h p://www.sustainablefoodlab.org), Sustainable Apparel Coali on (h p://www.apparelcoali on.org),
Voluntary Principles on Security and Human Rights (h p://www.voluntaryprinciples.org).
18

CASE STUDY ON REPUTATION: ABERCROMBIE& FITCH
The impact of reputa onal risk can be illustrated by Abercrombie & Fitch. In a 2006
interview,90 CEO Mike Jeﬀries owed the success of his company to the fact that they only
target the “cool kids.” Such a deliberate exclusion of customers as part of the corporate
strategy has been highly controversial over the last years. There was renewed a en on to
the “cool kids” ar cle in May 2013.91 The following months, tumbling sales were a ributed
to the controversy, also impac ng stock performance.92
In 2009, Jeﬀries was named one of the “highest paid worst performers” of 2008, according
to a CEO pay study from Corporate Library, which is now part of GMI Ra ngs/MSCI.93 In 2013,
he was listed by shareholder advisory firm Glass Lewis94 as one of the ten most overpaid
execu ves. Since 2008, sales have been declining for ten consecu ve quarters.95 Since 2009,
Abercrombie underperformed its peer group by an average of 62%96 on the stock market.

FIGU
U RE 3: A & F’S SHAA RE PRICE COMPA
A RED TO MA
A J ORR S COMPP E TITORSSCumulave stock returns (USD)
Normalized Performance

350
0
300
0
250
0
200
0
150
0
100
0
50
0
2010

2011
A&F
Inditex (Massimo Du)

2012

2013
GAP
PVH (Tommy Hilﬁger)

2014

2015
H&M
Ralph LaurenJeﬀries was removed from the Abercrombie leadership, first as a chairman97 (January 2014)
and later as the CEO (December 2014). This last announcement was followed by an 8% jumpin the share price.98
90
91
92
93
94
95
96
97
98

Denizet-Lewis (2006).
Temin (2013).
Yousuf (2013).
Corporate Library (2009).
Lutz (2013).
Linshi (2014).
Own calcula ons, based on data from FactSet. As of March 2015.
Peterson (2014).
Rupp (2014).

19

We havve invess gated th
he strateggic impo
ortance of su
ustainability topics su
uch
as environmen
ntaal, social annd govvernancee (ESG) isssuees for corporra ons. The
main coonclusioons of the reviewed
d researcch are:• Susttainabilitty topics can have a material eﬀect on a com
mpany’s risk profi
file,perfformancce poten al and reeputa onn and hence havve a finan
ncial imp
pact
on a firm’s performannce.
• Prodduct annd processs innnovaa on is cri cal to beenefi
fit financcially froomsusttainabilitty issues.
• Diﬀerent inndustries havee diﬀerent su
ustainability isssuees that arre material
for financiaal performaancce.
• Meddium too loonger-term comppe ve advantages caan be achievved throuugha brroader orienta on towarrds stakeeholderss (coommmuni es,, supplieers,
custtomers and emplo
oyeees) annd shareeholders.
• The managgement off susstainaability isssues needds too bee deeply embedd
ded
into
o an orrganizatio
on’s culture andd valuess. Paarticcular meechanisms
men
n onedd by researrcheers incclude:-

Responssibility at th
he booard leevel (ideaally the CEEO),-

Clear susstaainabilityy goaals thaat are meaasurable in quuan ty and me,-

An incenn ve structture for em
mployeess to innovaate and-Externall auditors whicch revieew progrress.

• Table 3 preeseents thee mo
ost immportantt academ
mic papeers on th
he businesscasee of susttainability..

20

TABLE 3: OVERVII E W OF STUDIESS ON T HE BUSINN ESS CASE FOR SUSS TAINABILII T Y
E C T IVE SELEC
C TIO
O N)
(SUBJEAUTHOR(S)YEAR

JOURNAL

TITLE

Davis

1973

Academy of Management
JournalThe Case for and Against Business Assump on of Social
Responsibili es.

Eccles and Serafeim

2013

Harvard Business Review

The Performance Fron er.

Hart

1995

Academy of Management
Review

A Natural-Resource-Based View of the Firm.

Porter and Kramer

2002

Harvard Business Review

Porter and Kramer

2006

Harvard Business Review

Porter and van der Linde

1995

The Journal of Economic
Perspec ves

Porter and van der Linde

1995

Harvard Business Review

21

The Compe

Compeve Advantage of Corporate Philanthropy.

Strategy and Society: The Link Between
ve Advantage and Corporate Social Responsibility.

Toward a New Concep on of the EnvironmentCompe veness Rela onship.
Green and Compe

ve.

T

3.1 SUSTAINABILITY
AND THE COST OF DEBT

his section reviews the effects of sustainabilityon the cost of capital, which is directly linked to acompany’s risk level and profitability. For our analysis wehave split the cost of capital into two component parts, theCase studies and academic literature are clear thatcost of debt and the cost of equity. For each we analyse

environmental externalities impose particular risks on

the rela onship of environmental, social and governancecorporations – reputational, financial, and litigation

issues separately. A summary at the end gives an overview

related – which can have direct implica ons for the cost ofof the reviewed empirical studies.

financing, especially for a firm’s cost of debt.99

F IGURE 4: COO MPA
A RISON O F CRED
D IT S PREADS

10-year CDS Spreads
450
0
400

in basis points

0
350
0
300
0
250
0
200
150
0
100
0
50
0
2010
BP p.l.c.

99

2011

2012

2013

Royal Dutch Shell

ChevronBauer and Hann (2010).

22

2014

2015

ExxonMobil

Total S.A.

Evidence suggests that by implementing reasonabledirectors on the board,102 the disclosure quality,103 andenvironmental, social, and governance (ESG) policies tothe existence of an -takeover measures.104 The researchmi gate such risks, companies can benefit in terms ofalmost unanimously demonstrates that good corporate

lower cost of debt (i.e. credit spreads).100

governance with respect to the aforemen oned measuressignificantly decreases a firm’s cost of debt (i.e. credit
spreads).105

To illustrate how an environmental disaster can aﬀect a
corpora on’s cost of debt, BP’s credit spread development
shown in Figure 4. A er the incident, the 10-year credit

3.1.2 COST OF DEBT AND
THE ‘E’ AND ‘S’ DIMENSIONS

spread of BP increased eigh old. 10-year credit spreads ofResearch inves ga ng the eﬀects of sound sustainability

a group of major oil companies were also aﬀected by thepolicies on a firm’s cost of debt has shown that firms

disaster but less severely.

with superior environmental management systems havesince the Deepwater Horizon catastrophe in April 2010 issignificantly lower credit spreads, implying that these

3.1.1 COST OF DEBT AND
THE ‘G’ DIMENSIONS

companies exhibit a lower cost of debt (a er controllingfor firm and industry characteristics).106 According torecent studies, the converse relationship also holds.

Academic literature has specifically investigated theFirms with significant environmental concerns have toeffects of corporate governance on cost of debt, andpay significantly higher credit spreads on their loans.107

the conclusions are relatively clear: good corporate

For instance within the pulp and paper industry firms thatgovernance pays oﬀ in terms of reduced borrowing costs

release more toxic chemicals have significantly higher bond(i.e. credit spreads). It has been documented that certain

yields than firms that release fewer toxic chemicals.108

governance measures have a significant impact on a firm’s
cost of debt, for example, the degree of institutional
investor ownership, 101 the proportion of outside“ IN THE PRESENN C E OF SHA
A REH
H OLDEE R CONTR
R OL, THE DIFFF ERE
E NCE IN B O NDY IELDS DUE TO D IFFERENCC ES IN TAKEOVER V ULNERABILITT Y CAA N BE AS
S H IGH AS
S
6 6 BASIS POINTT S.”
Cremerss et al., 2007
100
101

102
103
104

105

106
107
108

In a wider context of societal value crea on, Godfrey, Merrill, and Hansen (2009) find that CSR actually oﬀers corpora ons an ‘insurance’ benefit.
For evidence of ins tu onal ownership as a governance device and its nega ve eﬀect on bond yields (or its posi ve eﬀect on bond ra ngs), see, for example,
Bhojraj and Sengupta (2003), Cremers, Nair, and Wei (2007). Arguments against this rela onship have been made by Ashbaugh-Skaife, Collins, and LaFond(2006).
Bhojraj and Sengupta (2003).
Schauten and van Dijk (2011) inves gate the eﬀect of corporate governance on credit spreads. They analyse 542 bond issues at large European firms andstudy the eﬀect of four diﬀerent corporate governance measures: shareholder rights, an -takeover devices in place, board structure, and disclosure quality.
For evidence of the nega ve rela onship between an -takeover measures and corporate bond yields, see Klock, Mansi and Maxwell (2005). Similar evidence
is provided by Ashbaugh-Skaife, Collins, and LaFond (2006), who document a posi ve rela onship between the number of an -takeover measures and bondra ngs. The importance of an -takeover measures for bondholders is also stressed by Cremers, Nair, and Wei (2007). Chava, Livdan, and Purnaanandam(2009).
Contrary evidence is provided by Menz (2010), and Sharfman and Fernando (2008). Mixed findings are provided by Bradley, Chen, Dallas, and Snyderwine(2008). They provide evidence that their board index alone significantly lowers bond spreads and improves credit ra ngs. They follow the argument that morestable boards bring more security to bondholders, thereby lowering spreads.
Bauer and Hann (2010).
Chava (2014), and Goss and Roberts (2011). Goss and Roberts (2011) find that firms facing CSR concerns pay between 7 and 18 basis points more than firms
without CSR concerns.
Schneider (2011).
23

3.2 SUSTAINABILITY AND
THE COST OF EQUITY

Studies also show that credit ratings are positively
aﬀected by superior sustainability performance. Be ersustainability policies lead to be er credit ra ngs.109 In

3.2.1 COST OF EQUITY
AND THE ‘G’ DIMENSION

par cular, it has been demonstrated that employee wellbeing leads to be er credit ra ngs

110

and in turn lower

credit spreads.111

Studies show that good corporate governance influences
the cost of equity by reducing the firm’s cost of equity.112
This is not surprising, as good corporate governancetranslates into lower risk for corporations, reduces

“ FIR
R MS
S WITT H SOCIA
AL
R ES
S PON
N SIBILL ITY
Y CO
O NCE
E R NS PAAY
B ETT WEE E N 7 A N D 18 BA
A S ISS POINTSSM ORE T HAN
N FIR
R MS
S THA
AT A REM ORE R ESPP O NSS IBLL E.”

information asymmetries through better disclosure,113

Goss and Ro
oberts, 201
11equity.115 Interna onal evidence on Brazil and emerging

and limits the likelihood of managerial entrenchment.114
Conversely, research also shows that firms with higher
managerial entrenchment due to more anti-takeover
devices in place, exhibit significantly higher cost of
market countries also supports the view that superior
corporate governance reduces a firm’s cost of equity
significantly.116‘ COMPAA NIES W ITH BETTERR GO
O VERN
N ANCE SC
C ORES EXH
H IBITT A 1 36 BASISS POINTSS
LOWER COST OFF E QUITY’.
Ashba
augh-Skaiffe, et al., 2004

109

110
111
112

113
114
115
116

A g, El Ghoul, Guedhami, Suh (2013) study firms from 1991-2010 and use MSCI ESG STATS as their source for CSR informa on. Addi onal evidence isprovided by Jiraporn, Jiraporn, Boesprasert, and Chang (2014): a er correc ng for endogeneity, the authors conclude that firms with a be er CSR quality tend
to have be er credit ra ngs, poin ng towards a risk-mi ga ng eﬀect of CSR.
See Verwijmeren and Derwall (2010: 962): ‘Firms with be er employee rela ons have be er credit ra ngs, and thus a lower probability of bankruptcy.
See, for example, Bauer, Derwall, and Hann (2009).
See, for example, Ashbaugh-Skaife, Collins, and LaFond (2004) who show that well governed firms exhibit a cost of equity financing 136 basis points lower
than their poorly governed counterparts. Even a er adjus ng for risk, the diﬀerence between well-governed and poorly-governed firms is s ll 88 basis points.
Furthermore, Derwall and Verwijmeren (2007) also present evidence that be er corporate governance on average led to lower cost of equity capital in the
period 2003-2005.
See, for example, Barth, Konchitchki, and Landsman (2013). They show that greater corporate transparency with respect to earnings significantly lower thefirm’s cost of capital. Their study sample is comprised of US firms over 1974-2000.
Derwall and Verwijmeren (2007).
See, for example, Chen, Chen, and Wei (2011). They show that the governance index of Gompers et al. (2003) is significantly and posi vely related with afirm’s cost of equity. This implies that rela vely be er governed firms can benefit from lower cost of equity, rela ve to poorly-governed firms.
See, for example, Lima and Sanvicente (2013) for evidence from Brazil. Chen, Chen, and Wei (2009) provide evidence on the rela on between corporate
governance and cost of equity for a sample of firms from emerging markets. They also show that good corporate governance leads to lower cost of equity
capital.
24

3.2.2 COST OF EQUITY AND
THE ‘E’ AND ‘S’ DIMENSIONS
Several studies also demonstrate that a firm’s
environmental management117 and environmental risk
management118 have an impact on the cost of equity
capital. Firms with a be er score for the ‘E’ dimensionof ESG have a significantly lower cost of equity.119 Good
environmental sustainability also reduces a firm’s beta,120
and voluntary disclosure of environmental practices
further helps to reduce its cost of equity.121
Regarding the ‘S’ dimension of ESG, there is evidence that
good employee rela ons and product safety lead to a lower
cost of equity.122 Beyond this, research on sustainability
disclosure reveals that be er repor ng leads to a lower
cost of equity by reducing firm-specific uncertainties,
especially in environmentally sensi ve firms.123 Anotherstudy documents that a firm inves ng con nuously ingood sustainability prac ces has the eﬀect of lowering
a firm’s cost of capital by 5.61 basis points compared tofirms that do not.124“ SUPERIOR CSR PERFORMERS ENJOO Y A c .1.8
8 % REDUCC TIONN IN
N THE COSS T OFE QUITY””
Dhaliw
wal et al., 2011

117
118
119
120

121

122
123
124

See, for example, El Ghoul, Guedhami, Kwok, and Mishra (2011).
Evidence of the eﬀect of environmental risk management prac ces on a firm’s cost of equity financing is provided by Sharfman and Fernando (2008), who
document that a firm’s overall weighted average cost of capital is significantly lower when it has proper environmental risk management measures in place.
See, for example, El Ghoul, Guedhami, Kim, and Park (2014). The authors show for a sample of 7,122 firm-years between 2002 and 2011 that firms with be er
corporate environmental responsibility have significantly lower cost of equity.
Theore cal and empirical evidence of CSR and a corpora on’s beta is provided by Albuquerque, Durnev, and Koskinen (2013), who document that their selfconstructed composite CSR index is significantly and nega vely related to a firm’s beta, which implies that it also reduces its cost of equity financing, all otherthings being equal.
Dhaliwal, Li, Tsang, and Yang (2011) report a reduc on of 1.8% in the cost of equity capital for first- me CSR disclosing firms with excellent CSR quality.
Dhaliwal, Radhakrishnan, Tsang, and Yang (2012: 752) show that more CSR disclosure leads to lower analyst forecast error which indicates that CSR disclosure‘complements financial disclosure by mi ga ng the nega ve eﬀect of financial opacity on forecast accuracy’.
See, for example, El Ghoul, Guedhami, Kwok, and Mishra (2011) who show that alongside environmental risk management, employee rela ons and productsafety also influence the cost of equity financing.
Reverte (2012) finds a diﬀerence in the cost of equity of up to 88 basis points between those firms with good disclosure prac ces and those with bad
disclosure prac ces.
Cajias, Fuerst, and Bienert (2012) evaluate the eﬀect of aggregate CSR scores on the cost of equity capital and find that between 2003 and 2010 the eﬀect ofboth CSR strength and weakness was nega ve overall, implying lower costs of equity capital financing.
25This seection has inveestiggatedd the relationsship beetween corporaate
sustainability and corporratee cost of capitaal. The ressultss cann be summmarizedd asfollowss:• Firmms with good susttainaabilityy standaards enjoyy siggnificantly low
wer costt ofcapiital.
• Sup
perior sustainabilityy stanndards improvee corrporations’ access to125
capiital.
• Diﬀeren a ng betw
ween
n a firm’s cosst of equuity andd cost of debt, weconclude th
he followinng:• Costt of deb
bt:-

Good coorp
porate gooverrnancee structu
ures such as sm
mall and eﬃcient boaards
and goo
od disclosurre po
oliciess lead to loower borrrowiing co
osts.

-

Good ennvironmen
ntal manaagementt prac cess, su
uch as the insstalla on
n ofpollu onn abatemeent measu
ures and the avoidaancee of toxic releeases, lowwers
the costt of debt.

-

Employeee well-beinng reducees a firm’ss borrowinng coosts..

• Costt of equuityy:-The exisstence of an -ttakeo
over meassures incrreasees a firm’s co
ost of equuity
and vicee versa.

-

Environm
mental riskk man
nagem
ment pracc ces andd discclosu
ure on en
nvironmen
ntal
policies loower a firm
m’s cost off equity.

-

Good em
mployee reela ons an
nd produ
uct safety redu
ucess the costt of equityy offirms.

Table 4 summaarizes all 29
9 em
mpiriccal studiees on sustainaabiliity and itts eﬀectss on
cost of capital that have beeen revviewed for this reeporrt. In
n total, 26 of the 29
studiess (90%) find a rela onnship which pooints to a red
ducin
ng eﬀect of superrior
sustainability praac ces on th
he cosst of cap
pital.
125

See, for example, Cheng, Ioannou, and Serafeim (2014).

26

TABLE 4: EMPIRIC
C A L STUDIES INN V ESTIGATING TH
H E RELATIO
O NSH
H IP B ETWEENN A BILITY AN
N D C ORPOO RATE COS
S T OF CAPITTALSUSTAIN
STUDY AUTHORSTIMEPERIOD

ESG ISSUE

ESG
FACTOR

IMPACT (*)

Albuquerque, Durnev, and Koskinen (2013)2003-2012

Composite CSR index

ESG

Lower

Ashbaugh-Skaife, Collins, and LaFond (2004)

1996-2002

G

Lower

Ashbaugh-Skaife, Collins, and LaFond (2006)

2003

G

Lower

A g, El Ghoul, Guedhami, and Suh (2013)

1991-2010

Composite CSR index (excl. governance)

ES

Lower

Barth, Konchitchki, and Landsman (2013)

1974-2000

Earnings transparency

G

Lower

Bauer, Derwall, and Hann (2009)

1995-2006

Employee rela ons

S

Lower

Bauer and Hann (2010)

1995-2006

Environmental performance

E

Lower

Bhojraj and Sengupta (2003)

1991-1996

Governance a ributes (ins tu onal ownership,outside directors, block holders).

G

Lower

Bradley, Chen, Dallas, and Snyderwine (2008)

2001-2007

Several governance indicesG

Lower (1)Cajias, Fuerst, and Bienert (2012)

2003-2010

CSE strengths and concerns

ESG

Mixed

Chava (2014)

2000-2007

Environmental performance (net concerns)

E

Lower (2)Chava, Livdan, and Purnaanandam (2009)

1990-2004

Reversed governance index

G

Lower (3)Chen, Chen, and Wei (2011)

1990-2004

Governance index

G

Lower

Chen, Chen, and Wei (2009)

2001-2002

Composite governance index

G

Lower

Cremers, Nair, and Wei (2007)

1990-1997

An -takeover index and ownership structure

G

Lower

Derwall and Verwijmeren (2007)

2003-2005

Corporate governance quality

G

Lower

Dhaliwal, Li, Tsang, and Yang (2011)1993-2007

CSR disclosing quality

ESG

Lower (4)El Ghoul, Guedhami, Kim, and Park (2014)

2002-2011

Corporate environmental responsibility

E

Lower

El Ghoul, Guedhami, Kwok, and Mishra (2011) 1992-2007

Composite CSR index (excl. governance)

ES

Lower (5)Several individual corporate governance a ributes
and a composite governance index
Governance index and individual governancea ributes

Goss and Roberts (2011)

1991-2006

CSR concerns and strengths

ESG

Lower (6)Jiraporn, Jiraporn, Boesprasert, and Chang(2014)

1995-2007

Composite CSR score

ESG

Lower

Klock, Mansi, and Maxwell (2005)

1990-2000

Governance index

G

Lower

Lima and Sanvicente (2013)

1998-2008

Composite governance index

G

Lower

Menz (2010)2004-2007

Binary indicator variables for social responsibility

ESG

None (7)Reverte (2012)

2003-2008

CSR repor ng quality

ESG

Lower (8)Schauten and van Dijk (2011)

2001-2009

Disclosure quality

G

Lower (9)Schneider (2011)

1994-2004

Environmental performance: pounds of toxic
emissions

E

Lower (10)

Sharfman and Fernando (2008)

2002

Environmental risk management

E

Mixed (11)

Verwijmeren and Derwall (2010)

2001-2005

Employee well-being

S

Lower

27

(*) In the last column of the table, we state the eﬀect of be er ESG on the cost of capital of firms. ‘Lower’ indicatesthat be er ESG lowers cost of capital. ‘Mixed’ indicates that be er ESG has a mixed eﬀect on the cost of capital. ‘None’
indicates that be er ESG has no eﬀect on the cost of capital.

N OTE
E S TOO TABLEE 4:(1) More-stable boards indicate lower spreads. Mixed(6) Sustainability concerns increase loan spreads. Be er

findings regarding several other governance a ributes.

environmental performance is therefore valued

We count it as ‘lowering cost of capital’ because moreby lenders. They enjoy relatively better lending

stable boards decrease cost of debt financing.

condi ons. Therefore, counted as be er ESG quality(2) We count this as lowering costs of capital because‘lowers’ cost of capital.

bad environmental behaviour is penalized by lenders(7) Only one model shows significant results.

(i.e., they charge more). However, through exhibi ng(8) Especially for industries in environmentally sensi ve

a be er environmental quality, firms can get rela vely

sectors.

be er lending condi ons.

(9) The nega ve correla on between disclosure quality(3) The effect is positive when firms are exposed toand credit spreads persists only if shareholder rights

takeovers. Conversely, firms which are protected

are low.

from takeovers pay lower spreads (as in Klock, Mansi,(10) Hence, good environmental performance reduces

and Maxwell (2005), who use the conventional

yield spread.

G-index). Hence, Chava et al. (2009) support the idea(11) The authors find that good environmental riskthat low takeover vulnerability decreases the costmanagement increases the cost of debt and decreasesof debt financing. We therefore count this study as

the cost of equity. Hence, we count this study as

documen ng a reducing eﬀect of proper ESG quality

delivering ‘mixed’ results.

on the cost of capital.
(4) Especially for firms with sound sustainability policies
and prac ces.
(5) Quality on employee relations, environment, andproduct strategies were par cularly highlighted.

28

T

he previous section investigated the effects ofThis section starts with an analysis of available meta-sustainability on the cost of capital for corpora ons.

studies and then inves gates the research on the eﬀects

Overall, the conclusion was that sustainability reducesof environmental, social, and governance (ESG) issues ona firm’s cost of capital. The report now turns to theopera onal performance separately. A table summarizing

ques on whether sustainability improves the opera onal

the reviewed empirical studies can be found at the end of

performance of corpora ons.

this sec on.

There is debate around the link between sustainability and

4.1 META-STUDIES ONSUSTAINABILITY

a company’s opera ng performance. Many commentators
find a positive relationship between aggregatedsustainability scores and financial performance.126 Somesuggest that there is no correla on,127 and few argue that

There are several meta-studies and review papers

there is a negative correlation, between sustainability

which attempt to provide a composite picture of the128

Yet others propose that

relationship between sustainability and corporatecompanies experience a benefit from merely symbolic

financial performance. The general conclusion is thatand opera onal performance.

129

sustainability ac ons through increased firm value.

there is a posi ve correla on between sustainability andopera onal performance.

126

127

128
129

See, for example, Servaes and Tamayo (2013), Jo and Harjoto (2011) and Cochran and Wood (1984). Servaes and Tamayo (2013) conclude that CSR has
a posi ve eﬀect on financial performance, especially when the adver sing intensity of a corpora on is high. Firms benefit most from CSR if they also
proac vely adver se. This calls for a be er CSR disclosure policy through which companies communicate their CSR eﬀorts to the market and gain financiallyby, for example, a rac ng more customers. Jo and Harjoto (2011) show that CSR leads to higher Tobin’s Q, but this rela onship is significantly influenced
by corporate governance quality. Cochran and Wood (1984) on the other hand conclude that superior CSR policy and prac ce lead to be er opera onal
performance of firms. Also, Pava and Krausz (1996) conclude that there is at least a slightly posi ve rela on between CSR and financial performance using
both market-based and accoun ng-based performance measures. Further evidence is provided by Koh, Qian, and Wang (2014). Wu and Shen (2013) findthat CSR is posi vely related to financial performance; measured by accoun ng-based measures for 162 banks from 22 diﬀerent countries. Albuquerque,Durnev, and Koskinen (2013) find a significant and posi ve rela onship between their CSR score and Tobin’s Q. Cai, Jo, and Pan (2012) show that the value offirms in controversial businesses is significantly and posi vely aﬀected by CSR. In their classic study, Waddock and Graves (1997) show that corporate social
performance is generally posi vely related to opera onal performance, with varying degrees of significance.
See, for example, McWilliams and Siegel (2000), Garcia-Castro, Arino, and Canela (2010), and Corne , Erhemjamts, and Tehranian (2013). Garcia-Castro et al.
(2010) claim that the exis ng literature on CSR and performance suﬀers from the fact that endogeneity is not properly dealt with. By adop ng an instrumental
variables approach, they are able to show that the rela onship between an aggregate CSR index and financial performance becomes insignificant. They use
ROE, ROA, Tobin’s Q, and MVA as financial-performance measures.
See, for example, Baron, Harjoto, and Jo (2011).
Hawn and Ioannou (2013). Their results indicate that symbolic CSR changes significantly increase Tobin’s Q, while substan ve CSR ac on does not have any
significant eﬀect on firm performance. The authors suggest that ‘firms with an established base of CSR resources might undertake symbolic ac ons largely
because it is rela vely less costly for them to do so, and also because such firms enjoy suﬃcient credibility with social actors to get away with it’, p. 23.
29

In Table 5, we provide an overview of the most important meta-studies on sustainability and its rela onship to corporate
performance, and of studies which include a detailed overview of the literature on the topic.

TABLE 5: OVERVII E W OF METTA-ST
T UDIESS AND REVV IEWS IN THE FIE
E LD O F SUSS TAINABILL ITY AND E SG
PAPERSAUTHORSYEAR

JOURNAL

TITLE

Fulton, Kahn, and Sharples

2012

Industry report; publishedby Deutsche Bank Group

Sustainable Inves ng: Establishing Long-Term Value and Performance

Hoepner and McMillan

2009

Working Paper

Research on ‘Responsible Investment’: An Influen al Literature Analysis
Comprising a Ra ng, Characterisa on, Categorisa on and Inves ga on

Margolis and Walsh

2003

Administra ve Science
Quarterly

Misery Loves Companies: Rethinking Social Ini a ves by Business

Margolis, Elfenbein,
and Walsh

2007

Working paper

Does it Pay to be Good? A Meta-Analysis and Redirec on of Research on
the Rela onship Between Corporate Social and Financial Performance

McWilliams, Siegel,and Wright

2006

Journal of Management
Studies

Corporate Social Responsibility: Strategic Implica ons

Orlitzky, Schmidt,
and Rynes

2003

Organisa on Studies

Corporate Social and Financial Performance: A Meta-analysis

Pava and Krausz

1996

Journal of Business Ethics

The Associa on Between Corporate Social-Responsibility and Financial
Performance: The Paradox of Social Cost

Salzmann, Ionescu-Somers,
and Steger

2005

European Management
JournalThe Business Case for Corporate Sustainability: Literature Review andResearch Op ons

van Beurden and Gössling

2008

Journal of Business Ethics

The Worth of Value- A Literature Review on the Rela on Between
Corporate Social and Financial Performance

4.2 OPERATIONALPERFORMANCEAND THE ‘G’ DIMENSION

showing that poorly governed firms do have lower
opera ng performance levels.131 Similarly, there are also
papers showing that good corporate governance leads tobe er firm valua ons.132 A similar rela onship has been

The literature on corporate governance and its rela onshipdemonstrated for a sample of Swiss firms: good corporate

to firm performance is broad, o en focusing more on

governance is correlated with be er firm valua ons.133 On

stock market outcomes than firm profitability from ana related note, some studies suggests that a smaller and130

accoun ng perspec ve.

130
131

132
133

Nevertheless, there is researchtransparent board structure increases firm value and that

We focus only on accoun ng-based studies in this sec on; the eﬀects of corporate governance on stock price performance measures are discussed in the next
sec on.
Core, Guay, and Rus cus (2006) show that firms with more an -takeover devices in place (i.e., fewer shareholder rights as measured by the G-index of
Gompers, Ishii, and Metrick (2003)) display lower returns on assets. Likewise, Cremers and Ferrell (2013) show that poorly-governed firms exhibit significantly
lower industry-adjusted Tobin’s Qs over the period 1978-2006. Giroud and Mueller (2011) also support these results by finding a significant nega verela onship between the number of an -takeover devices in place and firm valua on.
See, for example, Brown and Caylor (2006). They study the governance quality of 1,868 firms and relate it to their valua on sta s cs. Brown and Caylor showthat their measure for corporate governance quality is posi vely and significantly related to firm value.
See, for example, Beiner, Drobetz, Schmid, and Zimmermann (2006).
30

firms with staggered or classified boards134 suﬀer in terms

4.3 OPERATIONALPERFORMANCEAND THE ‘E’ DIMENSION

of lower firm valua ons.135 There is also research showingthat the governance environment of corpora ons (i.e. thegovernance legisla on) significantly aﬀects opera onal
performance and firm valua on.136

Empirical research on the relationship between
Research has also shown that firm performance is directly

environmental and financial performance points in aaﬀected by execu ve compensa on prac ces.137 If execu ve

clear direc on. Studies demonstrate that good corporate

compensation schemes areproperly designed (to motivate
managers suﬃciently not to incite
excessive risk taking) the impact
on firm performance is generally
positive.

Poorly-designed

execu ve compensa on schemes

environmental“ CO
O M PANN IES
S W ITHH LARGGEB O ARR D S A PP
P EA
A R T O USE
E
A SSETT S L E SSS EFFICC I ENTLLYA N D E ARN
N LOW
W ER
R
P ROFITS.”

can tend to have the opposite

Yermmack, 1996

practices

ultimately translate into acompetitive advantage and thus
be er corporate performance.140
Proper corporate environmental
policies

resultinbetteroperational performance. In
particular, higher corporate

eﬀect, with higher execu ve pay
resul ng in lower firm performance.138

environmental ra ngs,141 the reduc on of pollu on levels,142
and the implementa on of waste preven on measures,143

More indications to the positive effects of corporate

all have a positive effect on corporate performance.

governance on financial performance in a range of

Likewise, the adoption of proper environmental

countries also exist, suppor ng the idea of a significant

management systems increases firm performance.144

rela onship between corporate governance quality andMoreover, the implementa on of global standards withfirm performance.139

respect to corporate environmental behaviour increases
Tobin’s Q for mul na onal enterprises.145Furthermore, it
has recently been demonstrated that more eco-eﬃcient

134

135

136

137
138
139
140
141
142
143
144
145

The terms ‘classified’, or ‘staggered’, boards refer to a par cular board structure in which not all board members are up for re-elec on in the same year. Under
this board structure, only a frac on of the board members are up for elec on at a par cular annual general mee ng. The remaining board members are up forelec on in the following year. This means that it becomes more diﬃcult for shareholders to replace board members because it will take several years un l acomplete board will be changed. For more details see Bebchuk and Cohen (2005) and Bebchuk, Cohen, and Wang (2011).
Yermack (1996) shows that larger boards significantly reduce firm value. Evidence of the eﬀect of staggered boards on firm value is provided by Bebchuk
and Cohen (2005) as well as by Bebchuk, Cohen, and Wang (2011). The la er study inves gates the causal eﬀects of staggered boards by the means of theinves ga on of two court rulings related to staggered boards. Overall, they study 2,633 firms and conclude that staggered boards significantly reduce firm
value.
Giroud and Mueller (2010) show that the introduc on of business combina on laws in the United States nega vely aﬀect the opera ng performance of firmsin less compe ve industries. This finding implies that firms opera ng in very concentrated industries suﬀer from these business combina on laws in terms oflower return on assets (ROA).
For example, Mehran (1995).
Core, Holthausen, and Larcker (1999) document that poorly-governed firms pay their execu ves more than their well-governed counterparts, resul ng inpoorer firm performance.
Ammann, Oesch, and Schmid (2011) examine 6,663 firm-year observa ons from 22 developed capital markets over the period 2003-2007 and findconsistently across all their models a significant rela onship between their measures of corporate governance quality and Tobin’s Q.
Porter and van der Linde (1995a, 1995b).
Russo and Fouts (1997).
For evidence of the eﬀect of an -pollu on measures, see Fogler and Nu (1975), Spicer (1978), Hart and Ahuja (1996), King and Lennox (2001), and Clarkson,
Li, and Richardson (2004). Clarkson et al. (2004) show that investments in pollu on abatement technologies pay oﬀ, especially for firms that pollute less.
King and Lennox (2002) document that proper waste preven on leads to be er financial performance as measured by Tobin’s Q and ROA.
Darnall, Henriques, and Sadorsky (2008).
Dowell, Hart, and Yeung (2000).
31

firms have significantly be er opera onal performance asgroups – employees, customers and the community –measured by return on assets (ROA).146 It is further argued

significantly improve operational performance.150 It isthat corporate environmental performance is the driving

also clear that proper stakeholder management prac ces

force behind the posi ve rela onship between stakeholdertranslate into higher firm value.151 More broadly, a diverse

welfare and corporate financial performance (measured by

workforce has a positive effect on firm performance,152

Tobin’s Q).147

and the evidence points to the importance of employee
relations for operational performance. The conclusion

With regard to poor environmental policies, both theis evident: good workforce prac ces pay oﬀ financially in

release of toxic chemicals and the number of environmental

terms of be er opera ng performance.153

lawsuits have been found to have a significant andnegative correlation to performance.148 Additionally,

For other, more specific social dimensions, there is alsocarbon emissions have been found to aﬀect firm value in aevidence of significant and posi ve eﬀects on corporate

149

performance. For example, banks that have be er scoressignificant and nega ve manner.

for ’Community Reinvestment Act Ra ngs’ exhibit be er
financial performance.154

Hence, evidence related to the ‘E’ dimension shows that amore environmentally friendly corporate policy translates

Given the evidence, it is clear that the social dimension

into be er opera onal performance.

of sustainability, if well managed, generally has a posi ve
influence on corporate financial performance. What is

4.4 OPERATIONALPERFORMANCEAND THE ‘S’ DIMENSION

missing in this strand of research is direct evidence ofother types of corporate social behaviour, for example,
corporations’ worker-safety standards in emerging
markets, respect for human rights, or socially responsible

Studies validate a correlation between the ‘S’ (social)adver sing campaigns.

dimension of sustainability and opera onal performance.
Good corporate relations with three major stakeholder‘A 10% REDUCTT IO
O N IN EMISSIONS OF TOXICC CHEMICA
A LS R ESUU LTS IN A $ 34
M ILLIONN INCREAA S E IN MARKEE T VALL UE’
Konar andd Cohen, 2001

146
147
148
149
150
151

152
153
154

Guenster, Derwall, Bauer, and Koedijk (2011).
Jiao (2010).
Konar and Cohen (2001).
See, for example, Matsumura, Prakash, and Vera-Munoz (2011).
Preston and O’Bannon (1997).
See, for example, Benson and Davidson (2010), Hillman and Keim (2001), and Borgers, Derwall, Koedijk, and ter Horst (2013). Borgers et al. (2013) find asignificant posi ve rela on between a stakeholder index and subsequent opera onal performance of corpora ons measured by opera ng income scaled byassets and net income scaled by total assets.
Richard, Murthi, and Ismail (2007) inves gate the eﬀect of racial diversity on produc vity and firm performance and find a posi ve rela onship between thelevel of racial diversity and performance.
See, for example, Huselid (1995), Smithey Fulmer, Gerhart, and Sco (2003), and Faleye and Trahan (2010). Huselid (1995) provides evidence that good
workforce prac ces translate into be er opera ng performance. Similar findings are shown by Smithley et al. (2003), and Faleye and Trahan (2010).
Simpson and Kohers (2002).
32

In this sec on,, we have anaalysedd the acaddemic literatture on the rela onshipbetweeen susttainability annd opera onaal perforrman
nce and connclude thefollowinng:• Metta-studiies generally show a posi ve correla onn bettween su
ustainabiility
and opera onal perfo
ormmancee.
• Reseearch on the impaact of ESG
G issues on operaa on
nal performaance shoows
a po
osi ve relaa onship:-

With reegard to go
overrnancce, issuess such ass boaard structuree, execu ve
compennsa on, an -taakeoveer mechaanisms, and incen
n ves arre viewedd as
most immportant.

-

Environm
mental topicss suchh as corp
porate ennviro
onm
mental management
prac cees, pollu on
n ab
batem
ment and resource eﬃcienccy are men onedd as
the mosst relevant to op
pera onal perfformancee.

-

Social faactors such as emplo
oyee rela onships and goodd workforrce prac ceshave a laarge impactt on
n operaa onal peerformancce.

Table 6 summaariizes all reeview
wed empiricall studies on th
he toopic of su
ustainabiility
in rela on to opera onaal peerform
mance.
In total we reviiewed 51 studdies, of which 45 (88%) sho
ow a posi ve correla on
betweeen sustaain
nability and operaa onal performan
nce..

33

TABLE 6: EMPIRIC
C A L STUDIES ON
N THE RELATIONN SHIP BETW
W EEN
N ES
S G AND COO R PORATET IO
O NAL PERFORM
M ANCE.
OPERATSTUDY AUTHORSTIMEPERIOD

ESG ISSUEESG FACTOR

IMPACT (*)

Albuquerque, Durnev, and Koskinen (2013)2003-2012

Composite CSR index

ESG

Posi ve

Ammann, Oesch, and Schmidt (2011)2003-2007

Compiled governance indicesG

Posi ve (1)Baron, Harjoto, and Jo (2011)

1996-2004

Aggregate CSR strengths index and CSR
concerns index

ESG

Mixed findings (2)Bebchuk and Cohen (2005)

1995-2002

Classified boards (Board structure)G

Posi ve (3)Bebchuk, Cohen, and Wang (2011)2010

Classified boards

G

Posi veG

Posi ve

S

Posi ve

Beiner, Drobetz, Schmid, and Zimmerman (2006)
Benson and Davidson (2010)

Composite and individual governanceindicators
Stakeholder management prac ces and1991-2002social issue par cipa on
2003

Borgers, Derwall, Koedijk, and ter Horst (2013)

1992-2009

Stakeholder rela ons index

S

Posi ve

Brown and Caylor (2006)

2003

Composite governance score

G

Posi ve

Busch and Hoﬀmann (2011)

2007

Carbon intensity

E

Mixed

Cai, Jo, and Pan (2012)

1995-2009

Aggregate CSR index

ESG

Posi ve (4)Clarkson, Li, and Richardson (2004)

1989-2000

Environmental capital expenditures

E

Posi ve (5)Cochran and Wood (1984)

1970-1979

CSR reputa on index

ESG

Posi ve

Core, Guay, and Rus cus (2006)

1990-1999

Governance index/shareholder rights

G

Posi ve (6)Core, Holthausen, and Larcker (1999)

1982-1984

Excess compensa on

GPosi ve (7)Corne , Erhemjamts, and Tehranian (2013)2003-2011

Overall ESG index

ESG

No eﬀect (8)Cremers and Ferrell (2013)

1978-2006

Governance index/shareholder rights

G

Posi ve (9)Darnall, Henriques, and Sadorsky (2008)

2003

E

Posi ve

Dowell, Hart, and Yeung (2000)

1994-1997

E

Posi ve

Faleye and Trahan (2011)

1998-2005

Good workforce prac ces

S

Posi ve

Ferrell, Liang, and Renneboog (2014)

1999-2011

Aggregate CSR and sub-topics

ESG

Posi ve

Garcia-Castro, Arino, and Canela (2010)

1991-2005

Aggregate stakeholder rela ons
measureESG

No eﬀect

Giroud and Mueller (2010)

1976-1995

Industry concentra on

G

Posi ve (10)Giroud and Mueller (2011)

1990-2006

Governance index

G

Posi ve (11)Guenster, Derwall, Bauer, and Koedijk (2011)

1997-2004

Eco-eﬃciency levels

E

Posi ve

Hart and Ahuja (1996)

1989-1992

Reduc on in pollu on

EPosi ve (12)Hawn and Ioannou (2013)

2002-2008

Symbolic CSR ac ons

ESG

Posi ve

Hillman and Keim (2001)

1994-1996

Stakeholder rela ons and social issues
par cipa on

SPosi ve (13)

Huselid (1995)-

Good workforce prac ces

S

Posi ve

Adop on of environmental
management prac ces
Adop on of global environmental
standards(conƟnued)
34

TABLE 6: CONTIN
N UED

STUDY AUTHORSTIMEPERIOD

ESG ISSUEESG FACTOR

IMPACT (*)

Jayachandran, Kalaignanam, and Eilert (2013)-

Corporate environmental performance,
product social performanceES

Mixed (14)Jiao (2010)

1992-2003

Stakeholder welfare score

S

Posi ve

Jo and Harjoto (2011)1993-2004

Aggregate CSR index and governance
index

ESG

Posi ve (15)King and Lennox (2001)

1987-1996

Total emissions

E

Posi ve (16)King and Lennox (2002)

1991-1996

Installa on of waste preven on
measures

E

Posi ve

Koh, Qian, and Wang (2014)

1991-2007

Aggregate CSR score

ESG

Posi ve

Konar and Cohen (2001)

1989

Release of toxic chemicals

E

Posi ve (17)Liang and Renneboog (2014)

1999-2011

Various CSR ra ngs

ESG

Posi ve

Matsumura, Prakash, and Vera-Munoz (2011)2006-2008

Total level of carbon emissions

E

Posi ve (18)McWilliams and Siegel (2000)

1991-1996

Socially responsible indicator variable

ESG

No Eﬀect

Mehran (1995)

1979-1980

Total execu ve compensa on and shareof equity based salaryG

Posi ve

Pava and Krausz (1996)

1985-1991

Aggregate CSR score

ESG

Posi ve

Preston and O’Bannon (1997)

1982-1992

Employee, customer, and community
rela onsS

Posi ve (19)Richard, Murthi, and Ismail (2007)

1997-2002

Diversity

S

Posi ve

1991-1992 Corporate environmental performanceE

Posi ve (20)Servaes and Tamayo (2013)

1991-2005

Aggregate CSR index

ESG

Posi ve (21)Simpson and Kohers (2002)

1993-1994

Community Rela ons

S

Posi ve

Smithey Fulmer, Gerhart, and Sco (2003)

1998

Employee wellbeing

S

Posi ve (22)

Spicer (1978)

1970-1972

Pollu on control mechanisms

E

Posi ve

Waddock and Graves (1997)

1989-1991

Weighted average CSR index

ESG

Posi ve

Wu and Shen (2013)2003-2009

Aggregate CSR index

ESG

Posi ve

Yermack (1996)

1984-1991

Reduc ons in board size

G

Posi ve

Russo and Fouts (1997)(*) In the last column of the table, we state the eﬀect of be er ESG on opera onal performance. ‘Posi ve’ indicatesthat be er ESG has a posi ve eﬀect on opera onal performance. ‘Mixed’ indicates that be er ESG has a mixed eﬀect
on opera onal performance. ‘Nega ve’ indicates that be er ESG has nega ve eﬀect on opera onal performance.

NO
OT ES
S TO TAA B LE 6:(1)

Evidence from numerous countries.

Tobin’s Q; CSR challenges show a significantly(2)

CSR strengths are not significantly correlated tonega ve correla on to Tobin’s Q.
35

(3)

Counts as positive, as better-governed firms(19) A correla on is found here, but no causal eﬀect.

without classified boards have a rela vely be er(20) This result holds especially for high growth

performance.

industries.

(4)

Posi ve but insignificant for sin industries only.

(21) Only when adver sing intensity is high.

(5)

Just for firms that are not major polluters.

(22) A correla on is found here, but no causal eﬀect.

(6)

This is counted as positive, because weakshareholder rights (a high G-index) lead to poor
opera ng performance. Hence, improvements inshareholder rights can trigger be er performance.
This reasoning applies to all studies which inves gate
the eﬀects of the governance index from Gompers,
Ishii, and Metrick (2003) on performance.

(7)

Counts as positive because less excessive pay(i.e. better governance) implies relatively better
performance.

(8)

Banking industry study.

(9)Counts as posi ve, same argument as for Core, Guay,
and Rus cus (2006).

(10) Counts as posi ve, because study shows that wellgoverned (in terms of industry competitiveness)
firms perform rela vely be er.
(11) Counts as posi ve.
(12) Generally positive, even more positive effect forfirms that pollute.
(13) Social issue participation shows a negative
correlation, but because these are controversial
business indicators, the eﬀect is posi ve overall.
(14) Product social performance has posi ve eﬀect on
Tobin’s Q, environmental performance has no eﬀect,
and environmental concerns have a nega ve eﬀect.
(15) G-index (by Gompers et al., (2003)) is nega vely
related to Tobin’s Q, implying that improvements in
the G-index will lead to rela vely be er valua ons.
(16) That is, less pollu on is value enhancing. Therefore
this study counts as posi ve.
(17) Firms that release fewer toxic chemicals benefit byhaving be er performance. Therefore counted as a‘posi ve eﬀect’.
(18) We count this study as ‘posi ve’ because a reduc onin the level of carbon emissions would result in arela vely be er performance.
36

T

5.1 STOCK PRICES AND
THE ‘G’ DIMENSION

he previous two sections investigated the link
between sustainability and corporate performance

where we found a significant posi ve correla on:

The way in which the quality of corporate governance••

90% of the cost of capital studies show that soundinfluences stock price performance has been the subject

ESG standards lower the cost of capital.

of in-depth analyses in financial economics and corporate

88% of the operational performance studies show

finance literature.155 The research has focused on par cularthat solid ESG prac ces result in be er opera onal

features of governance structures in order to review

performance.

eﬀects on profitability and financial performance. The

Based on these results, the following sec on analyses

focus has been on both external governance mechanisms

whether this informa on is beneficial for equity investors.

such as the market for corporate control,156 the level of

In doing so, we use the same methodology as before:

industry compe

we examine the effects of environmental, social, andas the board of directors158 and execu ve compensa on

governance (ESG) parameters on stock prices separately

prac ces.159 It has also been shown that revealed financial

and then consider the eﬀects for the aggregate scores.

misrepresentation leads to significantly negative stock

on,157 and internal mechanisms suchmarket reac ons.160‘A PORTT FOLIO T H AT GOES LON
N G IN WELL GO
O VERNED FIRM
M S AND SHORR T INP OORLY GOVERNN E D FIRMS
S CRE
E ATESS AN ALPH
H A OF10%
% TO
O 15%
% ANNUAA L LY OVER
T HE TIM
M E PERIOO D 1990 TO
O 20
0 01.’
Cremers and Nair, 2005

155

156
157
158
159
160

The financial economics literature in general and the corporate finance literature in par cular have clearly focused more on research which relates thecorporate governance quality to corporate financial performance. This is because it is o en claimed that the quality of corporate governance is easier toquan fy than the quality of environmental or social performance, and that the financial consequences are easier to measure.
See Gompers, Ishii, and Metrick (2003) for the most prominent example of research on the rela on between takeover exposure and stock-price performance.
Their results have been confirmed by Core, Guay, and Rus cus (2006).
For example: Giroud and Mueller (2010) and (2011).
Evidence is, for example, provided by Yermack (1996).
For example, Core, Holthausen, and Larcker (1999).
Karpoﬀ, Lee, and Mar n (2008). The authors study 585 firms which have been involved in financial misrepresenta on cases with the SEC over the me period
from 1978 to 2002. 25.24%.
37

Probably the most prominent study on corporatecharacteris cs as there has been some sugges on thatgovernance and its relationship to stock market

adjus ng for industry clustering may remove alpha.164

performance was published in the Quarterly Journalof Economics in 2003. Researchers from Harvard andIn summary, the majority of current studies suggest that

Wharton showed, for the first me, that the stocks of well-superior governance quality leads to better financial

governed firms significantly outperform those of poorly-

performance.

governed firms. Their empirical analysis revealed that along-short por olio of both well- and poorly-governed

5.2 STOCK PRICES AND
THE ‘E’ DIMENSION

firms (i.e., going long in firms with more-adequate
shareholder rights and short in firms with less-adequate
shareholder rights) leads to a risk-adjusted annual

Research has also documented a direct relationshipabnormal return (henceforth, alpha) of 8.5% over the161

between the environmental performance of firms

period 1990 to 1999.

and stock price performance. In par cular, it has been
Further research supports their finding that superiordemonstrated that posi ve environmental news triggers

governance quality is valued posi vely by the financial

positive stock price movements. 165 Similarly, firms

market.162 For example, a por olio that goes long in well

behaving environmentally irresponsibly demonstrate

governed firms and short in poorly governed firms createssignificant stock price decreases.166 Specifically, following

an alpha of 10% to 15% annually over the me period 1990

environmental disasters in the chemical industry, the stock

to 2001.163

price of the aﬀected firms reacts significantly nega vely.167

However, there remains more work to be done

It has been further shown that firms with higher pollu on

in researching whether these findings are driven

figures have lower stock market valuations.168 Other

by governance aspects or by other firm or sector

prominent research has revealed that firms which are

161

162

163

164
165

166

167

168

Gompers, Ishii, and Metrick (2003) inves gate the performance implica ons of the exposure of corpora ons towards the market for corporate control,
construc ng a governance index which consists of 24 unique an -takeover devices. Higher index values imply many an -takeover mechanisms in place (≥ 14),or a low level of shareholder rights (‘dictatorship’ or poorly governed firms). In contrast, well-governed firms display very low levels (≤ 5) of the governanceindex (the ‘democracy’ firms).
Bebchuk, Cohen, and Ferrell (2010) use an ‘entrenchment index’ based on six governance provisions with poten al managerial entrenchment eﬀects. The
authors find that their entrenchment index is nega vely related to firm value as measured by Tobin’s Q., hence, their findings support the results obtained
by Gompers, Ishii, and Metrick (2003) as well as those of Cremers and Ferrell (2013) in that they document the importance of corporate governance for firm
value.
See Cremers and Nair (2005) who inves gate the eﬀects of governance quality on stock market performance. Their finding that well governed firms
outperform is, however, condi onal on internal governance quality, i.e., their result only holds if there is high ins tu onal ownership next to high takeover
vulnerability.
See, for example, Johnson, Moorman, and Sorescu (2009).
See Klassen and McLaughlin (1996). The authors inves gate the stock price reac on to the announcement of posi ve environmental news and use theannouncement of the winning of an environmental award (verified by a third party organiza on) as their measure for good environmental performance.
Conversely, they also document nega ve stock price reac ons for adverse corporate environmental events.
See, Flammer (2013). The author inves gates stock price reac ons around news related to the environmental performance of corpora ons. Inves ga ng
environmentally related news over the me period 1980-2009, the author concludes that on the two days around the news event (i.e. one day before theannouncement of the environmentally related news and the announcement day itself), stocks with “eco-friendly events” experience a stock price increase of
on average 0.84% while firms with “eco-harmful events” exhibit a stock price drop of 0.65%.
See Capelle-Blancard and Laguna (2010). The authors inves gate in total 64 explosions in chemical plants at 38 diﬀerent corpora ons over the me period
from 1990 to 2005. On the day of the explosion, the average stock price reac on is nega ve with 0.76%. Two-days a er the event, shareholder lost on average
1.3%. The authors also find that share prices react more nega vely if the disaster involved the release of toxic chemicals.
Cormier and Magnan (1997) find that firms that pollute more have lower stock market values. They argue that this is due to the ‘implicit environmental
liabili es’ that these firms carry with them. Hamilton (1995) argues in a similar vein, showing that a company’s share price shows a significantly nega ve
reac on to the release of informa on on toxic releases.
38

5.3 STOCK PRICES AND
THE ‘S’ DIMENSION

more ‘eco-eﬃcient’ significantly outperform firms thatare less ‘eco-eﬃcient’,169 and this result holds even a er
accoun ng for transac on costs, market risk, investment
style, and industries. This key finding points to a

Besides the environmental and governance dimensions

posi ve rela onship between corporate environmentalof sustainability, researchers have also inves gated theperformance and financial performance170. The converse

eﬀect of par cular social issues on corporate financial

rela onship also holds: firms that violate environmental

performance. Perhaps the most prominent study on theregula ons experience a significant drop in share price.171

social dimension of ESG and its eﬀect on corporate financial
performance is by Professor Alex Edmans, who was thenOn the other side, research also indicates that theat the Wharton School at the University of Pennsylvania.

market does not value all corporate environmental news

He inves gated the ‘100 Best Companies to Work For’equally.172 For example, a voluntary adop on of corporate

in order to check for a rela onship between employee

environmental ini a ves has been known to result in a

wellbeing and stock returns. His findings indicate that anega ve stock price reac on upon the announcement of

por olio of the ‘100 Best Companies to Work For’ earned

173

the inita ve.

an annual alpha of 3.5% in excess of the risk-free rate from1984 to 2009 and 2.1% above industry benchmarks.174
Similar outperformance has also been observed for a more

A FTT ER R EPO
O R TINGE NV
V IRO
O NMENN TA
A LLY
Y POSITII VE
E VE
E NTS
S STO
O C KSS SH
H OW A N
AVE
E RAG
G E ALPP HA
A OFF 0.8
84%.
C ON
N VE
E R SELLY,, A FTER NE
E G ATT IVE
E
E VE
E NTS
S , STT OCKK S UNDERPP E RFOO RM
B Y -0.6
6 5%.

extended period from 1984 to 2011.175
Empirical results also show interna onal evidence on theposi ve rela onship between employee sa sfac on andstock returns.176
This is a highly significant finding because it indicates thatalphas seem to survive over the longer term and thatFlam
mmer, 2 013
169

170

171
172
173

174
175

176

See Derwall, Guenster, Bauer, and Koedijk (2005): The authors inves gate the stock market performance of firms that are more ‘eco-eﬃcient’ and firmsthat are less ‘eco-eﬃcient’. They also focus on the concept of ‘eco-eﬃciency’ as a measure of corporate environmental performance. They define it as the
economic value that the company generates rela ve to the waste it produces in the process of genera ng this value (p. 52). In the period 1995-2003, they findthat the most ‘eco-eﬃcient’ firms deliver significantly higher returns than less ‘eco-eﬃcient’ firms.
Galema, Plan nga, and Scholtens (2008) argue that the reason some studies find no significant alpha a er risk adjus ng using the Fama-French risk factors
is that corporate environmental performance significantly lowers book-to-market ra os, implying that the return diﬀerences between high CSR and low CSR
stocks are created through the book-to-market channel because ‘SRI results in lower book-to-market ra os, and as a result, the alphas do not capture SRI
eﬀects’, p. 2653.
Karpoﬀ, Lo , and Wehrly (2005) provide evidence of this rela onship.
See, for example, Brammer, Brooks, and Pavelin (2006).
See, Fisher-Vanden and Thorburn (2011): The authors study 117 firms over the me period 1993-2008 and examine shareholder wealth eﬀects resul ng
from par cipa on in the voluntary environmental programmes using an event study methodology. Overall and across several empirical specifica ons,
they document a significant and nega ve stock market reac on upon the announcement of joining the voluntary environmental performance ini a ves.
Shareholder value is therefore destroyed by voluntarily joining these programmes, hence the authors conclude that ‘corporate commitments to reduce GHG
emissions appear to conflict with firm value maximiza on’.
Edmans (2011) argues that the stock market does not fully value intangibles in the form of employee rela ons.
In his follow-up paper, Edmans (2012) extends the sample period un l 2011 and tests for any alphas over the new sample period from 1984-2011. Consistent
with his earlier findings, the results indicate an alpha of 3.8% annually in excess of the risk-free rate. Likewise, the alphas adjus ng for industries are higher
than in the shorter sample period with 2.3% annually.
See Edmans, Li, and Zhang (2014). The authors inves gate the rela on of employee sa sfac on and stock returns in 14 countries over several diﬀerent me
periods. They find that for 11 out of the 14 countries the alphas of a por olio of the companies with the highest employee sa sfac on scores are posi ve.
Their evidence also points to the fact that the observed and o en quoted posi ve rela onship between good employee rela ons and stock returns may nothold for all countries and that also country diﬀerences with respect to labor flexibility must be taken into account.
39

the market has s ll not yet priced in all the informa on

a posi ve eﬀect, while index exclusions have a nega ve

regarding employee sa sfac on.

eﬀect on respec ve stock prices.180 There is also wider
evidence that exclusion from sustainability stock indicesSimilar results have been documented elsewhere.177 Other

causes significant nega ve stock price reac ons.181 Other

studies on the social dimension of ESG show that firms

evidence shows that stocks of firms with a superior

which make very high or very low charitable dona ons

sustainability profile deliver higher returns than thosereport better financial performance than other firms,of their conventional peers,182 and that sustainability

especially over the long-term,178 although in this context,

quality provides insurance-like effects when negative

we agree with those who ques on whether charitable

events occur, helping to support the stock price upon the

donations are a real measure for sustainability or ifannouncement of the nega ve event.183 It has also been

dona ons are just seen as a ‘symbolic ac on’.179

demonstrated that firms experience significant posi ve
stock price reac ons when shareholder-sponsored CSR
proposals are adopted by corpora ons.184

5.4 STOCK PRICESAND AGGREGATESUSTAINABILITY SCORES

The effects of an aggregated sustainability measure
have also been inves gated in the context of corporate
mergers and acquisi ons.185 For example, by following a

A number of studies look at aggregated sustainability

trading strategy which goes long in acquirers with a be er

indices. For example, the addi on to, or exclusion from,sustainability profile and going short in acquirers with athe Dow Jones Sustainability World Index has been foundworse sustainability profile, investors are able to realize an

to have some eﬀect on stock prices: index inclusions haveannual risk-adjusted alpha of 4.8%, 3.6%, and 3.6% over

‘A PORTT FOLIO C O MPRISED
D OF THE ‘100 BESTT COMPANIESS TO WORK FO
O R INA MERICA’ YIELDD ED AN ALPP HA OF 2.. 3% ABOVV E INDUSTRY BEN
N CHMARKK S OVER T HEP ERIOD 1984-2
2 0 11.’
Edmans, 2012

177

178
179
180
181
182
183
184
185

Three examples of addi onal evidence are Smithey Fulmer, Gerhart, and Sco (2003), Filbeck and Preece (2003), and Faleye and Trahan (2011). Smithey
Fulmer et al. (2003) show that the ‘100 Best Companies to Work For’ are able to outperform the market, but not match peer firms. Filbeck and Preece (2003)
conclude that a persistent outperformance of these firms is not observed, but that ‘support may exist for such superior results for longer holding periods’, p.
790. Faleye and Trahan (2011) report posi ve stock price reac ons upon the announcement of the Fortune list which includes the ‘100 Best Companies toWork For’.
See, for example, Brammer and Millington (2008). Godfrey (2005) shows that ‘strategic corporate philanthropy’ can indeed benefit shareholders.
For example, Hawn and Ioannou (2013) discuss symbolic CSR ac ons in the context of firm value.
See Cheung (2011). The author also shows that most of the sample firms are opera ng in the manufacturing industry, implying that even companies inindustries that tradi onally have a poor CSR profile frequently become members of a sustainability index.
See, for example, Becche , Cicire , and Hasan (2009) and Doh, Howton, Howton, and Siegel (2010).
Statman and Glushkov (2009).
Godfrey, Merrill, and Hansen (2009).
Flammer (2014). The author shows for a sample of 2,729 shareholder-sponsored CSR proposals that implemen ng them leads to an alpha of 1.77%.
See, for example, Deng, Kang, and Low (2013), and Aktas, de Bodt and Cousin (2011).

40

one-, two-, and three-year holding periods respec vely.186

S TO
O CKS
S OF SUSS TAINN ABLEE
C OM
M PA
A N IESS T ENN D T O O UTT P ERFF ORM
M
T HE
E IR L ESS S USS TAINAB
B LE
E
C OU
U NTT E RPA
A R TS BY 4.8%
% AN
N NU
U A LLLY

More generally, when companies with a good sustainability
profile are acquired, the market reac on is unanimously
posi ve.187
Another recent study which relates an aggregate

Ecclles, Iooannnoou, and Serraffeim, 201
13sustainability score to stock market performance findsthat a ‘high-sustainability’ por olio outperforms a ‘lowsustainability’ por olio by 4.8% on an annual basis (whenusing a value-weighted por olio, the results indicate anannual outperformance of 2.3%).188 Overall, these findings
point to the possibility of earning an alpha by inves ng infirms with a superior sustainability profile.
Against this, there is some evidence indica ng a nega ve
relationship between aggregate sustainability scoresand stock market performance exists, however such
evidence is scarce.189 Despite several studies showing
no relationship, or a negative relationship, between
sustainability scores (both aggregated and disaggregated)and stock price performance, the majority of studies find aposi ve rela onship where superior ESG quality translates
into superior stock price performance rela ve to firms
with lower ESG quality.
The importance of good quality non-financial informa on
was recently emphasized by a survey of 163 ins tu onal
investors190, 89% of whom indicated that non-financial
performance information played a pivotal role ininvestment decision making over the last twelve months.
186

187
188

189

190

Deng, Kang, and Low (2013) study 1,556 completed US mergers between 1992 and 2007 to address the key ques on whether CSR creates value foracquiring firms’ shareholders. They find that superior CSR quality on the part of the acquirer creates value for both the acquiring shareholders and the target
shareholders. They also document that bondholders’ CARs (cumula ve abnormal returns) are generally nega ve upon the announcement of a merger, but
are less nega ve for those mergers in which an acquirer with a good CSR profile is involved, which adds to the evidence provided by Cremers, Nair, and Wei(2007).
Aktas, de Bodt and Cousin (2011) inves gate 106 interna onal merger deals from 1997-2007 using Innovest IVA ra ngs.
Eccles, Ioannou, and Serafeim (2013) classify the sustainability quality of firms based on a sustainability index which evaluates whether corpora ons adopt
several diﬀerent kinds of CSR policies (e.g., human rights, environmental issues, waste reduc on, product safety, etc.). The authors primarily inves gate thestock market performance of both groups of firms and therefore circumvent any reverse causality issues. Their empirical analysis reveals that a por olio
consis ng of low-sustainability firms shows significantly posi ve returns. Further, the high-sustainability por olio displays posi ve and significant returns overthe sample period. Importantly, the performance diﬀeren al is significant in economic and sta s cal terms. The authors also find that the high-sustainability
por olio outperforms the low-sustainability por olio in 11 of the 18 years of the sample period.
See for example, Brammer, Brooks, and Pavelin (2006). They focus on the UK market and call for a disaggrega on of CSR measures in order to disentangle
the individual eﬀects of each of the underlying CSR measures (also related to Table 1 of this report). Lee and Faﬀ (2009) show that companies ‘lagging’ withrespect to corporate sustainability underperform compared with their superior counterparts and the market.
Ernst & Young (2014).
41

Based on our reeview in thiis secc on, thee following can be concclu
uded withrespectt to thee rela onnshipp bettween su
ustainabbilityy and financcial market
perform
mance:• Superior su
ustainability qualityy (as meeasured by aggreegate su
ustainabiility
scorres) is valued by the stockk markett: more sustaainaable firm
ms generaallyoutp
performm less sustaainaable firms.
• Stoccks of well-governeed firm
ms perfo
orm be er thann stocks of poorlygoveerned firmms.
• On the ennvironmen
ntal dimmension of sustaainaabilitty, corpo
orate ecoeﬃciency and enviro
onmmentaally respo
onsible behaaviorr are view
wed as themosst imporrtaant facto
ors leeadinng to supperior stocck markket perform
mance.
• On the soccial dimensio
on, thhe literaature shoowss thaat good employyeerela ons an
nd emplooyeee sa sfac on contribu
ute to be er sto
ock marrket
perfformancce.
• Tablle 7 sum
mmarizes all reeviewed paperrs on susttainaability and itss rela on
n tofinancial market perfformmancee. In totaal, we revview
wed 41 studiees, of whhich
33 (80%) document a posi ve corrella on beetweeen good su
ustainability
and superioor financiaal maarkett perform
mance.

42

TABLE 7: EMPIRIC
C A L STUDIES INN V ESTIGATING TH
H E RELATIO
O NSH
H IP O F VARIOUUSA C TORS AND COR
R PORAATE FINANCC IAL PERFORMAA NCE
ESG FASTUDY AUTHORS
Aktas, de Bodt, and Cousin(2011)
Bebchuk, Cohen, and Ferrell(2009)
Bebchuk, Cohen, and Wang(2013)
Becche , Cicire , and Hasan(2009)
Borgers, Derwall, Koedijk, andter Horst (2013)
Brammer and Millington(2006)
Brammer, Brooks, and Pavelin(2006)
Capelle-Blancard and Laguna(2010)
Cheung (2011)

TIME
PERIOD

ESG ISSUE

ESG
FACTOR

IMPACT (*)

1997-2007

Intangible Value Assessment Ra ngs

ESG

Posi ve (1)1990-2003

Entrenchment index

G

Posi ve (2)2000-2008

Governance quality/shareholder rightsG

No eﬀect/no rela on

1990-2004

Sustainability index exits and entries

ESG

Posi ve (3)1992-2009

Stakeholder rela ons index

S

Mixed findings (4)1990-1999

Charitable giving

S

Mixed findings (nonlinear) (5)

2002-2005

Composite CSR index

ES

Mixed (6)1990-2005 Environmental disasters (explosions) at chemical plants

E

Posi ve (7)2002-2008

Sustainability index inclusion/exclusions

ESG

Posi ve

Governance index/shareholder rights

G

Posi ve

Excessive compensa on

GPosi ve (8)Amount of pollu on

EPosi ve (9)Core, Guay, and Rus cus
1990-1999(2006)
Core, Holthausen, and Larcker
1982-1984(1999)
Cormier and Magnan (1997)

1986-1993

Cremers and Nair (2005)

1990-2001 Reversed governance index and block holder ownership

G

Posi ve

Deng, Kang, and Low (2013)

1992-2007

Composite CSR index

ESG

Posi ve

Corporate eco-eﬃciency

E

Posi ve

Sustainability index inclusion/exclusion

ESG

Mixed (10)Corporate sustainability index

ESG

Posi ve

Derwall, Guenster, Bauer, and1995-2003
Koedijk (2005)
Doh, Howton, Howton, and2000-2005
Siegel (2010)
Eccles, Ioannou, and Serafeim
1991-2010(2013)
Edmans (2011)

1984-2009

Employee sa sfac on

S

Posi ve

Edmans (2012)

1984-2011

Employee sa sfac on

S

Posi ve

Edmans, Li, and Zhang (2014) 1984-2013

Employee sa sfac on

S

Generally posi ve

Faleye and Trahan (2011)

1998-2005

Employee sa sfac on

S

Posi ve

Filbeck and Preece (2003)

1998

Employee sa sfac on

S

Posi ve

Fisher-Vanden and Thorburn(2011)

1993-2008

Environmental performance ini a ve par cipa on

EPosi ve

Flammer (2013)

1980-2005

Corporate environmental footprint

E

Posi ve

Flammer (2014)

1997-2011

Shareholder-sponsored CSR proposals

ESG

Posi ve

Giroud and Mueller (2010)

1976-1995

Industry concentra on

G

Posi ve (11)Giroud and Mueller (2011)

1990-2006

Governance index in highly concentrated industries

G

Posi ve (12)Godfrey, Merrill, and Hansen(2009)
Gompers, Ishii, and Metrick(2003)

19912002/03

Social ini a ve par cipa on

ESG

Posi ve

1990-1998

Shareholder rights

G

Posi ve(conƟnued)

43

TABLE 7: CONTIN
N UED

STUDY AUTHORSTIMEPERIOD

ESG ISSUE

ESG
FACTOR

IMPACT (*)

Hamilton (1995)

1989

Volume of toxic releases

E

Posi ve (13)2004-2006

Environmental performanceE

Mixed findings

1990-1999

Governance quality/shareholder rightsG

No eﬀect/no rela on

1980-2000

Environmental regula on viola ons

ESG

Posi ve (14)1978-2002

Financial misrepresenta on

GPosi ve (15)Kaspereit and Lopa a (2013)

2001-2011

Corporate sustainability and GRI

ESG

Posi ve

Klassen and McLaughlin(1996)

1985-1991

Environmental management awards

E

Posi veKrüger (2014)

2001-2007

CSR news events

ESG

Posi ve (16)Lee and Faﬀ (2009)

1998-2002

Corporate sustainability quality

ESG

Nega ve

Smithey Fulmer, Gerhart, andSco (2003)

1998

Employee wellbeing

S

Posi ve (17)Composite CSR index

ES

Posi ve

Reduc ons in board size

G

Posi ve

Jacobs, Singhal, andSubramanian (2010)
Johnson, Moorman, andSorescu (2009)
Karpoﬀ, Lo , and Wehrly(2005)
Karpoﬀ, Lee, and Mar n(2008)

Statman and Glushkov (2009) 1992-2007
Yermack (1996)

1984-1991(*) In the last column of the table, we state the eﬀect of be er ESG on stock price performance. ‘Posi ve’ indicates thatbe er ESG has a posi ve eﬀect on stock price performance. ‘Mixed’ indicates that be er ESG has a mixed eﬀect on stock
price performance. ‘Nega ve’ indicates that be er ESG has nega ve eﬀect on stock price performance.

NO
OT ES
S TO TAA B LE 7:(1)

Evidence from numerous countries.

(2)

We count this study as having a ‘posi ve’ eﬀect on

authors find a nega ve rela on for the disaggregatedstock prices because the authors conclude that a

CSR categories of environment and community, buthigher entrenchment index reflects bad governancea weakly posi ve one for employment.

(6)

structures. This means that by improving the

(3)

(7)

suffer from environmental disasters experiencebe er.

a significant share price drop. Firms which are

We count this study as posi ve as index dele ons

prepared for such events (by, for example, pu ng

result in significant negative stock price returns.

par cular safety means in place), rela vely benefit

Assuming that superior ESG firms stay in the index,

from experiencing no significant nega ve stock price

be er ESG could prevent significant nega ve stock

reac ons.
(8)

Counted as ‘posi ve’, because excess compensa on
reduces the subsequent stock returns.

The posi ve eﬀect is not apparent from 2004-2009.
(9)

Therefore we label it ‘mixed findings’.
(5)Counted as ‘positive’, because firms which

entrenchment index, firms can perform rela vely

price reac ons.
(4)

We treat this study as ‘mixed findings’ because theWe treat this study as ‘posi ve’ because firms that

Extremely high and extremely low – with both

pollute less (i.e., firms that are more environmentally

resul ng in improved firm performance.

friendly) perform rela vely be er. No direct increase44

in share value observed - not stock price reac on
per se.
(10) Counts as ‘mixed findings’ because index dele ons
cause significant negative returns implying that
more sustainable firms remain on the index and do
not suﬀer from these nega ve valua on eﬀects.
(11) Highly concentrated industries experiencea significant negative stock price reaction toexogenous changes in the compeve environment.

(12) Governance pays off, especially in relatively lesscompe

ve industries.

(13) We treat this study as ’posi ve’ in our calcula ons
because lower volumes of toxic releases would leadto rela vely be er stock price movements.
(14) We count this study as ‘positive’ because bad
performers suffer while good performers dorela vely be er.
(15) This study is counted as posi ve because it showsthat firms which conduct financial misrepresenta on
are punished by sto ck markets through significant
stock price declines.
(16) This study counts as posi ve as the results indicatethat shareholders react strongly nega ve to nega ve
CSR news and posi ve to posi ve CSR news – at least
when no agency problems are present in firms.
(17) ‘Positive’ because the analysis reveals anoutperformance of a market benchmark.

45

T

hus far in the report, we have analyzed existingThis influencing, which is usually undertaken via ‘ac ve

research to demonstrate the posi ve correla onownership’, and ordinarily is a combina on of three forms:

between ESG parameters and investment performance.

1. Proxy Vo ng:

We have demonstrated that companies with higher

A low-cost tool to engage with firms in order to achievesustainability scores on average have a be er opera onal

better corporate sustainability/ESG standards. The

performance, are less risky, have lower cost of debt andbenefits may seem logical, but the literature available

equity, and are be er stock market investments.

to date only provides limited evidence that proxy vo ng
is an eﬀec ve tool to promote proper ESG standards,

An addi onal feature of note is that various studies haveor that it is helpful in creating superior financial

found a ‘momentum eﬀect’ regarding ESG parameters.

performance at investee firms.192
2. Shareholder Resolu ons:

In other words, strategies that assign a higher por olio
weight to companies with improving ESG factors have

Shareholder resolu ons at an annual general mee ng

191

can be a powerful tool to influence a company’s

outperformed strategies that focus on sta c ESG criteria.

management. When a company wants to avoid
It is therefore logical for investors to seek to influence

publicity on a certain topic, it can concede in return forthe companies into which they have invested in order toa withdrawal of the respec ve shareholder proposal.193
3. Management Dialogue:

improve the company’s ESG metrics. The investors thenbenefit from the companies’ improvement once other

Dialogue with the invested company’s management

market par cipants integrate the new informa on into

team is o en used as a form of private engagement by

their investment decisions.

ins tu onal investors,194 and successful management
engagement has the poten al to posi vely influence
the stock price of target firms. It has been demonstrated
that successful private engagement leads to an
average annual alpha of 7.1% subsequent to successful
engagement.195

191
192
193

194

195

See, for example, the study by MSCI ESG Research ‘Op mizing Environmental, Social, and Governance Factors in Por olio Construc on’ by Nagy, Cogan, andSinnreich (2012).
See, for example, Gillan and Starks (2000) and (2007).
See, for example, Bauer, Braun, and Viehs (2012), and Bauer, Moers, and Viehs (2013). Bauer et al. (2013) provide detailed evidence on the determinants ofshareholder proposal withdrawals, whereas Bauer et al. (2012) inves gate which factors drive shareholder to file resolu ons with certain companies. They
also study the determinants of the resolu ons’ vo ng outcomes.
See, for example, Eurosif (2013), McCahery, Sautner, and Starks (2013), Bauer, Clark, and Viehs (2013), and Clark and Hebb (2004). Clark and Hebb (2004)
argue that direct engagements by pension funds with their investee firms represent an expression of the long-term inves ng proposi on. Bauer, Clark, andViehs (2013) inves gate the engagement ac vi es of a large UK-based ins tu onal investor and find that shareholder engagement is increasing over me.
The engagement takes place within all three dimensions of ESG, and in some years the number of environmental and social engagements exceeds the numberof governance engagements, poin ng to a growing importance of environmental and social issues. The authors also show that private engagements suﬀer
from a home bias eﬀect: UK firms are more likely to be targeted than firms from other countries.
See the study by Dimson, Karakas, and Li (2013).
46

To date, active ownership has achieved a great deal,

S UC
C CES
S SFUL EN
N GAG
G EM
M EN
N T S LEE AD
D
T O A LPP H AS O F 7 .1%% IN T HE YE
E AR
F OLL LOWW ING
G T HE EN
N GAG
G E M ENTT.

and this is likely to con nue the more investors engage.
Companies such as Hermes EOS, F&C, and Robeco oﬀer
a rac ve ac ve ownership services enabling investors tojoin forces and set a common agenda and priori es, while196

the PRI clearing houseDimmson,, Karrakass, and Li, 201
13oﬀers a pla orm for collabora ve

engagements with regard to priority themes.
Ac ve ownership is a powerful tool. However, in its current
form, it lacks the structural support of a key stakeholder
group – the customer of the invested companies. In ourview, the next step in the evolu on of ac ve ownership is toinclude the ul mate beneficiaries of ins tu onal investors,
who are at the same me the ul mate consumers of thegoods and services of the invested companies, into theagenda and priority se ng process.

196

More informa on on the UN PRI’s clearing house can be found here: h p://www.unpri.org/areas-of-work/clearinghouse/.
47

T

he report has clearly demonstrated the economic

3. Investors should be active owners and exert theirrelevance of sustainability parameters for corporate

influence on the management of their invested

management and for investors. The main results of thecompanies to improve the management ofreport are:sustainability parameters that are most relevant to

1. 90% of the cost of capital studies show that sound ESG

opera onal and investment performance.

standards lower the cost of capital.

4. It is in the best interest of asset management

2. 88% of the studies show that solid ESG prac ces resultcompanies to integrate sustainability parameters into

in be er opera onal performance.

the investment process to deliver compeve risk-

3. 80% of the studies show that stock price performanceadjusted performance over the medium to longer

is posi vely influenced by good sustainability prac ces.

term and to fulfill their fiduciary duty towards theirinvestors.198
5. The future of active ownership will most likely be

Given the strength, depth, and breadth of the scien fic

one where mul ple stakeholders (such as individual

evidence, demonstra ng that sustainability informa on

investors and consumers) are involved in se ng theis relevant for corporate performance and investment

agenda for the ac ve ownership strategy of ins tu onal

returns, we conclude as follows:investors.
6. There is need for ongoing research to iden fy whichsustainability parameters are the most relevant for

1. It is in the best long-term interest of corporate

opera onal performance and investment returns.

managers to include sustainability into strategic
management decisions.
2. It is in the best interest of ins tu onal investors andtrustees, in order to fulfill their fiduciary du es, torequire the inclusion of sustainability parameters into
the overall investment process.197

197
198

For similar arguments, see the so-called ‘Freshfield Reports’: United Na ons Environment Programme Finance Ini a ve (2005) and (2009).
United Na ons Environment Programme Finance Ini a ve (2005) and (2009).
48

This clear economic case for sustainable corporate

ac ve ownership strategy that goes beyond the tradi onal

management and investment performance can be

instruments that ins tu onal investors currently employ.

supported on the basis of logic alone. The most important
stakeholders for ins tu onal investors like pension funds

The future of ac ve ownership will most likely be one

and insurance companies are the beneficiaries of thesewhere mul ple stakeholders such as individual investors

institutions, i.e., the people who live in the sphere ofand consumers will find it attractive to be involved in

impact of the companies in the investment por olios.

se ng the agenda for the ac ve ownership strategy ofCompanies affect the environment and communities,

ins tu onal investors.

provide employment, act as trading partners and service
providers, as well as contribute through tax payments tothe overall budget of countries.
Aside from the clear economic benefit for the investment
por olio, it is axioma c that it is in the best interest of anindividual to influence companies to demonstrate prudent
behaviour with regard to sustainability standards sincethose companies have a direct impact on the life of theindividual person.
Based on current trends199, we expect that the inclusionof sustainability parameters into the investment process
will become the norm in the years to come. This will
be supported by a push from the European Union toincrease companies’ transparency and performanceon environmental and social matters200, on improving
corporate governance 201 and on corporate social
responsibility202.
The most successful investors will most likely have set up
con nuous research programs regarding the most relevant
sustainability factors to be considered in terms of industry
and geography. In such a scenario, we expect that it will bea requirement for professional investors to have a credible

199
200
201
202

See, PricewaterhouseCoopers (2014).
European Commission (2014a), and European Commission (2013a).
European Commission (2014b).
European Commission (2013b), European Commission (2013c), and European Commission (2013d).

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