Beyond Compliance: Sustainable Business Practices and the Bottom Line

In recent years, there has been considerable research activity devoted to the relationship between the environmental performance and financial performance or stock returns of publicly traded companies. Also, many new "green" and "socially responsible" mutual funds have been created, as well as forprofit efforts that evaluate and rate corporate environmental performance and link it to stock returns.1 That there is a positive correlation between environmental performance and financial performance on a cross-sectional basis is clear for many industry sectors, and there is a premium observed when one compares stock returns over time for "good" versus "bad" environmental performers in these same sectors. Not surprisingly, the strength of the correlation varies across sectors, as does the observed stock returns premium attributed to good environmental performance. What seems to be happening is that the traditional notion of environmental compliance as a necessary cost of doing business is being transformed into something where pollution prevention, waste treatment, recycling, etc., and going "beyond compliance" represent either a direct cost savings or a competitive advantage (Porter and Van der Linde 1995a and Porter and Van der Linde 1995b). In addition, firms with better environmental records may have reduced compliance costs and a lower risk of future environmental liabilities (Konar and Cohen 2001). But whether the line of causation goes from environmental performance to financial performance or vice versa (the idea that financially successful firms can afford to be good environmental performers), or that both are the result of good management, is still an open question.2 Measuring environmental performance and management quality is still problematic, and only recently have firms begun to pay attention-publicly at least-to environmental issues as a central part of business strategy.3 Most of the literature on this subject to date falls into four categories. The first is portfolio studies wherein the stock returns of "good" environmental performers are compared to those of "bad" environmental performers. In this category are academic studies like Cohen, Fenn, and Konar and the evidence provided by the rating firms. In the Cohen, Fenn, and Konar study, industry-balanced portfolios of environmental leaders and laggards as of 19871989 were constructed from the S&P 500 and the average financial performance was then tracked. In 80% of the comparisons, the lowpolluter portfolio performed better than the high-polluter portfolio. Adjusted for risk, the number was 75%. In both comparisons, however, the number of instances in which the difference was statistically significant was considerably less. Other efforts in this regard have grown out of the accelerating interest in socially responsible investing (SRI) here and abroad. In the United States, SRI has been growing twice as fast as mutual fund investing. And 79% of SRI funds screen (either in or out) on environmental performance. Waugh Lecture. Dennis J. Aigner is professor and dean at the Donald Bren School of Environmental Science & Management, University of California, Santa Barbara, CA. Jeff Hopkins and Rob Johansson are economists at the Economic Research Service of the U.S.