Is responsible corporate behaviour linked to better financial performance? (Part 2)

Let's dive into it !

Question) Does good social performance lead to good financial performance, or is reverse causality also at play here? And if yes, is there a framework of approaching this question?

Answer) At the outset, I need to recognize the fact that most of the studies which exist in the space cover the aspect of correlation and not causation of one leading to the other – that doesn’t negate any of the outcomes but puts these insights in that context. Alex Edmans covers this in detail in his book on “Growing the Pie” (Edmans, 2022). Hence, below, I attempt to cover a few examples, which will show why the two are heavily co-related at least. It begs questions on when and by how much a corporation should start being “responsible” based on their size and profitability. Are there degrees and phases of maturity to behaving “responsibly”? That is a different framework in itself, which I shall cover in later posts on this topic. For this post, let’s dive into what the data tells us about linkages between corporate profitability and responsibility.

In the book Firms of endearment: How world-class companies profit and purpose, (Raj Sisodia, Conscious Capitalism, 2014) Raj Sisodia and his co-authors shortlisted and evaluated the financial performance of companies that had more humanistic profiles. They found that these companies outdid their S&P 500 peers by a 10.5:1 over a period of 15 years (1996-2011).  

When we look at highly ethical companies, Ethisphere is a body which produces an annual list of the world’s most ethical companies. In 2011, 110 companies were recognised and it was visible that these companies out-performed the S&P 500 peers by an average of 7.3% annually (John Mackey, Appendix A - The business case for conscious capitalism, 2014).

In addition, in the year 1992, HBS professors published a book on corporate culture and performance, and found that in 207 large US companies in 22 industries over a time span of 11 years, who had a strong stakeholder-oriented culture from employees to senior leaders; they out-performed their peers on revenue growth (682% vs 166%), stock price increase (901% vs 74%) and net income increase (756% vs 1%) (John Mackey, Appendix A - The business case for conscious capitalism, 2014).

There are also certain counter-intuitive evidence. In the famous book, Good to Great, Jim Collins had evaluated companies that out-performed others – it threw up names like Circuit City, Fannie Mae, Wells Fargo, Altria / Philip Morris. Fannie Mae got caught in the financial crisis, Wells Fargo needed bailout packages during 2008 and Philip Morris, has certainly had a overall net negative value-add to society, given the high deaths due to tobacco consumption. Did the companies contribute to higher social benefit, reduce negative externality or keep the larger stakeholder view in mind – certainly not. This is evident when we look at the same companies tracked against the previous table, over the same time period. They hardly outperform the S&P500 performance, and see the “firms of endearment” outperform them by a very high % (John Mackey, Appendix A - The business case for conscious capitalism, 2014).

In addition, very clearly increased financial performance leads to more efforts and investments being put into CSR activities. Few researchers have found through regression analysis that an increase in corporate financial performance was connected positively with an increase in corporate social responsibility. Their analysis is among the best of its kind, in having an in-depth multidimensional measure of corporate social responsibility, for which you can refer to John Campbell’s paper on “Why would corporations behave in socially responsible ways” (Campbell, 2007).

So, the question is not if better corporate responsible behaviour is connected with better financial performance (as the above examples show innumerable connections between the two), but more on how the responsibility expectations from a corporation start to grow once it grows in its size (revenue/market-cap), profitability (EBITDA), monopolistic advantages and also the type of extractive industry it would be operating in (mining, processing, high-end manufacturing etc). I shall propose a framework on how to approach this, in a later post in this series.

Keep Reading! Keep questioning!

Bibliography

Campbell, J. L. (2007). Why would corporations behave in socially responsible ways? An institutional theory of corporate social responsibility. Academy of Management Review, Vol 32, No 3, Pages 946-967.

John Mackey, R. S. (2014). Appendix A - The business case for conscious capitalism. In R. S. John Mackey, Conscious Capitalism (pp. 275-290). Boston: Harvard Business School Publishing Corporation.

Raj Sisodia, J. M. (2014). Conscious Capitalism. Boston: Harvard Business School Publishing Corporation.

Edmans, Alex (2022). Growing the Pie: How great companies deliver both purpose and profit. New York: Cambridge University Press