case study

1. In early 2015, four years into the program, describe how effective you think the implementation of the USLP strategy has been. (2 points)

2. Given our analysis of the many risks, barriers and impediments Poleman faced in introducing this bold USLP strategy, how was he able to overcome these obstacles and implement such a successful radical transformational change? (3 points)

3. Limiting ourselves to the options identified by Polman and his ULE team, which of these three strategies would you advise them to take. Give support for your position using supporting references. (5 points)

‘double down’ by pushing ahead on USLP objectives;

‘hunker down’ by scaling back on USLP and focusing more on the current financial challenges;

or ‘pivot and refocus’ the strategy on the new partnership-based transformational change agenda

Make use of supplemental material as well as examples/cases, to demonstrate your arguments.

HBR.ORG
May 2013
reprinT r1305B
The Big idea
The Performance
Frontier
innovating for a sustainable strategy
by Robert G. Eccles and George Serafeim
This article is made available to you with compliments of Robert G. Eccles. Further posting, copying or distributing is
copyright infringement.
The Big Idea
Robert g. eccles is a professor of management practice
at Harvard Business School
and the chairman of the
Sustainability Accounting
Standards Board.
george Serafeim is an
assistant professor of
business administration at
Harvard Business School
and a member of the SASB
Standards Council.
2 Harvard Business Review May 2013
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Innovating for a sustainable strategy
by Robert G. Eccles and George Serafeim
May 2013 Harvard Business Review 3
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The Big idea tHe PeRfoRmAnCe fRontieR: innovAting foR A SuStAinABle StRAtegy
B
y now most companies have sustainability programs.
They’re cutting carbon emissions, reducing waste,
and otherwise enhancing operational efficiency.
But a mishmash of sustainability tactics does not add up
to a sustainable strategy. To endure, a strategy must address
the interests of all stakeholders: investors, employees,
customers, governments, NGOs, and society at large.
CoPyRigHt © 2013 HARvARd BuSineSS SCHool PuBliSHing CoRPoRAtion. All RigHtS ReSeRved.
4 Harvard Business Review May 2013
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illuStRAtion: PeteR StRAin
Low
fInancIal pERfORMancE
HIGH
those whose programs—relevant or not—depress
To do that, it has to increase shareholder value while
financial results.
at the same time improving the firm’s performance
In this article we examine the trade-offs and proon environmental, social, and governance (ESG)
vide a framework for creating sustainable strategies
dimensions.
that—by definition—simultaneously boost both
Companies understand this, but too often they
launch programs with the hope that they’ll be finan- financial and ESG performance. It requires compacially rewarded for “doing good,” even when the is- nies to do two things: focus strategically on the most
sues they address aren’t relevant to their strategy “material” ESG issues—the ones that have the greatest impact on the firm’s ability to create shareholder
and operations. Largely missing from these efforts
value; and produce major innovations in products,
is a clear understanding of the very real trade-offs
that exist between financial and ESG performance. processes, and business models that prioritize those
concerns.
Improving one typically comes at a cost to the
other. While using expensive solar energy is good
for the environment, it’s often bad for the bottom
innovation and Performance
line; paying workers above-market wages benefits
The penalties for ignoring ESG issues can be harsh.
the community but eats into profits. The capital
Foxconn, Apple’s manufacturer in China, was remarkets know this only too well. As a result they
minded of this in 2010, when revelations about
don’t reward firms for ESG programs that fail to
the deplorable working conditions in its factories
enhance financial performance, and they punish
unleashed a firestorm of bad press and ultimately
halved its market cap. BP is still mopping up after
the catastrophe on its Deepwater Horizon oil rig in
The PeRfoRMance fRonTieR
the Gulf of Mexico—as much a managerial as an
In the absence of substantial innovation, the financial performance
engineering
disaster. And the banking giant UBS
of firms declines as their environmental, social, and governance
(ESG) performance improves. To simultaneously improve both kinds
learned—after an estimated $200 billion outflow of
of performance, they need to invent new products, processes, and
private client assets, fines of $780 million, and presbusiness models.
sure from national governments to disclose clients’
names—that in the age of transparency, hiding beMajor
hind Swiss secrecy laws is not a good strategy.
innovation
In each case the company prioritized financial
Moderate
innovation
over ESG performance, putting controls in place to
prevent similar debacles only after the fact. Misguided decisions like these are made because the
Minor
innovation
costs of negative externalities (external consequences of the company’s activities), such as pollution or abusive labor practices, are often borne by
no
society,
to the benefit of shareholders. Conversely,
innovation
activities that help society, such as voluntarily reHIGH
Low
ESG pERfORMancE
ducing emissions or investing in youth education
initiatives, often create costs for the firm.
SOuRcE AutHoRS’ eConometRiC AnAlySiS of moRe tHAn 3,000 oRgAnizAtionS
For arTicle reprinTs call 800-988-0886 or 617-783-7500, or visiT hBR.oRg
idea in Brief
investments in sustainability
programs often require tradeoffs in companies’ financial
performance, but this doesn’t
have to be. By strategically
focusing on the environmental, social, and governance
(eSg) issues that are the most
relevant—or “material”—to
shareholder value, firms can
simultaneously boost both
financial and eSg performance.
firms must do four things to
achieve this:
• identify which eSg issues
are most critical in their particular business. materiality
maps that the Sustainability
Accounting Standards Board is
creating for 88 industries can
aid this process.
• Quantify the financial
impact that improvements on
those issues would have.
The exhibit on the previous page presents a
conceptual model of this relationship. We developed this model through interviews, surveys, and
several years of field research involving hundreds
of companies across numerous sectors. Financial
performance, as gauged by revenues, profit margins, stock price, and other metrics, is plotted on
the Y axis; ESG performance, represented by lower
carbon emissions and waste, fair labor practices,
effective risk management, and other metrics, is
captured on the X axis. The slope of a line (what’s
shown represents a composite picture of more than
3,000 companies from 2002 to 2011) reveals the relationship between financial and ESG performance.
The steeper the line’s downward slope, the greater
the negative impact a firm’s ESG improvements
have on financial performance; the steeper the upward slope, the greater the positive impact such improvements have. We call this line “the performance
frontier.”
Because of limitations on the measurement of
ESG performance and the presence of myriad confounding variables such as leadership style and company culture, it is not yet possible to plot a precise
graph for any single company. But our econometric
analyses of 3,000-plus organizations confirm that if
companies innovate, they can simultaneously improve ESG and financial performance and move the
trajectory of the frontier line upward.
Pushing the frontier
While minor innovations, such as efficiency improvements, can nudge a downward-sloping performance frontier up a bit, only major innovations
in products, processes, or business models can shift
the slope from descending to ascending. Such innovations are high risk, involving large-scale investments and long payback periods (often of five years
or more). Typically, they concern a bundle of related
• undertake major innovation in products, processes,
and business models to
achieve the improvements.
• Communicate with stakeholders about those innovations. integrated reporting,
which combines financial and
eSg performance information
in one document, is an effective way to do this.
1
to facilitate the process,
companies must break down
barriers to change—namely,
incentive systems and investor
pressure that emphasize shortterm performance; a shortage
of required expertise; and
capital-budgeting limitations
that fail to account for projects’
environmental and social value.
ESG issues and tackle significant, unsolved challenges in a sector.
Four broad initiatives are required to develop the
kind of innovation programs that create a sustainable strategy.
idenTify MaTeRial eSg iSSueS
The list of ESG concerns that could have a large impact on financial performance is long and broad. It
ranges from emissions, water and energy use, and
waste management to labor practices, community
development, employee safety, and executive compensation. Whether an issue significantly affects a
company’s ability to create long-term shareholder
value depends on both the sector the firm operates
in (carbon emissions are more material for a coalfired utility than for a bank) and its particular strategy (human rights are more material for a company
using low-cost labor in developing countries than for
a firm using skilled workers in developed countries).
The Sustainability Accounting Standards Board
(SASB), where one of us (Bob) is chairman and the
other (George) is a member of the Standards Council,
is currently devising a framework to help companies
determine their material ESG issues. The nonprofit is
developing standards for use by public corporations
in disclosing performance on dozens of ESG measures. Central to the project is the creation of Materiality Maps for 88 industries in 10 sectors. Each map
prioritizes 43 ESG issues, ranking their materiality for
a given industry on a scale from 0.5 to 5, with 5 being
most material. The higher the score for an issue, the
greater its probable impact on a firm’s financial performance. At press time, SASB had completed maps
for two sectors and 13 industries; new sector maps
are expected to become available approximately every three months.
Materiality is assessed through a rigorous process that examines “evidence of interest” by search-
May 2013 Harvard Business Review 5
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The Big idea tHe PeRfoRmAnCe fRontieR: innovAting foR A SuStAinABle StRAtegy
ing thousands of source documents, from 10-Ks to
media reports, for ESG keywords; and “evidence of
economic impact” by evaluating whether management (or mismanagement) of the issue will affect
valuation parameters such as revenue growth and return on capital. (See the sidebar “How to Determine
‘Materiality.’”)
The “Which Issues Matter Most?” exhibit contains a map for the health care sector and ranks
ESG dimensions for six industries. The most material ESG issues are shaded in a darker color. You can
see that in the biotechnology industry, for instance,
product quality and safety are paramount, whereas
regulatory issues, access to services, and customer
satisfaction are among the most important issues for
managed care providers. Conversely, fuel management is hardly material at all in the biotech industry
(although it is quite material in health care distribution), while supply chain standards are less material
for health care distribution (although they are quite
material in biotech).
If a Materiality Map isn’t available for an industry, a company can join the SASB Industry Working
Group for its sector to see the analysis under way and
engage with shareholders and other stakeholders to
develop a general sense of the relevance of various
issues.
A host of factors complicate evaluations of the relationship between ESG and financial performance.
Not the least of them are limitations on the ability
to precisely measure ESG performance—a challenge
that SASB and others are working to address. Nevertheless, companies can make an informed estimate
of the slope of the performance-frontier curve for
any pair of ESG and financial variables by determining whether each incremental improvement
in ESG performance causes a corresponding positive or negative change in financial results—or has
no impact.
3
2
QuanTify The RelaTionShiP
BeTween financial and
eSg PeRfoRMance
Once you understand your firm’s material ESG issues, assess the impact that improvements in each
would have on financial performance. Such performance has many dimensions, of course. Depending on the company’s strategy and the issue being
considered, the most important dimension could
be cost reduction, revenue growth, or gross margin
defense.
In its “Plan A” sustainability program, the British retailer Marks & Spencer evaluated 180 ESG initiatives ranging from becoming carbon neutral to
improving employee health, looking at how they’d
affect sales, costs, the brand, employee motivation,
and the resilience of the business. With some the impact was easy to measure; with others it wasn’t. In
some cases the trade-offs between financial and ESG
performance were clear. Because many initiatives
required investments, Marks & Spencer conducted
return-on-investment analyses to determine which
projects to devote more resources to.
innovaTe PRoducTS, PRoceSSeS,
and BuSineSS ModelS
The analyses you’ve done will provide the foundation for your innovation strategy. Once you know
which ESG issues to focus on, you should determine how the firm compares with its peers on them.
Trade associations and the trade press can be useful
resources for this. If your firm’s performance in an
area—say, energy use or labor practices—falls short of
industry benchmarks, getting it up above par is a first
priority. At the very least it will mitigate your risks,
since stakeholders tend to focus on industry laggards
in campaigns aimed at increasing corporate ESG performance. Many improvements, such as reducing
manufacturing waste, involve minor or moderate innovations that can enhance efficiency and, therefore,
financial performance. Those sorts of innovations are
increasingly necessary (but not sufficient) to ensure
competitiveness.
Addressing the most significant trade-offs between financial and ESG performance—challenges
that are often unsolved in a sector—requires major,
organization-wide innovation: entirely new products,
processes, and business models that improve performance in “bundles” of material issues. Developing
a single product or process innovation to address a
specific issue may be part of the solution but in and
of itself won’t shift the performance frontier for the
company as a whole.
Consider the cases of three very different companies that have instituted the kind of broad initiatives
we’re talking about:
Natura. The Brazilian cosmetics and fragrances
company has implemented a major process innovation that supports its pioneering management culture and business model. For fiscal year 2002, Natura issued its first integrated annual report, which
captured financial as well as environmental and so-
6 Harvard Business Review May 2013
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How to determine “materiality”
The Sustainability Accounting Standards Board (SASB) has
identified five broad categories of environmental, social, and
governance (ESG) issues that can affect a firm’s financial
performance and therefore be highly material to investors.
The materiality of any issue varies from one industry to the
next, however.
To gauge it within an industry, SASB evaluates evidence
of interest by different types of stakeholders and evidence of
economic impact. Companies can use a similar approach to find
out which ESG issues are most material to their investors if SASB
assessments for their industry are not yet available.
cial performance. Natura was among the first companies in the world to make this shift, long before
the practice had gained currency through the work
of organizations like the International Integrated
Reporting Council (the IIRC, where Bob is a council
member). The company saw integrated reporting as
the best way to signal its management’s focus on environmental and social stewardship and to ensure
leadership’s commitment to those goals.
In addition, the company has tied managers’
performance ratings and bonuses to environmental
and social goals as well as financial results, so that
decision making will be guided by all three types of
measures. The company also pays close attention to
stakeholders, formally seeking input from investors,
customers, and employees on decisions that affect
their interests. Indeed, Natura’s business model
is predicated on a particular form of engagement:
Its sales force of 1.4 million “consultants” share in
the firm’s profits and serve as emissaries for the
brand and conduits for customer and community
feedback.
Natura’s performance showcases the impact of
its management culture, business model, and innovativeness in both products and processes. (In
2011, Forbes ranked Natura among the top 10 most
innovative companies.) In Brazil, Natura—which
launched 435 new products from 2009 to 2011—has
a leading market share of 23.2% (greater than Unilever’s or Avon’s), a 62% household penetration rate,
and nearly 100% brand recognition. From 2002 to
2011 the firm’s revenues grew by 463% and its net
income by 3,722%, and the company had an average gross margin of 68%, compared with the industry average of 40%. In 2010, the company’s return
on assets (24.7%) and return on equity (62.1%) also
far surpassed industry averages. Financial analysis
shows that the company’s high profitability was
driven by exceptional operating performance and
not by financial leverage. Since 2002, Natura has
significantly reduced its greenhouse gas emissions
and water consumption, developed more environ-
evidence of inTeReST is determined by searching tens of
thousands of source documents using keywords. The results reveal
the intensity with which issues arise in each industry. The documents
examined include Form 10-Ks, legal news, CSR reports, shareholder
resolutions, media reports, and innovation journals.
evidence of econoMic iMPacT is determined by evaluating
both anecdotal reports and quantitative studies to gauge whether
management (or mismanagement) of the issue will affect traditional
corporate valuation parameters: revenue growth, return on capital,
risk management, and management quality.
a foRwaRd-looking adjuSTMenT acknowledges an
emerging issue that is not yet reflected in these evidence-based tests.
In a small number of cases, SASB may make an adjustment to raise
the importance of an issue if the management (or mismanagement)
of it might create positive or negative effects that other stakeholders, industries, or generations will have to deal with, or if there is the
potential for systemic disruption. In any case, the effects must be
reasonably likely to occur and of significant magnitude to be deemed
material.
mentally friendly packaging, and provided training and education opportunities to about 560,000
consultants.
Dow Chemical Company. Dow has suffered ferocious public criticism of its environmental record,
including outcries over its manufacture of the defoliant Agent Orange and the dioxin contamination
near its Midland, Michigan, facilities. To understand
and respond to stakeholder concerns, in 1992 the
company recruited a group of leading scientists and
policy experts to form an advisory body charged
with challenging the firm on its environmental
goals and processes. Among other things, the experts recommended that the company shift its focus
from how to get rid of waste to eliminating waste
altogether.
Dow ultimately embraced aggressive wastereduction targets and to that end launched two decades’ worth of massive innovation in new products,
such as solar-cell shingles, and processes, including
new health and safety procedures that drastically re-
May 2013 Harvard Business Review 7
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The Big idea tHe PeRfoRmAnCe fRontieR: innovAting foR A SuStAinABle StRAtegy
which iSSueS MaTTeR MoST?
pHaRMacEutIcalS
HEaltH caRE
dIStRIButIOn
ManaGEd caRE
3.75
3.75
1.25
0.75
0.75
1.00
environmental accidents and remediation
0.75
1.25
1.50
1.00
1.00
0.75
Water use and management
1.00
1.25
1.25
1.00
1.00
1.00
energy management
2.25
2.50
2.25
3.75
1.00
1.75
Fuel management and transportation
0.50
0.75
0.75
0.50
2.25
0.50
1.00
EnvIROnMEnt
SOcIal capItal
HuMan capItal
HEaltH caRE
dElIvERy
BIOtEcH
climate change risk
ESG ISSuES In HEaltH caRE
BuSInESS MOdEl &
InnOvatIOn
MEdIcal EquIpMEnt
& SupplIES
SASB’s Materiality Maps, like this one for the health care sector,
rate how relevant 43 environmental, social, and governance issues
in five categories are to shareholders, on a scale from 0.5 to 5.0.
The higher the number, the greater the probable impact on a
firm’s financial performance.
lEadERSHIp & GOvERnancE
duced the number of leaks, breaks, and spills. As Dow
improved its sustainability performance, its strategy
evolved to include helping its customers address
their own environmental challenges—a $350 billion market opportunity. In every year since 2009,
EBITDA that is directly attributable to new-product
innovation has exceeded $400 million at Dow. It hit
$1 billion in 2012 and is projected to reach $2 billion
by 2015. The company has also grown the net present
value of its R&D pipeline from $5 billion in 1997 to
$33 billion in 2011. Innovative new products, many
of which offer improved sustainability performance,
account for 90% of that pipeline’s value.
CLP Group. Electric utilities are in a bind when it
comes to optimizing both carbon emissions and financial performance. On one hand, pressure to limit
emissions is growing—though inexpensive and dirty
coal remains the chief technology for electricity generation. On the other, consumers expect low prices
and investors want decent and predictable returns.
Complicating matters, the regulatory environment
governing carbon emissions is murky at best and
varies from country to country.
How can a company meet these conflicting expectations in an uncertain environment? Hong Kong–
based CLP Group has found the answer through a
business model innovation that gives it unusual
agility in balancing renewable and nonrenewable
sources of energy generation across regions as regulatory conditions and technologies change. First, it
has developed analytic capabilities that allow it to
optimize when and how it makes use of low-carbon
energy sources, including solar, wind, and hydroelectric power. Second, it has become skilled at responding strategically to the regulatory regimes in
its diverse markets. And finally, CLP has learned to
monitor new technology developments and figure
out how they can make alternative energy sources
more viable.
The stock market has recognized the potential
of this new and more flexible business model. From
2005 to 2012 CLP’s shares outperformed the S&P index of electric utilities by 20 percentage points (48%
versus 28%). CLP’s price/earnings ratio rose from 17
in 2005 to 24 in 2012—a 41% increase. In contrast, the
P/E ratio for the index of electric utilities declined
by 10%, from 19 to 17, within the same time period.
Because the P/E ratio reflects the expected growth in
the firm’s earnings and the cost of capital investors
need as compensation for their risk, these numbers
suggest that investors require a lower cost of capital
GHG emissions and air pollution
1.00
1.00
1.75
1.00
1.00
Waste management and effluents
3.00
3.00
2.50
2.25
1.25
0.75
Biodiversity impacts
1.00
0.75
1.00
1.25
1.00
1.00
communications and engagement
1.00
1.00
0.75
1.00
0.50
1.25
community development
0.50
0.75
0.75
1.75
1.25
0.50
impact from facilities
0.50
1.00
1.00
4.00
1.25
1.00
customer satisfaction
0.75
0.75
1.00
2.25
1.00
3.00
customer health and safety
5.00
5.00
3.00
3.00
1.50
2.50
Disclosure and labeling
3.00
3.00
2.50
0.75
2.75
0.75
Marketing and ethical advertising
2.50
2.50
2.50
1.75
2.00
1.75
access to services
4.25
4.50
2.50
3.00
3.00
3.00
customer privacy
0.75
0.75
1.00
2.25
1.75
2.75
new markets
3.50
3.75
1.00
0.75
0.75
0.75
Diversity and equal opportunity
1.25
1.25
1.00
1.25
1.25
1.25
Training and development
3.00
2.75
2.00
2.50
1.50
2.00
recruitment and retention
2.25
2.50
1.50
3.00
1.75
1.50
compensation and benefits
1.75
1.75
1.50
1.25
1.25
1.00
labor relations and union practices
1.75
1.75
1.75
1.25
1.75
1.25
employee health, safety, and wellness
2.00
2.00
2.00
2.00
2.50
1.50
child and forced labor
0.50
0.75
0.75
0.50
0.50
0.50
long-term viability of core business
0.75
0.75
0.75
0.50
0.75
3.50
accounting for externalities
0.50
0.50
0.50
0.50
0.50
3.00
research, development, and innovation
5.00
5.00
4.75
1.00
0.75
0.75
product societal value
2.75
3.00
3.00
3.00
0.50
2.50
product life-cycle use impact
3.75
3.75
4.50
0.75
2.25
0.75
packaging
1.00
1.00
1.00
0.50
0.75
0.50
2.50
product pricing
2.50
2.50
2.50
2.50
2.50
product quality and safety
5.00
5.00
3.00
5.00
3.00
2.25
regulatory and legal challenges
3.00
3.00
3.00
3.00
3.00
3.00
policies, standards, and codes of conduct
2.50
2.50
2.25
1.00
1.75
1.00
shareholder engagement
0.75
0.75
0.75
0.75
0.75
3.00
Business ethics and competitive behavior
2.50
2.50
2.50
2.50
3.00
2.00
Board structure and independence
1.25
1.50
1.25
1.50
1.50
1.25
executive compensation
1.00
1.00
1.00
0.75
1.00
0.75
lobbying and political contributions
0.50
0.75
0.75
1.25
1.00
0.75
raw material demand
0.75
0.75
0.75
0.50
0.75
0.50
supply chain standards and selection
2.50
2.25
2.25
0.75
0.75
1.00
supply chain engagement and transparency
0.75
1.00
0.75
1.00
0.50
0.50
n loweR mAteRiAlity n HigHeR mAteRiAlity
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4
from CLP, since it is doing a better job of walking the
tightrope between carbon emissions and economic
performance.
coMMunicaTe The coMPany’S
innovaTionS To STakeholdeRS
A company cannot assume that shareholders and
other stakeholders will understand how its innovations have improved ESG and financial performance—and how the two interrelate—if it fails to
communicate effectively. This is more than a matter
of public relations; major innovations often require
substantial investments whose benefits will not be
seen for years to come. If a company expects shareholders to commit for the long term in order to receive those benefits, it needs to provide them with
information that justifies their investments. Combining ESG and financial performance information
in a single document, as Natura did, is an effective
way to do this.
While such integrated reporting remains the
exception, it’s gaining momentum largely as a voluntary practice around the world—though it is now
required of all companies listed on the Johannesburg
Stock Exchange. To help promote it, the IIRC published a draft framework for integrated reports in the
spring of 2013; it expects to release the final “version
1.0” in December.
As a communications tool, integrated reporting
involves more than posting a PDF on a company
website. The most effective reporting is as much
about listening as talking, and it serves as a key
platform for stakeholder engagement. It’s a way to
establish a conversation that considers a company’s
performance in a holistic way, identifies the tough
trade-offs, and builds a case for innovation and the
benefits it can generate. This engagement is also central to eliciting feedback on how well the company is
meeting expectations, the quality of its communications, and what it can do to improve them.
Natura, for example, developed a virtual social
network called Natura Conecta that invited the
public to participate in discussions about corporate
responsibility, sustainability, and people’s expectations of the company. In the first year more than
8,000 people registered and contributed to the company’s integrated reporting process. Participants in
the network were invited to create a WikiReport for
inclusion in the final integrated annual report.
Finally, integrated reporting enhances discipline.
It forces management and employees to think about
both the financial and the ESG implications of their
decisions and helps spur innovation as they seek to
improve both kinds of performance.
organizational Barriers to change
Though the imperative for developing a sustainable
strategy is clear, the process often isn’t. In interviews
with more than 200 executives and in-depth research
on 30 companies engaged in the process, we’ve identified four barriers to change that must be overcome:
Short-term incentives. Many employees, including senior managers, are rewarded for shortterm performance. Because addressing most sustainability issues requires a long-term outlook, firms’
incentive structures often undermine their ability
to improve on ESG measures. Moreover, employees
are frequently given incentives to boost the performance of their division or unit, but not corporatewide performance. This also works against ESG
improvement as it discourages the cross-division
collaboration that’s essential to innovation.
As a firm that produces major commodities such
as aluminum, copper, iron, coal, oil, and gas, BHP Billiton understands the business risks environmental
mismanagement poses, and so has structured corporatewide executive compensation to protect its license to operate. In 2011 the company adopted a balanced scorecard approach for its ESG metrics, which
include fatalities, environmental incidents, HSE
(health, safety, and environment) risk management,
human rights impact assessment, and environmental and occupational health. Fifteen percent of executives’ short-term incentives are now based on delivering on goals in those areas. (Though short-term, the
incentives are designed to improve long-term ESG
performance.) According to the company, linking remuneration to ESG performance has had a significant
impact. For example, the amount of greenhouse gas
the firm emitted per unit of energy consumed fell by
16% from 2006 to 2012, and in 2012 Billiton recorded
its lowest injury rate in more than a decade.
Shortage of expertise. New strategies that
address environmental and social challenges often
require new skill sets. When CLP realized it had to
diversify its energy sources away from fossil fuels to
include more hydroelectric, wind, and solar power,
it had to recruit dozens of engineers with capabilities
in those technologies. The new talent helped CLP increase the percentage of electricity from renewable
sources that it delivers to customers from less than
1% in 2004 to 18% in 2011.
May 2013 Harvard Business Review 9
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The Big idea tHe PeRfoRmAnCe fRontieR: innovAting foR A SuStAinABle StRAtegy
what is a license to operate?
in discussions about
corporate sustainability,
the concept of a firm’s
“license to operate” frequently arises, as does
the potential for that
license to be diminished
or even lost.
the State is the ultimate
source of a corporation’s
charter, which is where the license to operate begins. more
broadly, the license is granted
by society and represents
a continuum of permission
to do business. Customers
have to be willing to buy
the firm’s products, suppli
suppliers to provide the materials
the company needs to make
them, and people to go to
work there. Changing social
expectations, such as those
about firms’ responsibility for
the environment and for their
communities, can threaten
the company’s license. these
expectations are typically represented by nongovernmental
organizations, which may put
pressure on a company in
a variety of ways (boycotts,
social media campaigns, and
lawsuits, for example). if the
Capital-budgeting limitations. The
long-term investments that most sustain
sustainability improvements require make them
unattractive to corporations that apply high
discount rates in calculating projects’ net present
values. Companies need to consider an expanded
definition of value that takes into account the en
environmental and social worth of a project and what
that means for a company’s brand, ability to attract
employees, and license to operate.
At Natura, senior vice president of finance Ro
Roberto Pedote and his team are working to develop a
valuation model that more explicitly incorporates
ESG factors. In one instance the company assessed
a policy that would encourage managers to hire a
significant number of people with handicaps at a
new distribution center. While the financial costs
of this policy were relatively easy to determine,
the value to society, the value from increased employee morale and long-term productivity, and the
positive impact on Natura’s reputation and brand
were harder to quantify. Ultimately, Natura determined that the policy was a good investment. According to João Paulo Ferreira, vice president for
operations and logistics, equipment at the center
is undergoing adjustments to accommodate employees with physical and cognitive disabilities.
The first group of employees hired under the new
policy have been trained and are now working at
the facility.
Organizations that develop the tools to accurately incorporate nonfinancial metrics into their
valuation methods and capital-budgeting processes
will better understand the relationship between
ESG and financial performance. Without such tools,
firms will find it difficult to shift the slope of the performance frontier.
Investor pressure. A company developing a
sustainable strategy needs to attract farsighted in-
company refuses to change
its behavior, and ngo activity
induces customers, suppliers, and employees to stop
engaging with the company or
the State takes action (such as
levying fines), the firm’s ability
to compete erodes. the license,
though not literally revoked, is
diminished—a situation no firm
wants to find itself in.
vestors that support this goal. Unilever, under CEO
Paul Polman, achieved this by ceasing quarterly
earnings guidance in 2009. The move sent a strong
signal that the company wanted investors who
were interested in the firm’s long-range prospects
and would not put its strategy at risk by demanding
maximum short-term profitability.
Our research shows that through focused communications and integrated reporting, a company
can actually increase its proportion of long-term
investors. By analyzing the language that executives
use during conference calls with sell-side analysts,
for example, George has been able to document that
companies with more long-term-oriented communications tend to attract more investors who are in it
for the long haul.
Today coRPoRaTionS are larger than ever: Just
1,000 businesses now account for half of the total
market value of the world’s 60,000 public companies. As they grow, firms will be under increasing
pressure to devise sustainable strategies, creating
economic value in ways that are consistent with
the interests of customers, employees, and society
at large. The organizational and management tools
for accomplishing this, such as Materiality Mapping and integrated reporting, are still evolving
and will be refined through experimentation and
experience.
This vast concentration of economic power gives
companies the ability and the responsibility to assume roles that were previously the province of nations. By building sustainable strategies, the world’s
most influential and innovative firms—perhaps
more effectively than nations themselves—can pave
the way to a sustainable society, one that meets the
needs of the current generation without sacrificing
those of generations to come.
hBR Reprint R1305B
10 Harvard Business Review May 2013
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copyright infringement.
The Impact of Corporate Sustainability on Organizational Processes and Performance
Robert G. Eccles, Ioannis Ioannou, and George Serafeim
Abstract
We investigate the effect of corporate sustainability on organizational processes and performance. Using a
matched sample of 180 US companies, we find that corporations that voluntarily adopted sustainability
policies by 1993 – termed as High Sustainability companies – exhibit by 2009, distinct organizational
processes compared to a matched sample of firms that adopted almost none of these policies – termed as
Low Sustainability companies. We find that the boards of directors of these companies are more likely to
be formally responsible for sustainability and top executive compensation incentives are more likely to be
a function of sustainability metrics. Moreover, High Sustainability companies are more likely to have
established processes for stakeholder engagement, to be more long-term oriented, and to exhibit higher
measurement and disclosure of nonfinancial information. Finally, we provide evidence that High
Sustainability companies significantly outperform their counterparts over the long-term, both in terms of
stock market as well as accounting performance.

Robert G. Eccles is a Professor of Management Practice at Harvard Business School. Ioannis Ioannou is an
Assistant Professor of Strategy and Entrepreneurship at London Business School. George Serafeim is an Assistant
Professor of Business Administration at Harvard Business School, contact email: gserafeim@hbs.edu. Robert Eccles
and George Serafeim gratefully acknowledge financial support from the Division of Faculty Research and
Development of the Harvard Business School. We would like to thank Christopher Greenwald for supplying us with
the ASSET4 data. Moreover, we would like to thank Cecile Churet and Iordanis Chatziprodromou from Sustainable
Asset Management for giving us access to their proprietary data. We are grateful to Chris Allen, Jeff Cronin,
Christine Rivera, and James Zeitler for research assistance. We thank Ben Esty, David Larcker (discussant), Joshua
Margolis, Costas Markides, Jeremy Stein (discussant), Catherine Thomas, and seminar participants at Boston
College, the NBER conference on the ―Causes and Consequences of Corporate Culture‖, Cardiff University, Saint
Andrews University, International Finance Corporation, Columbia University, INSEAD and the Business and
Environment Initiative at Harvard Business School for helpful comments. We are solely responsible for any errors in
this manuscript.
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1. Introduction
Neoclassical economics and several management theories assume that the corporation’s objective is profit
maximization subject to capacity (or other) constraints. The key agent in such models is the shareholder,
acting as the ultimate residual claimant who provides the necessary financial resources for the firm’s
operations (Jensen and Meckling, 1976; Zingales, 2000). However, there is substantial variation in the
way corporations actually compete and pursue profit maximization. Different corporations place more or
less emphasis on the long-term versus the short-term (Brochet et al., 2011); care more or less about the
impact of externalities from their operations on other stakeholders (Paine, 2004); focus more or less on
the ethical grounds of their decisions (Paine, 2004); and assign relatively more or less importance on
shareholders compared to other stakeholders (Freeman et al., 2007). For example, Southwest Airlines has
identified employees and Novo Nordisk patients (i.e., their end customers) as their primary stakeholder.
During the last 20 years, a relatively small but growing number of companies have voluntarily
integrated social and environmental issues in their business models and daily operations (i.e. their
strategy) through the adoption of related corporate policies.1 Such integration of environmental and
social issues into a company’s business model raises a number of fundamental questions for scholars of
organizations. Does the governance structure of firms that adopt environmental and social policies differ
from that of other firms and, if yes, in what ways? Do such firms have distinct stakeholder engagement
processes and adopt different time horizons for their decision-making? In what ways are their
measurement and reporting systems different? Finally, what are the performance implications of
integrating social and environmental issues into a company’s strategy and operations?
Some scholars argue that companies can ―do well by doing good‖ (Godfrey, 2005; Margolis et
al., 2007; Porter and Kramer, 2011) based on the assumption that meeting the needs of other stakeholders
– e.g. employees through investment in training – directly creates value for shareholders (Freeman et al.,
2010, Porter and Kramer, 2011). It is also based on the assumption that by not meeting the needs of other
stakeholders, companies can destroy shareholder value because of consumer boycotts (e.g., Sen et al.,
2001), the inability to hire the most talented people (e.g., Greening and Turban 2000), and by paying
potentially punitive fines to governments.
On the other hand, other scholars argue that adopting
environmental and social policies can destroy shareholder wealth (e.g., Friedman 1970; Clotfelter 1985;
Navarro 1988; Galaskiewicz 1997). In its simplest form, their argument is that sustainability may simply
be a type of agency cost: managers receive private benefits from embedding environmental and social
1
During the same period many more companies were active in corporate social responsibility (CSR) as an ancillary
activity. However, many of these companies did not necessarily implement or were unable to implement CSR as a
central strategic objective of the corporation. Moreover, CSR has diffused broadly in the business world only in the
last seven years (Eccles and Krzus, 2010).
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policies in the company’ strategy, but doing so has negative financial implications for the organization
(Baloti and Hanks 1999; Brown et al., 2006). Moreover, these companies might experience a higher cost
structure (e.g. paying their employees living rather than market wages). Consequently, the argument
continues, companies that do not operate under such additional environmental and social constraints will
be more competitive and as a result, will be more successful in a highly competitive environment. In fact,
this hypothesis is well captured in Jensen (2001) who states: ―Companies that try to do so either will be
eliminated by competitors who choose not to be so civic minded, or will survive only by consuming their
economic rents in this manner.‖ (p. 16).
In this study, we shed light on the organizational and performance implications of integrating
social and environmental issues into a company’s strategy and business model through the adoption of
corporate policies. The overarching thesis of our work is that organizations that voluntarily integrate
environmental and social policies in their business model represent a fundamentally distinct type of the
modern corporation, characterized by a governance structure that in addition to financial performance,
accounts for the environmental and social impact of the company, a long-term approach towards
maximizing inter-temporal profits, an active stakeholder management process, and more developed
measurement and reporting systems. Empirically, we identify 90 companies – we term these as High
Sustainability companies – with a substantial number of environmental and social policies adopted for a
significant number of years (since the early to mid-1990s), reflecting strategic choices that are
independent and in fact, far preceded the current hype around sustainability issues (Eccles and Krzus,
2010). Subsequently, we use propensity score matching in 1993 to identify 90 comparable firms that
adopted almost none of these policies; we term these as Low Sustainability companies. In the year of
matching, the two groups operate in exactly the same sectors and exhibit statistically identical size, capital
structure, operating performance, and growth opportunities. By generating matched pairs of firms as early
as 1993, we are therefore able to not only focus on long-term organizational implications but also to
introduce a long time lag between our independent and dependent variables, thus mitigating the likelihood
of bias that could arise from reverse causality.
Consistent with our expectations, we find that the group of High Sustainability firms is
significantly more likely to assign responsibility to the board of directors for sustainability and to form a
separate board committee for sustainability. Moreover, they are more likely to make executive
compensation a function of environmental, social, and external perception (e.g., customer satisfaction)
metrics. This group is also significantly more likely to establish a formal stakeholder engagement process
where risks and opportunities are identified, the scope of the engagement is defined ex ante, managers are
trained in stakeholder engagement, key stakeholders are identified, results from the engagement process
are reported both internally and externally, and feedback from stakeholders is given to the board of
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directors. This set of High Sustainability firms also appears to be more long-term oriented: they have an
investor base with a larger proportion of long-term oriented investors and they communicate more longterm information in their conference calls with sell-side analysts. Since information is a crucial asset that
a corporation needs to have for effective strategy execution by management, as well as the effective
monitoring of this execution by the board, we find that High Sustainability firms are more likely to
measure information related to key stakeholders such as employees, customers2, and suppliers — and to
increase the credibility of these measures by using auditing procedures. We also find that High
Sustainability firms not only measure but also disclose more nonfinancial (e.g., environmental, social, and
governance) data. Our findings suggest that to a large extent the adoption of these sustainability policies
reflects by 2009 their underlying institutionalization within and across the organization rather than
reflecting acts undertaken as part of ―greenwashing‖ and ―cheap talk‖ (Marquis and Toffel, 2011).
Importantly, we show that there is significant variation in subsequent accounting and stock
market performance across the two groups of firms in the long run. In particular, we track corporate
performance for 18 years and find that High Sustainability firms outperform Low Sustainability firms
both in stock market as well as accounting performance. Using a four-factor model to account for
potential differences in the risk profile of the two groups, we find that annual abnormal performance is
higher for the High Sustainability group compared to the Low Sustainability group by 4.8% (significant at
less than 5% level) on a value-weighted base and by 2.3% (significant at less than 10% level) on an equal
weighted-base. We find that High Sustainability firms also perform better when we consider accounting
rates of return, such as return-on-equity (ROE) and return-on-assets (ROA) and that this outperformance
is more pronounced for firms that sell products to individuals (i.e., business-to-customer [B2C]
companies), compete on the basis of brand and reputation, and make substantial use of natural resources.
Finally, using analyst forecasts of annual earnings we find that the market underestimated the future
profitability of the High Sustainability firms compared to the Low Sustainability ones.
2. Sample Selection and Summary Statistics
To understand the effects of integrating social and environmental issues in an organization’s business
model, we first need to identify companies that have explicitly placed a high level of emphasis on
employees, customers, products, the community, and the environment as part of their strategy and
business model. Moreover, we need to find firms that have adopted these policies for a significant number
of years prior to CSR becoming widespread, to reduce the possibility of potential measurement error due
to the inclusion of firms that are either ―greenwashing‖ or adopting these policies purely for public
relations and communications reasons. Finally, by identifying firms based on policy adoption decisions
that were made a sufficiently long time ago – thus introducing a long lag between our independent and
2
Although we find directionally consistent results for customers, our results are not statistically significant.
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dependent variables – we mitigate the likelihood of biases that could potentially arise from reverse
causality.
We identify two groups of firms: those that have and those that have not adopted a
comprehensive set of corporate policies related to the environment, employees, community, products, and
customers. The complete set of these policies is provided in the Appendix. Examples of policies related to
the environment include whether the company has a policy to reduce emissions, uses environmental
criteria in selecting members of its supply chain, and whether the company seeks to improve its energy or
water efficiency. Policies related to employees include whether the company has a policy for diversity
and equal opportunity, work-life balance, health and safety improvement, and favoring internal
promotion. Policies related to community include corporate citizenship commitments, business ethics,
and human rights criteria. Policies related to products and customers include product and services quality,
product risk, and customer health and safety. The Thomson Reuters ASSET4 database, which has already
been used in the literature (Cheng, Ioannou and Serafeim, 2012; Ioannou and Serafeim, 2012), provides
data on the adoption or non-adoption of these policies, for at least one year, for 775 US companies in
fiscal years 2003 to 2005.3 We eliminate 100 financial institutions, such as banks, insurance companies,
and finance firms, because their business model is fundamentally different and many of the environmental
and social policies are not likely to be applicable or material to them. For the remaining 675 companies
we construct an equal-weighted index of all policies (Sustainability Policies) that measures the percentage
of the full set of identified policies that a firm is committed to in each year.
Moreover, we track over time the extent of adoption of these policies for those organizations that
score at the top quartile of Sustainability Policies. We do so by reading published reports, such as annual
and sustainability reports, and visiting corporate websites to understand the historical origins of the
adopted policies. Furthermore, we conducted more than 200 interviews with corporate executives to
validate the historical adoption of these policies. At the end of this process, we were able to identify 90
organizations that adopted a substantial number of these policies in the early to mid-90s. We label this set
of firms as the High Sustainability group. Of the remaining 78 firms, 70 firms adopted these policies
gradually over time mostly after 1999. For eight firms we were unable to identify the historical origins of
these policies. The High Sustainability group had adopted by the mid-90s on average 40% of the policies
identified in the Appendix, and by the late 2000s almost 50%. Subsequently, we match each of the firms
in the High Sustainability group with a firm that scores in the lowest two quartiles of Sustainability
3
Founded in 2003, ASSET4 was a privately held Swiss-based firm, acquired by Thomson Reuters in 2009. The firm
collects data and scores firms on environmental and social dimensions since 2002. Research analysts of ASSET4
collect more than 900 evaluation points per firm, where all the primary data used must be objective and publicly
available. Typical sources include stock exchange filings, annual financial and sustainability reports, nongovernmental organizations’ websites, and various news sources. Every year, a firm receives a z-score for each of
the pillars, benchmarking its performance with the rest of the firms in the database.
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Policies. Firms in those two quartiles have, on average, adopted only 10% of the policies, even by the late
2000s. These same firms had adopted almost none of these policies in the mid-90s. Because we require
each firm in the High Sustainability group to be in existence since at least the early 1990s, we impose the
same restriction for the pool of possible control firms. After this filter, the available pool of control firms
is 269.
We implement a propensity score matching process to produce a group of control firms that looks
as similar as possible to our High Sustainability group. The match is performed in 1993 because this is the
earliest year that we can confirm any one of the firms included in the High Sustainability group had
adopted these policies. To ensure that our results are not particularly sensitive to the year we choose for
the matching procedure, we redo the matching in 1992 and 1994. In any one year less than 5% of the
matched pairs change, suggesting that the year we choose for matching does not affect our final sample
set. We match each High Sustainability firm with a control firm that is in the same industry classification
benchmark subsector (or sector if a firm in the same subsector is not available), by requiring exact
matching for the sector membership. We use as covariates in the logit regression the natural logarithm of
total assets (as a proxy for size), ROA,4 asset turnover (measured as sales over total assets), market value
of equity over book value of equity (MTB), as a proxy for growth opportunities, and leverage (measured
as total liabilities over total assets). We use propensity score matching without replacement and closest
neighbor matching.5 Size and asset turnover load with a positive and highly significant coefficient in the
logit regression (untabulated results). The coefficient on MTB is positive and weakly significant. The
coefficients on leverage and ROA are both insignificant. We label the set of control firms that are selected
through this process as the Low Sustainability group.
Table 1 Panel A, shows the sector composition of our sample and highlights that a wide range of
sectors are represented. Panel B shows the average values of several firm metrics across the two groups in
the year of matching. The High Sustainability group has on average, total assets of $8.6 billion, 7.86%
ROA, 11.17% ROE, 56% leverage, 1.02 turnover, and 3.44 MTB. Similarly, the matched firms (i.e., the
Low Sustainability group) have on average, total assets of $8.2 billion, 7.54% ROA, 10.89% ROE, 57%
leverage, 1.05 turnover, and 3.41 MTB. None of the differences in the averages across the two groups are
statistically significant, suggesting that the matching process worked effectively. The two groups are
statistically identical in terms of sector membership, size, operating performance, capital structure, and
4
We also used ROE as a measure of performance and all the results were very similar to the results reported in this
paper. We also included other variables such as stock returns over the past one, two or three years but none of them
was significant.
5
Using a caliper of 0.01 to ensure that none of the matched pairs is materially different reduces our sample by two
pairs or four firms. All our results are unchanged if we use that sample of 176 firms.
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growth opportunities. Moreover, the two groups have very similar risk profiles: both the standard
deviation of daily returns and the equity betas are approximately equal.
3. Corporate Governance
The responsibilities of the board of directors and the incentives provided to top management are two
fundamental attributes of the corporate governance system. Boards of directors perform a monitoring and
advising role and ensure that management is making decisions in a way that is consistent with
organizational objectives. Top management compensation systems align managerial incentives with the
goals of the organization by linking executive compensation to key performance indicators that are used
for measuring corporate performance (Govindarajan and Gupta, 1985). Ittner, Larcker, and Rajan (1997)
showed that the use of nonfinancial metrics in annual bonus contracts is consistent with an
―informativeness‖ hypothesis, where nonfinancial metrics provide incremental information regarding the
manager’s action choice.
Therefore, we posit that for organizations that consider environmental and social objectives as
core issues for their strategy and operations, the board of directors is more likely to have direct
responsibility over such issues; it is also more likely that top management compensation will be a
function of sustainability metrics in addition to other traditional financial performance metrics. To test
these predictions we analyze proprietary data provided to us by Sustainable Asset Management (SAM).
SAM collects the relevant data and constructs the Dow Jones Sustainability Index. Once a year, SAM
initiates and leads an independent sustainability assessment of approximately 2,250 of the largest
corporations around the world. The SAM Corporate Sustainability Assessment is based on the annual
SAM Questionnaire, which consists of an in-depth analysis based on approximately 100 questions on
economic, environmental, and social issues, with a particular focus on companies’ potential for long-term
value creation. The questionnaire is designed to ensure objectivity by limiting qualitative answers through
predefined multiple-choice questions. In addition, companies must submit relevant information to support
the answers provided. The SAM Questionnaires are distributed to the CEOs and heads of investor
relations of all the companies in the starting universe. The completed company questionnaire, signed by a
senior company representative, is the most important source of information for the assessment.
Table 2, Panel A shows the governance data items that SAM provided to us for fiscal year 2009,
as they relate to the board of directors and the executives’ incentive systems. We find results that are
consistent with our predictions. Fifty three percent of the firms in the High Sustainability group assign
formal responsibility around sustainability to the board of directors. In contrast, only 22% of the firms in
the Low Sustainability group hold the board accountable for sustainability. Similarly, 41% (15%) of the
firms in the High Sustainability group (Low Sustainability group) form a separate board committee that
deals with sustainability issues. The responsibilities and duties of a sustainability committee include both
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assisting the management with strategy formulation and reviewing periodically sustainability
performance. For example, the principal functions of the sustainability committee of the Ford Corporation
include assisting management in the formulation and implementation of policies, principles, and practices
to foster the sustainable growth of the company on a global basis and to respond to evolving public
sentiment and government regulation in the area of GHG emissions and fuel economy and CO 2
regulation. Other functions include assisting management in setting strategy, establishing goals, and
integrating sustainability into daily business activities, reviewing new and innovative technologies that
will permit the company to achieve sustainable growth, reviewing partnerships and relationships that
support the company’s sustainable growth, and reviewing the communication and marketing strategies
relating to sustainable growth.
Another important governance feature is the set of metrics that are linked to senior executive
compensation. The two groups differ significantly on this dimension as well: High Sustainability firms
are more likely to align senior executive incentives with environmental, social, and external (i.e.,
customer) perception performance metrics, in addition to financial metrics. Of the firms in the High
Sustainability group, 18%, 35%, and 32% link compensation to environmental, social, and external
perception metrics, respectively. In contrast, only 8%, 22%, and 11% of the firms in the Low
Sustainability group link compensation to environmental, social, and external perception metrics. Firms in
the High Sustainability group are more likely to use monetary incentives to help executives focus on
nonfinancial aspects of corporate performance that are important to the firm. For example, Intel has
linked executive compensation to environmental metrics since the mid-90s, and since 2008 Intel links all
employees’ bonuses to environmental metrics. The 2010 metrics focused on carbon emission reductions
in Intel’s operations and energy-efficiency goals for new products. While the environmental component
represents a relatively small portion of the overall employee bonus calculation, Intel believes that it helps
focus employees on the importance of achieving its environmental objectives.
Moreover, in Panel B we present results from a multivariate analysis of these governance
mechanisms. To avoid results overload, we construct a variable that summarizes all the mechanisms
discussed in Panel A by calculating the percentage of mechanisms that a firm has adopted. Because the
firms might look considerably different in terms of size, growth opportunities, and performance at 2009,
we control for these factors in our model by measuring them at the end of 2009. Consistent with the
results above, we find that firms in the High Sustainability group adopt significantly more of the
mechanisms described in Panel A: the coefficient on High Sustainability is positive and significant
(0.144, p-value=0.006). Larger firms and more profitable firms have more of these mechanisms, whereas
growth opportunities are not related to their adoption. Overall, the results suggest that firms included in
the High Sustainability group are characterized by a distinct governance structure: responsibility over
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sustainability is more likely to be directly assigned to the board of directors and top management
compensation is also more likely to be a function of a set of performance metrics that critically includes
sustainability metrics.
4. Stakeholder Engagement
Since High Sustainability firms are characterized by a distinct corporate governance model that focuses
on a wider range of stakeholders as part of their corporate strategy and business model, we predict that
such firms are also more likely to adopt a greater range of stakeholder engagement practices. This is
because engagement is necessary for understanding these stakeholders’ needs and expectations in order to
make decisions about how best to address them (Freeman, 1984; Freeman et al., 2007). With regards to
stakeholder management, prior literature has suggested and empirically shown that it is directly linked to
superior financial performance by enabling firms to develop intangible assets in the form of strong longterm relationships, which can become sources of competitive advantage (e.g., Hillman and Keim, 2001).
In other words, superior stakeholder engagement is fundamentally based on the firm’s ability to establish
such relationships with key stakeholders over time. Similarly, it has been argued that when a corporation
is able to credibly commit to contracting with its stakeholders on the basis of mutual trust and cooperation
and a longer-term horizon – as opposed to contracting in an attempt to curb opportunistic behavior – then
the corporation ―will experience reduced agency costs, transactions costs, and costs associated with team
production‖ (Jones, 1995; Foo, 2007; Cheng et al., 2011). We argue therefore, that firms that have
embedded the elements of mutual trust and cooperation and the building of long-term relationships with
key stakeholders through the incorporation of social and environmental issues in their strategy and
business model will be better positioned to pursue these more efficient forms of contracting (Jones, 1995).
On the other hand, firms that have not integrated social and environmental issues are more likely to
contract on the basis of curbing opportunistic behavior and this will impede their ability to adopt a broad
range of stakeholder engagement practices.
To get a better understanding of the differences in the stakeholder engagement model across the
two groups of firms in our sample, we again use proprietary data obtained through SAM. Panel A of
Table 3 presents a comparison between the High and Low Sustainability firms across several data items
that relate to actions prior to, during, and after stakeholder engagement. In particular, each item in Table 3
measures the frequency of adoption of the focal practice within each of the two groups, and the last
column presents a significance test of the differences between them. As before, the data are for the fiscal
year of 2009. We find that High Sustainability firms are more likely to adopt practices of stakeholder
engagement for all three phases of the process (prior to, during, and after) compared to Low Sustainability
ones.
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Prior to the stakeholder engagement process, High Sustainability firms are more likely to train
their local managers in stakeholder management practices (14.9% vs. 0%, Training), and to perform their
due diligence by undertaking an examination of costs, opportunities, and risks (31.1% vs. 2.7%,
Opportunities Risks Examination). Moreover, High Sustainability firms are more likely to identify issues
and stakeholders that are important for their long-term success (45.9% vs. 10.8%, Stakeholder
Identification). During the stakeholder engagement process itself, our analysis shows that High
Sustainability firms are more likely to ensure that all stakeholders raise their concerns (32.4% vs. 2.7%,
Concerns) and to develop with their stakeholders a common understanding of the issues relevant to the
underlying issue at hand (36.5% vs. 13.5%, Common Understanding). In addition, they are more likely to
mutually agree upon a grievance mechanism with the stakeholders involved (18.9% vs. 2.7%, Grievance
Mechanism) and to agree on the targets of the engagement process (16.2% vs. 0%, Targets).Moreover,
High Sustainability firms are more likely to pursue a mutual agreement on the type of engagement with
their stakeholders (36.5% vs. 8.1%, Scope Agreement).
Finally, we find that after the completion of the stakeholder engagement process, High
Sustainability firms are more likely to provide feedback from their stakeholders directly to the board or
other key departments within the corporation (32.4% vs. 5.4%, Board Feedback), and are more likely to
make the results of the engagement process available to the stakeholders involved (31.1% vs. 0%, Result
Reporting) and the broader public (20.3% vs. 0%, Public Reports). In sum, High Sustainability firms
appear to be more proactive, more transparent, and more accountable in the way they engage with their
stakeholders.
Moreover, in Panel B we present results from a multivariate analysis of these stakeholder
engagement mechanisms. Similar to Section 3, we construct a variable that summarizes all the
mechanisms discussed in Panel A by calculating the percentage of mechanisms that a firm has adopted.
Consistent with the results above, we find that firms in the High Sustainability group adopt significantly
more of the stakeholder engagement mechanisms described in Panel A. In general, the results of this
section confirm our predictions: High Sustainability firms are distinct in their stakeholder engagement
model in that, compared to the Low Sustainability firms they are more focused on understanding the
needs of their stakeholders, making investments in managing these relationships, and reporting internally
and externally on the quality of their stakeholder relationships.
5. Time Horizon
The previous section argued for a distinct stakeholder management model and provided evidence for the
adoption of a wider range of stakeholder engagement practices. In assessing the impact of stakeholder
engagement, previous literature has argued that the effective management of stakeholder relationships can
generate persistence of superior financial performance over the longer-term, or in the faster recovery of
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poorly performing firms (Choi and Wang, 2009). This occurs because building good stakeholder relations
as part of a corporation’s strategy, takes time to materialize, is idiosyncratic to each corporation, and
depends on its history; such relationships are based on mutual respect, trust, and cooperation and take
time to develop. In other words, effective stakeholder engagement necessitates the adoption of a longerterm time horizon.
To date, the extant literature on ―short-termism‖ (e.g., Laverty, 1996) has shown that executive
compensation incentives that are based on short-term metrics may push managers towards making
decisions that deliver short-term performance at the expense of long-term value creation. Consequently, a
short-term focus on creating value may result in a failure to make the necessary strategic investments to
ensure future profitability. Importantly, such a short-term approach to decision-making often implies a
negative externality being imposed on various other key stakeholders. In other words, short-termism is
incompatible with extensive stakeholder engagement and a focus on stakeholder relationships. It is also
true then that the pathologies of short-termism are less likely to be suffered by corporations with a clear
focus and commitment to multiple stakeholders. Given the documented commitment of High
Sustainability firms to stakeholder engagement therefore, we further predict that they are more likely to
adopt such a longer-term approach, and that this approach will also be reflected in the type of investors
that are attracted to such corporations.6
In Panel A of Table 4 we empirically test whether High Sustainability firms are focused more on
a longer-term horizon in their communications with analysts and investors. A company communicates its
norms and values both internally and externally, and since a long-term time horizon is one key element of
integrating social and environmental issues into strategy, we would expect High Sustainability firms to
put greater emphasis on the long-term than the Low Sustainability ones do. Investors that are interested in
generating short-term results by selling their stock after it has (hopefully) appreciated will avoid investing
in long-term-oriented firms since these firms are willing to sacrifice such short-term results if doing so
will produce long-term gains. In contrast, investors who plan to hold a stock for a long period of time will
be attracted to firms that are optimizing financial performance over a longer time horizon and are less
interested in short-term performance fluctuations. For example, after Paul Polman became the CEO of
Unilever and announced the implementation of the Sustainable Living Plan while abolishing quarterly
earnings reports, ownership of Unilever’s stock by hedge funds dropped from 15% to 5% in three years,
6
We acknowledge that under some conditions the reverse may be true: investor behavior may be driving managerial
decision-making. However, in the case of sustainability policies, we argue that this is rather unlikely. Since
stakeholder relations take several years to build, the probability of a large enough shareholder base retaining
ownership for a sufficiently long amount of time in order to institute a radical corporate change towards
sustainability seems low. This line of argument would also require investors to themselves engage with the company
over a long period of time in such a way as to establish a culture of more long-term thinking which in turn, would
push the corporation towards better shareholder and other stakeholder engagement.
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which led to reduced fluctuations in the company’s share price. To test our predictions, we use data from
Thomson Reuters Street Events to measure the extent to which the content of the conversations between a
focal corporation and sell-side analysts is comprised of long-term vs. short-term keywords. We construct
this measure following the methodology in Brochet, Loumioti, and Serafeim (2012), as the ratio of the
number of keywords used in conference calls that characterize time periods of more than one year over
the number of keywords that characterize time periods of less than one year. Second, we measure the time
horizon of the investor base of a corporation following Bushee (2001) and Bushee and Noe (2000), by
calculating the percentage of shares outstanding held by ―dedicated‖ vs. ―transient‖ investors. Bushee
(2001) classifies institutional investors using a factor and a cluster analysis approach. Transient investors
have high portfolio turnover and highly diversified portfolios. In contrast, dedicated investors have low
turnover and more concentrated holdings. We measure how long-term oriented the investor base of a firm
is by calculating the difference between the percentage of shares held by dedicated investors and the
percentage of shares held by transient investors.
The results presented in Table 4 are consistent with our predictions. We find that High
Sustainability firms are more likely to have conference call discussions with analysts whose content is
relatively more long-term as opposed to short-term focused (1.08 vs. 0.96, Long-term vs. Short-term
Discussion). In addition, High Sustainability firms are significantly more likely to attract dedicated rather
than transient investors (-2.29 vs. -5.31, Long-term vs. Short-term Investors). In Panel B of Table 4 we
present results from a multivariate analysis of these long-term oriented behaviors and characteristics and
we find consistent results. In sum, our findings suggest that High Sustainability firms are effective
communicators of their long-term approach: not only do they speak in those terms but in fact, they are
convincing long-term investors to invest in their stock.
6. Measurement and Disclosure
Measurement
Performance measurement is essential for management to determine how well it is executing on its
strategy and to make any necessary corrections (Kaplan and Norton, 2008). The quality, comparability,
and credibility of information are enhanced by internal and external audit procedures that verify the
accuracy of this information or the extent to which practices are being followed. Given that High
Sustainability firms place a greater emphasis on stakeholder engagement than the Low Sustainability
firms, we would expect the same to be true for particular key stakeholder groups including employees,
customers, and suppliers. In particular, we would expect the High Sustainability firms to place
significantly more emphasis on measuring and monitoring performance, auditing performance measures,
adherence to standards, and reporting on performance. Using the proprietary SAM data described in
Section 4, we are able to test for differences in the extent to which the two groups of firms measure, audit,
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and report on their performance as it relates to these three stakeholder groups. Table 5 presents a
comparison between the High and Low Sustainability firms for Employees (Panel A), Customers (Panel
B), and Suppliers (Panel C). Similar to the results of previous sections, each of these three panels
measures the frequency of adoption of the focal practice within each of the two groups, and the last
column presents a significance test of the differences between them.
For Employees, we find significant differences on three of the four metrics. High Sustainability
firms are significantly more likely to measure execution of skill mapping and development strategy
(54.1% vs. 16.2%, HR Performance Indicators/Nonfinancial), the number of fatalities in company
facilities (77.4% vs. 26.3%, KPI Labor/EHS Fatalities Tracking), and the number of ―near misses‖ on
serious accidents in company facilities (64.5% vs. 26.3%, KPI Labor/EHS Near Miss Tracking). We find
no significant difference between the two groups for the percentage of companies that use health and
safety performance tracking to follow labor relations issues. This may be due to laws and regulations
requiring all firms to perform such measures (e.g., as required by the Occupational Health and Safety
Administration [OSHA]), thereby leveling the field and eliminating any potential differences that could
have been in place under conditions where such laws and regulations did not exist; the high percentages
for both groups indicate that this might be the case (95.2% vs. 89.5%, KPI Labor / EHS Performance
Tracking). These results therefore, reflect the greater commitment that High Sustainability firms make to
the employee stakeholder group.
Panel B focuses on Customers and shows the frequency of adoption of seven relevant practices.
Contrary to our expectations and in contrast to our findings regarding Employees, there is virtually no
difference between High Sustainability and control firms on any one of these metrics, although across all
metrics more firms in the High Sustainability group measure customer-related data. We note that across
both groups a very small percentage of firms have adopted these metrics. If anything, one could argue that
the relationship between effective engagement and the creation of shareholder value is even more direct
for Customers than it is for Employees; yet even in the High Sustainability group, very few are measuring
the quality of this relationship. We suggest that one possible reason for this could be the rather primitive
state of customer relationship management practices. Moreover, our data seem to suggest that these
results are linked to the ease with which these practices can be measured. For example, variables like Cost
of Service and Potential Lifetime Value are very difficult to measure with only 6.8% and 8.1%,
respectively, of the High Sustainability firms measuring this variable. The highest percentages for this
group are for Geographical Segmentation (18.9%), Customer Generated Revenues (18.9%), and
Historical Sales Trends (16.2%) which are relatively easier to measure.
In contrast to Customers, there are some significant differences between the two groups of firms
in terms of Suppliers. In particular, we examine the standards used to select and manage relationships
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with Suppliers, which can determine the quality of the relationship they have with the firm. Panel C
shows the frequency of adoption of 11 related practices: six of these are strongly and significantly
different across the two groups with p-values of