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The Relationship between Sustainability Performance and Financial Performance

The Relationship between Sustainability Performance and Financial Performance



At the Canadian Responsible Investment Conference, June 20, 2011, Dr. Olaf Weber gave a presentation on the relationship between sustainable development performance and financial performance, ...

At the Canadian Responsible Investment Conference, June 20, 2011, Dr. Olaf Weber gave a presentation on the relationship between sustainable development performance and financial performance, including EBITDA margin, credit risks, option pricing and rules of thumb valuation.



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  • This presentation was delivered by Dr. Olaf Weber at the Canadian Responsible Investment Conference in Victoria, British Columbia on June 20, 2011.
  • This slide deck is targeted towards portfolio managers with institutional investors, ESG and securities analysts, and high net-worth advisors. It is part of a ‘tech-intensive’ session on ESG Valuation and Risk Management.
  • So far we talked about a relation. However, we did not discuss the direction of the relation. Thus there are mainly two directionsFinancial performance influences environmental performance and environmental performance influences financial performanceFinancial performance influences environmental performance means that for example Investing in community relations and charity is only done if the company was successful and thus can afford the costs for investing in the community, charity or environmental issues.Environmental performance influences financial performance, means that it pay to be green. Examples are energy-efficiency measures to reduce energy costsThus a Win-win-situation is creating a positive impact on the companies success and on the environment.
  • Let us have a look on some research results. Margolis and Walsh analysed a high number of studies on the relation between environmental and financial performance. They came to the conclusion that a majority of these studies reported about a positive relation between environmental and financial performance.A small number reported about a negative relation, meaning that high environmental performance creates costs or diminishes returns.About 20 studies reported a small relation and about 15 reported mixed results that could not confess a positive or a negative relation.Thus let us explore these results, find arguments for them and try to explain why there is such a variance.
  • Generally there are three kinds of relations between environmental and financial performanceA Positive relation means: Good environmental performance creates successful business. It does pay to be green. Maybe because it reduces costs or attracts more clients.A Negative relation means that good environmental performance creates less successful business. It costs to be green. Maybe because investments in environmental issues are not rewarded by the market or the clientsA Neutral relation means that environmental performance and corporate success are independent.

The Relationship between Sustainability Performance and Financial Performance The Relationship between Sustainability Performance and Financial Performance Presentation Transcript

  • The Relationship between Sustainability Performance and Financial Performance
    Dr. Olaf Weber
    Export Development Canada Chair in Environmental Finance, SEED, University of Waterloo
  • Content
    EBITDA and Sustainability Performance
    Credit Risk and Sustainability Performance
    SRI Funds and Sustainability Performance
  • Two Possible “Cause and Effect” Relations between Sustainability Performance and Financial Performance
    Financial performance influences sustainability performance
    investing in community relations and charity
    Sustainability performance influences financial performance
    energy-efficiency measures to reduce energy costs
  • Research Results on the Relationship between SD and Financial Performance
    MARGOLIS, J. D. & WALSH, J. P. (2001) People and Profits? The Search for a Link Between a Company´s Social and Financial Performance, Mahwah NJ, London, Lawrence Earlbaum Associates, Publishers.
  • Three Kinds of Relations
    Good Sustainability performance creates successful business
    Good Sustainability performance creates less successful business
    environmental initiatives are applied poorly
    SD performance and corporate success are independent
  • Why a Positive Effect of SD Performance on Business?
    Access to Markets/Regulatory Approvals
    Customer Attraction/Retention
    Address Media/Activist Pressures
    Discounted Loan Rates
    Reduced Insurance Premiums
    Operational Efficiency
    Due Diligence Regarding Partnerships/Acquisitions
    Legal Due Diligence/Assurance
    Employee Satisfaction/Retention/Productivity
    Industry Self-Regulation
    Facilitate Divestitures
    SRI Funds (Retail/Institutional)
  • Why a Negative Effect of Sustainability Performance on Business?
    higher costs
    end of pipe environmental technology
    lower benefits
    environmentally friendly products are not accepted by consumers because of high prices
    Sustainability performance has been poorly applied
    investing in the wrong fields (offsets vs. technology)
  • Why a Neutral Effect of Sustainability Performance on Business?
    The influence of Sustainability performance is too small compared to other influences
    Sustainability performance is not perceived by the market
  • Negative and Positive Effect for Portfolios:Portfolio Theory vs. Socially Responsible Investment (SRI)
    What happens if non-sustainable companies are excluded from the investible universe?
    Positive effect: non-sustainable companies are destined to mediocre financial performance
    Negative effect: constraining the investible universe is destined to mediocrity
    Does sustainability correlate with financial performance?
    Milevsky, M., Aziz, A., Goss, A., Comeault, J., & Wheeler, D. (2006). Cleaning a Passive Index: How to Use Portfolio Optimization to Satisfy CSR Constraints. The Journal of Portfolio Management(Spring), 110-118.
  • Sustainability Performance and EBITDA Margin
    Earnings Before Interest, Taxes, Depreciation and Amortisation margin (EBITDA)
    EBITDA margin is EBITDA divided by total revenue
    It measures the extent to which the cash operating expenses use up revenue
  • The Influence of Sustainability Performance onEBITDA Margin
    Study based on ASSET4 / Thomson Reuters ESG data
    More than 100 companies
    Sustainability drivers
    Sustainability outcomes
    Weber, O., Koellner, T., Habegger, D., Steffensen, H., & Ohnemus, P. (2008). The relation between sustainability performance and financial performance of firms. Progress in Industrial Ecology, 5(3), 236-254.
  • Sustainability Drivers and Outcomes
    Based on reporting
    Strategies and operations to manage sustainability performance
    Based on quantitative measures
    Positive impact on the environment or the society
    A company may have a state of the art environmental management system, but very high CO2 emissions
  • Indicators Analysed
    • Social drivers
    • Employment
    • Labour-management relations
    • Health and safety
    • Training and education
    • Diversity and opportunity
    • Human rights
    • Society
    • Product responsibility
    • Social outcomes
    • i.e. community support
    Environmental drivers
    Products and services
    Compliance and expenditures
    Environmental outcomes
    i.e. CO2 emissions
  • Model
    Year 1
    Year 1
    Year 1-3
  • Environmental Outcomes by Sector
  • Environmental Drivers and EBITDA per Sector
  • Environmental Outcomes and EBITDA per Sector
  • Environmental Drivers and EBITDA
  • Environmental Outcomesand EBITDA
  • Multiple Regression Models for Drivers and Outcomes
    There is a positive influence of the outcomes on EBITDA margin
  • The Relationship between Sustainability Performance and Financial Indicators
  • Conclusions (EBITDA)
    There is a positive relation between sustainability performance and EBITDA margin
    Generally the positive relation between sustainability outcomes and EBITDA margin is stronger than between sustainability drivers and EBITDA margin
    The sustainability result counts
  • 23
    Default Risk…
    Integrating Sustainability Indicators into Credit Risk Management
  • Credit Risks and Sustainability Credit Risks
    Credit risk is the uncertainty about the future outcome of loans
    Compliance with the credit agreement
    Default (non-compliance with the credit agreement as defined by Basle II)
    Sustainability Credit Risk
    Uncertainty about the future outcome of loans emerging from environmental, economic and social sustainability risks
  • Ability to
    Ability to repay?

    Collateral value?

    Reputation risk?

    Core Questions
    Does a commercial debtor’s sustainability performance affect its credit risk rating?
    Does adding criteria aimed at assessing a debtor’s sustainability performance provide added value to traditionalfinancial rating criteria?
  • Sustainability Risks in Credit Business
    Security risks of sites used as collateral that are contaminated
    Contamination of a site affects the collateral value
    Reputation risk
    Banks can attract a bad reputations because of bad reputation of a debtor
    Influences on the ability to repay the loan
    Debtors can be obliged to invest in environmental technologies because of regulations
    Changes in environmental attitudes of consumers or industries influence the business performance of a debtor
  • Credit Rating Criteria
  • Results
    Economic (sustainability) criteria
    Environmental (sustainability) criteria
    Social (sustainability) criteria
    Traditional criteria
    Default / non-defaultclassification by thecredit manager
  • Predicting Credit Risk by Traditional Rating and Sustainability Indicators
    Traditional rating (logistic regression)
    Correct predictions = 81.1%
    AUROC = .91
    Traditional and sustainability rating (logistic regression)
    Credit Risk = 5.10*trad.+2.14*econ. sust.+1.10*soc. sust.-1.44*env.sust.-21.87
    Correct predictions = 85.7%
    AUROC = .94
  • Are Banks Integrating SD/Environmental Indicators into the Risk Management Process?
  • Conclusions (Credit Risk)
    Ability to

    Ability to repay

    Future earnings

    Debtors may improve their credit ratings by improving their sustainability performance
    Banks may improve their credit risk prediction by integrating sustainability indicators into the risk management process
  • The Performance of SRI Funds in Times of Turmoil
    Is there a significant difference in the financial return between a portfolio of SRI funds and a conventional index during times of turmoil?
    Is there a relation between financial and sustainability ratings based on the past performance of funds and the return of an SRI fund portfolio in times of turmoil?
  • Database
    151 SRI Equity Funds
    December 2001 to June 2009
    Sustainability rating
    Monthly returns
    MSCI World as benchmark
    Source: Weber, O., Mansfeld, M., & Schirrmann, E. (2011). The Financial Performance of RI Funds After 2000. In W. Vandekerckhove, J. Leys, K. Alm, B. Scholtens, S. Signori & H. Schaefer (Eds.), Responsible Investment in Times of Turmoil (pp. 75-91). Berlin, Germany: Springer.
  • Results: Returns between 2001 and 2009
  • Returns in Bull Phase
  • Returns in Bear Phase
  • Conclusions SRI Funds
    SRI Funds are able to outperform conventional benchmarks
    General market impacts influence SRI funds as well
    Sustainability rating alone does not guarantee outperformance
    The combination between sustainability rating and financial rating creates outperformance
  • The use of sustainability criteria in company analyses, credit risk evaluations and asset management may create financial benefits
    Cause-effect studies are needed
    From correlative studies to filtering out those that are able to combine sustainability and financial performance
  • Thank you!
    Dr. Olaf Weber
    Associate Professor, Export Development Canada Chair in Environmental Finance
    School for Environment, Enterprise and Development
    University of Waterloo