Sustainability and financial performance: the chicken or the egg dilemma

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There is a clear link between corporate sustainability and financial results, but which one is the trigger? Well, the link can actually run both ways.

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Sustainability and financial performance: the chicken or the egg dilemma

  1. 1. Sustainability and financial performance: thechicken or the egg dilemma January 2013 www .t h i si sxy . c om
  2. 2. X&Y PartnersSustainability and financial performance: the chicken or the egg dilemma Contacts: Romeu Gaspar romeu.gaspar@thisisxy.com UK: +44 (20) 3239 5245 | PT: +351 210 961 834 Skype: xypartners 2
  3. 3. X&Y Partners Sustainability and financial performance: the chicken or the egg dilemmaSustainability and financial performance: thechicken or the egg dilemmaThere is a clear link betw een lead to increased investments incorporate sustainability and sustainability? In this article wefinancial results, but w hich explore the issue of causality betweenone is the trigger? W ell, the sustainability and financiallink can actually run both performance, and what it means forw ays. various stakeholders.Little doubt remains about the The relationship between sustainabilitycorrelation between improved and financial performance is asustainability practices and better complex one. To begin with, there isfinancial results: Exhibit 1 compiles the not a standard metric for measuringresults of close to 160 research sustainability, since it covers a broadpapers, most of which found a positive number of socio-economic andcorrelation between these two environmental issues. Financialbenefits. But which one is the trigger? performance, although narrower inIn other words, do better sustainability scope, can also be measured inpractices lead to improved financial different ways, from share price toresults, or does the availability of funds profits. Even after selecting concreteExhibit 1 – Results of 159 studies from 1972 to 2008, analyzing the correlation betweensustainability and financial performance 3
  4. 4. X&Y Partners Sustainability and financial performance: the chicken or the egg dilemmaExhibit 2 – Stock market returns of the CDLI and Global 500 indexes (2005-2012)metrics and identifying a clear includes Siemens, Coca-Cola,correlation, one question remains: is Microsoft and many other industrythat correlation causal? Take Exhibit 2, leaders with an above-average stockfor instance, which compares the stock performance that is likely the result ofperformance of companies in the CDLI several best practices, some directly(Carbon Disclosure Leadership Index) related to sustainability, others not.with the Global 500 Index. The CDLIExhibit 3 – Suggested virtuous cycle of good management, sustainable practices andincreased financial performance 4
  5. 5. X&Y Partners Sustainability and financial performance: the chicken or the egg dilemmaExhibit 4 – Results of 159 studies from 1972 to 2008, analyzing the correlation betweensustainability and accounting/market metricsRecent studies have shed some light Employees: You can have the cakeonto this issue, suggesting that both and eat it toosustainable practices and solid For a job seeker or employee, afinancial performance stem from good company that is both sustainable andmanagement, causing a virtuous financially strong is a keeper,cycle: actions to increase sustainability irrespectively of what is the driver andtrigger good financial performance, what is the result. Companies withwhich allows for additional investments stronger financials are more likely toin sustainability, which again improves provide attractive remunerationfinancial performance (Exhibit 3). packages, and offer better job security.So it looks to be a “chicken or the egg” Sustainable companies often providesort of dilemma. Does it matter what is better working environments andthe chicken and what is the egg? If clearer career development paths.you are a prospective employee Investors: Look at mediatinglooking for the best company to work metricsfor, it probably doesn’t. But if you arean investor, a senior manager or a For an investor however, it is key topolicy maker, it can indeed matter: understand if enhanced sustainability practices are an indicator of future strong financials, or merely the result 5
  6. 6. X&Y Partners Sustainability and financial performance: the chicken or the egg dilemmaof past financial slack. This often revenues, but not betweeninvolves identifying a more direct link environmental costs and profits.between the two factors: as supported Whenever possible, it is thereforeby Exhibit 4, it is more likely to find a preferable to drill down further, lookingcorrelation between sustainability and for correlations between sustainabilityaccounting metrics than between and mediating metrics such as energysustainability and market metrics. For consumption, process efficiency orinstance, efficiency improvements to waste production.the manufacturing process of a For Venture Capital (VC) and Privatepharmaceutical company will have a Equity (PE) investors, amore direct impact on the company’s complementary strategy might be tooperating margin than on its share analyze the relationship betweenprice, because the latter depends on sustainability and innovation. A studyadditional variables. from Deloitte (Exhibit 5) has found thatFurthermore, different sustainability sustainability leaders are 4 to 6 timesactions can impact accounting metrics more likely to become top innovators.differently. For instance, recent Likelihood increases with time,research of the Japanese Electronics reinforcing that sustainability is indeedsector has found a strong causal link one of the pillars of innovation.between environmental costs and Incidentally, the reverse – topExhibit 5 – Bi-directional correlation between sustainability and innovation 6
  7. 7. X&Y Partners Sustainability and financial performance: the chicken or the egg dilemmaExhibit 6 – Payback period for sustainability initiatives, as reported in 2012 by members of theCarbon Disclosure Project Theinnovators becoming sustainability actions described in Exhibit 6, forleaders – also happens, but is less instance, are all environmentallyprevalent. beneficial but have very different payback periods.Senior Management: Investing insustainability will not solve broader Policy Makers: Minimumfinancial problems sustainability requirements are valuable but should not beThe argument made in Exhibit 3 can overwhelmingbe mirrored: bad management canlead both to misguided investments in From a legislative perspective,sustainability and to poor financial minimum sustainability requirementsresults. This suggests that sustainable can be valuable, forcing inattentiveinvestments are not a silver bullet for companies to look into the benefits ofbad financial performance, and can sustainability. However, these policieseven worsen matters. Furthermore, as should not be overwhelming, as to notdiscussed in a previous article, risk overburdening financiallysustainable investments need to be distressed companies with additionalindividually analyzed from both an investments. It can also be argued thateconomical and a sustainability very strict sustainability requirementsstandpoint, in order to strike a good are unnecessary, as the market itselfbalance between these two factors. 7
  8. 8. X&Y Partners Sustainability and financial performance: the chicken or the egg dilemmawill push for a higher level of and reduction targets. Most membersconformity. The World Business of these two voluntary schemes goCouncil for Sustainable Development considerably further than what is(WBCSD), for instance, includes close mandated by the sustainabilityto 200 global members and 1500 requirements in place for the countriesregional members. The Carbon they operate on.Disclosure Project includes more than500 companies that publicly discloseinformation about their carbon footprint 8

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