Why it pays to be socially responsible in business

Companies that wanted to contribute to society used to receive short shrift from investors. But not anymore. So what’s changed and how is CSR driving profits? Ioannis Ioannou explains

Most companies around the globe face growing pressure to become more socially and environmentally responsible, more accountable to their stakeholders and shareholders and to conduct business ethically. More generally, they are expected to have a positive social impact by promoting inclusive and sustainable growth.

Why do they face these pressures now, more so than before? The short answer is that with great power comes great responsibility. According to a 2016 Global Justice Now study, countries accounted for just 31 of the world’s 100 largest economies – 69 were companies.

Indeed, the world’s top 10 corporations generate more revenue in total than 180 of the poorest countries combined. This is reflected in the global concentration of economic activity: according to some estimates, combined sales for the world’s top 1,000 firms is more than 80% of combined GDP for the OECD’s 35 members.

Based on these numbers, some would argue that the role of business is becoming more important and potentially more far-reaching than that of governments.

Ioannis Ioannou is Associate Professor of Strategy and Entrepreneurship. He was speaking about the rise of responsible corporations at the 11th Private Equity Symposium, held by London Business School and Wharton in May 2018. The event explored the future of private equity and the opportunities and challenges for the industry. You can also listen to the full discussion.

The modern organisation’s large footprint highlights its potential to have a positive impact on society and the environment if the right incentives, motives, institutions and people are in place. Just think about the positive impact that one company, such as Unilever, could have when it focuses on making sustainable living commonplace. This is a company whose products and services reach up to two billion people daily.

Of course, Unilever isn't alone. In recent years many companies have set themselves ambitious goals and targets, to help build a sustainable future. In other words, corporate social responsibility (CSR) is becoming increasingly influential in terms of how companies operate, set strategies and develop their business models.

We also know from academic research that beyond compliance, being a responsible company and a good corporate citizen is a fundamental strategic choice.

In some of my own work with co-authors, we have explored the business link between CSR and financial performance. Having reliable, accurate and comparable data in recent years has allowed us to investigate this issue much more effectively.

Today, most scholars agree that the evidence shows a clear positive causal link between responsibility and financial performance, in both the short- and long-term.

In other words, companies perform better when making a positive contribution towards sustainable and inclusive growth as they gain better access to human capital and finance and benefit from increased customer loyalty.

Investors’ haven’t always been as positive about socially responsible companies as they are now. For our research, we studied the role of capital markets as a critical modern institution for allocating limited financial capital around the world.

In the early 1990s, the general public and business figures believed that investment analysts were indifferent about whether companies engaged in CSR initiatives.

The data shows that this isn’t true – they cared. But not in the way you might think.

CSR is no longer a turn-off for investors

My co-authors and I found that investment analysts were less optimistic about companies that performed well against CSR metrics. Why? Because they thought responsible companies were destroying shareholder wealth. Analysts were significantly more likely to recommend a sell or strong sell, believing that such companies were being responsible at the expense of economic returns.

However, analysts’ perceptions have since changed, with many no longer seeing shareholder primacy as the only way to value creation.

It’s not just analysts. In other studies we did, my co-authors and I found that companies with superior sustainability performance gained better access to finance. They faced lower capital constraints, simply because they were more transparent, and had more stable relationships with their stakeholders.

Markets are becoming more sophisticated and can detect when a company says more than it actually does. In a different study, my co-authors and I found that a gap between what a company says and what it does has a detrimental impact on its market value.

It’s clear that CSR benefits companies, but how do they embed it into their DNA? What does it really mean for an organisation to be truly committed to corporate responsibility? Are we now seeing businesses that don’t conform to the traditional model of maximising shareholder value?

Our research found that responsible companies have several key differences and distinguishing features such as increased stakeholder engagement, longer-term view on decision-making and more transparency and accountability. I will briefly explain each one.

Organisations that commit to being socially and environmentally responsible are:

1. Characterised by distinct governance mechanisms, reflecting the joint interests of all their stakeholders. Such companies involve the board more in CSR issues and link executive compensation to environmental and social objectives (in addition to financial objectives).
2. Understanding of their stakeholders’ needs and invest time in managing these relationships. They report internally and externally on the quality of those partnerships, making them more proactive, transparent and accountable when engaging with their stakeholders.
3. Effective communicators. They talk about the long run and persuade long-term investors to invest in their stock.
4. More likely to measure information related to key stakeholders such as employees, customers and suppliers, and to increase the credibility of these measures by using auditing procedures. They measure and disclose relatively more and higher quality non-financial data.

Our research shows that companies need to build these four pillars to embed CSR into their DNA. Organisations that do this can achieve greater profits while having a positive impact on society.

Ioannis Ioannou is Associate Professor of Strategy and Entrepreneurship. He was speaking about the rise of responsible corporations at the 11^th Private Equity Symposium, held by London Business School and Wharton in May 2018. The event explored the future of private equity and the opportunities and challenges for the industry.

Watch or listen to the full discussion.