May 1, 2015
Corporate Sustainability’s1 rise – as a more strategic approach to management in a world of accelerating globalization and rising resource constraints – just got an important “shot in the arm.” It has come in the form of rigorous quantitative research out of Harvard Business School. Specifically, Corporate Sustainability, First Evidence on Materiality, is a working paper by professor George Serfeim and colleagues which analyzes respected data sets and finds that companies that outperform their peers on “material” non-financial sustainability considerations provide significantly more value to shareholders than similar companies in their industries who perform poorly on those items.
Most Boards of Directors of publicly traded and large private companies have noticed that Corporate Sustainability has gained great momentum over the past seven years as a superior management framework within which to organize and energize operational innovation and excellence. During these years, Sustainability Roundtable Inc. (“SR Inc”) has been pleased to work with more than seventy mid-market or large corporations year over year – many in the Fortune 500.
We have noticed that the most sophisticated corporations and Boards of Directors embrace Corporate Sustainability as a management framework that is more strategic because it expressly recognizes that companies are operating in an increasingly global and resource constrained economy. This fundamental strategic insight into the shaping challenges of our 21st century economy is one increasingly shared by the most sought after investors, customers, and talent as well as regulators across the globe. Consequently, an organized commitment to Corporate Sustainability has helped these top companies to better align operations and innovation efforts with a growing interest of top investors, customers, talent and regulators.
These trends have also been underscored by broader management research. In 2007, Accenture partnered with the UN Environmental Program for a six year, three-survey examination of the views of more than 1,000 global CEOs across 27 industries. Accenture found in each of the three bi-annual surveys that 93% of global CEOs perceived “sustainability” as “key to their future business success.” In Accenture’s most recent 2013 survey, a remarkable 63% of the global CEOs reported that they believed “sustainability related issues” would “transform their industries” within 5 years. Until very recently, however, there has been a frustrating lack of consensus regarding what sustainability considerations matter most in different industries. And without a precise, respected, industry specific definition of what Corporate Sustainability related issues are “material,” it has been difficult for enterprises to effectively focus their efforts on non-financial issues related to Corporate Sustainability and also difficult to evaluate related efforts.
This is of special importance because a key tenet of an effective commitment to Corporate Sustainability is the need to focus on those considerations that are important to key stakeholders. These key stakeholders go beyond “just” shareholders to include groups such as employees, customers, regulators, and relevant NGOs, who are important to the long-term success of a firm.
General examples of the different priorities of key stakeholders in different industries include: key stakeholders of an insurance firm prioritizing a concern for the environmental and social change impacts on that firm’s assets and operations; key stakeholders of a software company prioritizing data security and customer privacy issues; or key stakeholders of a medical equipment and supplies company prioritizing waste and hazardous material related issues. The relative importance of these and many other “corporate sustainability” related issues are different in different industries.
For financial analysts and investors, however, to perceive these non-cash items that do not regularly appear on a company’s financial statement as “material,” it is necessary to have a precise definition of what constitutes a “material” sustainability issue in a given industry and to have rigorous statistical evidence demonstrating that performance on those issues is, in fact, material to shareholders’ financial interests. Professor Serafeim has now helped supply both a widely respected, industry specific definition of material sustainability issues and statistical evidence that high-performance on these issues correlates to superior shareholder benefit.
SASB Seeks to Become the FASB of Corporate Sustainability
Professor Serafeim serves on the Board of Advisors of the Sustainability Accounting
Standards Board (“SASB”) that was founded in 2010 and is led by Jean Rogers, who formerly led Management Consulting at Arup and at Arup was a founding SR Inc Charter Member Executive. SASB is Chaired by Michael Bloomberg (Chairman of SR Inc Charter Member Bloomberg LP). SASB seeks to rationalize accounting for sustainability considerations in a manner similar to how the Financial Accounting Standards Board (FASB) has regularized financial accounting.
In examining “materiality,” SASB has been guided by the U.S. Supreme Court’s definition of material information as presenting “a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available” (TSC Indus. v. Northway, Inc., 426 U.S. 438, 449 (1976) which was affirmed in Matrixx Initiatives, Inc. v. Siracusano in 2011). SASB has used a systemized multi-stakeholder process involving leading relevant corporations, market participants, and expert NGOs to determine what non-financial sustainability related items fit within that definition for an enterprise in different industries. Using this approach, SASB has made impressive progress towards developing respected standards for what is “material” to corporate sustainability across 7 different sectors and in 80 different industries. Presumably, professor Serafeim’s service on SASB’s Advisory Board has been helpful to this multi-year process.
Professor Serafeim’s most important contribution to date, however, is likely his work with colleagues to quantitatively demonstrate that what SASB has defined as “material” in different industries does, in fact, significantly increase shareholder benefit if companies focus on these material issues and outperform their peer companies on them. This is especially important because SR Inc Advisors have observed Sustainable Business & Enterprise Roundtable Member Executives frustrated by senior management, which may perceive sustainability issues as carrying additional costs for “doing the right thing.” As such, they are perceived as an added layer of responsibility that is handled (or not) to the side of core business management systems and operations – as opposed to being areas wherein high-performance will clearly advance the interests of shareholders as well as other stakeholders.
What Serafeim & Colleagues Found & How They Did It
What Serafeim and colleagues have smartly done is apply new SASB industry-specific guidance on material Environment, Social and Governance (“ESG”) issues to MSCI KLD 400 Social Index2 firm-level performance ratings on an array of sustainability issues and time series data of shareholder value performance. The study surfaces three key findings that should get board, senior management and investor attention:
The focus on “material ESG” issues in these findings helps illuminate how many earlier studies have largely failed to discern the significant near-term shareholder value of strong ESG performance3. We think that as these findings are tested and refined, they will meaningfully contribute to the broader effort to enable management to better understand and manage material “costs” and “benefits” that are not financially accounted for today.
A Reward for Shareholders; Not From Shareholders
It is striking that professor Serafeim and colleagues have found that companies that outperform on material ESG issues outperform peers in benefit to shareholders. It is all but certain shareholders are not rewarding companies for “doing the right thing” on these issues due to their recognized materiality, but shareholders are instead being rewarded because the company “did the right thing” by performing well on material ESG issues. Furthermore, Serafeim and colleagues’ findings – published before SASB’s definition of material ESG issues across different industries is generally recognized by investors – suggest to us the practical power of the fuller cost accounting or “eyes wide open” approach to business strategy that an organized commitment to greater sustainability encourages.
This more strategic, broadly considered approach to management that is part and parcel to an organized commitment to Corporate Sustainability is vitally important to companies that intend to develop innovations of growing importance in a changing world. It is therefore not surprising that Serafeim’s other colleagues at Harvard Business School recognized back in 2009 that Sustainability had become no less than “the key driver of innovation.”
Conclusion
Professor Serafeim and colleagues’ work leverages SASB’s promising new data architecture to provide sound evidence that – even before “future proofing” and innovation value is realized – shareholders benefit significantly when management understands deeply – and manages well – those non-financial considerations that will help the company flourish in a rapidly changing world. We look forward to the testing of their work by scholars, critics and the burgeoning ranks of well-capitalized, sustainability minded, investors.
1Dow Jones Sustainability Indices defined Corporate Sustainability in 1999 as: a business approach that creates long-term shareholder value by embracing opportunities and managing risks deriving from economic, environmental, and social developments. In 2013, Sustainability Roundtable Inc. published to Member-Clients the following definition: “Corporate Sustainability is a more strategic approach to management in a world of rising resource constraints.”
2“Comprises companies with high Environmental, Social and Governance (ESG) ratings…The Index aims to serve as a benchmark for investors whose objectives include owning companies with very high ESG ratings and avoiding companies that are incompatible with specific values-based criteria.” https://www.msci.com/resources/factsheets/index_fact_sheet/msci-kld-400-social-index.pdf
3A 2012 meta study of ESG practices by Deutsche Bank Group is an important exception that used a “positive” as opposed to “negative” screen for ESG performance and found a positive correlation between strong ESG performance and share performance.
Jim Boyle is CEO & Chairman of Sustainability Roundtable, Inc. (SR Inc). For more than six years, Jim has led full-time teams of diverse experts assisting world-leading corporations, real estate owners, and federal agencies in their move to greater sustainability. Before founding SR Inc., Mr. Boyle advised fast growth technology firms, private equity firms, and institutional investors as an advisor on real estate strategy and implementation, and before that, as a large law firm attorney assisting corporate and investment clients on complex real estate and environmental compliance-related issues. He has led in developing SR Inc’s confidential, sector-industry specific, annual management assessment and recommendation process for more sustainable operations and real estate that is compatible with major public standards globally. Further, he has directed the development of hundreds of pieces of SR Inc original Executive Guidance, Implementation Guidebooks, Solution Assessments, and Tools to assist SR Inc Member-Clients in their move to more sustainable business. He is a graduate of Middlebury College and Boston College Law School, and early in his career, he served as a federal law clerk and as an aide to John F. Kerry in the United States Senate.
David Osborn brings to SR Inc over 25 years experience in building professional services and technology-driven businesses serving a broad range of client industries. David graduated from Dartmouth College where his studies concentrated in Economics and Geology and received his MBA with honors from Northwestern’s Kellogg Graduate School of Management. After receiving his MBA, David went to work for Bain & Company in their Boston office and then progressed up to Managing Partner at Booz, Allen & Hamilton (BAH). Over a long career David led Australia/Asias for Booze Allen from Sydney ultimately became head of Financial Service for North America based in New York. He transitioned out of large firm consulting in 2004 to serve as Managing Partner / EVP an innovative business service company and helped lead over 200% growth before joining SR Inc where he did the same.
