MHCi MONTHLY FEATURE:

May 2004

The Business Case for CSR

[plus discussion between author and Sir Geoffrey Chandler]

The first question anyone coming to the whole area of corporate responsibility and sustainability will ask is ‘is it good for business?’ How should this be answered? To find an empirical correlation between financial performance and social, case economic or environmental performance it is vital to be clear about the definitions of:

1. financial and economic performance

2. social performance

3. environmental performance.

Yet it is hard to disentangle social from economic or environmental performance, as there are many social variables and some of these will be closely correlated with each other. A company that pays good wages is also likely to have a good occupational health and safety record. It therefore appears that not only are social, economic and even environmental performances not independent variables, but also that there are a great number of different measures of performance in the social, economic and environmental dimensions. Any study which systematically addressed all of them would be enormous in scale – and in practice this has rarely been attempted. While there are some examples of systematic justifications (see boxes below), justification more usually takes the form of case studies. However inspiring this may be, it does not serve as a good basis for generalisation. Where a more systematic study is attempted, use is usually made of some kind of proxy of social, economic or environmental performance, such as a commitment to corporate responsibility, perhaps evidenced by a published code of ethics. This latter approach, while it allows generalisation, by itself does not establish the business case beyond the proxy indicator. In particular, it does not indicate which of the many kinds of social performance has the most financial impact.

The measurement of financial performance suffers from the opposite problem. There are a great many well-defined measures of financial performance, based on dividends, return on capital, share price, total shareholder return, market value added, etc. The problem here is choosing the most appropriate one to correlate with social performance. Depending on the indicator chosen, and the time perspective over which it is viewed, different findings may emerge.

There are two slightly more subtle methodological problems which should also be borne in mind before turning to what some of the studies have found. The first is how to think about any correlation between good social performance and financial performance. If the correlation is more than merely a statistical quirk, what is the nature of the causality? In other words, how does good social performance cause good financial performance? If that is not clear, then such studies will remain an inspiration.

The second is that the relationship between financial and social performance may not be susceptible to such empirical analysis. There may be so many variables influencing financial performance, that it is not possible to isolate the influence of corporate responsibility. For practical purposes, the relationship may therefore seem to be a chaotic one, in the formal sense that small changes in corporate responsibility may have disproportionately large effects (good or bad) on financial performance. Statistical analysis can help untangle these effects but normally depends on a sizeable population of companies which can provide adequate data on their social performance on a regular basis.

One way to gain a broad perspective on the financial impact of corporate responsibility is the Dow Jones Sustainability Index (DJSGI) which is prepared from a global base of companies. It is clear that the difference in share price performance of the self-declared good sustainability performers is marginal, but favours sustainability – see a previous monthly feature on this.

Another study, by Curtis Verschoor of top US companies, found a good correlation between an explicit commitment to an ethical approach to business and market value added. Of the 500 largest US companies, those with a code and a strong commitment to ethics had an average market value added three times that of those without any commitment. The same study also found that those companies where the ethics executive was a member of the professional Ethics Officer Association, had a lower correlation with good performance. The conclusion drawn from this is that the commitment matters far more than the code. In Verschoor’s words:

“An emphasis on proper values deals with setting examples, interpreting ethical principles and structuring appropriate reward systems. Ethical culture spreads from clear and unequivocal goal setting at the top and openness throughout the organization. On the other hand, compliance has to do with rules, hierarchy and sanctions. Legalistic codes of conduct designed only to protect an organization from conflicts of interest or rogue managerial behaviors are unlikely to motivate loyal employee behavior and result in long-term retention of favorable relationships with suppliers, customers and other stakeholders.”

Perhaps the most promising correlation is between good social performance in relation to staff and corporate performance. In the UK, Investors in People has claimed that the return on capital employed is double the national average and pre tax profit margin is 50% higher where their staff management approach is followed. The reasons for such a dramatic relationship revolve largely around greater staff motivation, resulting in:

• reduced costs
• increased invitations to tender
• increased sales
• improved customer/client retention
• improved productivity
• increased customer satisfaction
• improved quality of service/product.

So, bearing all these issues in mind, what does the evidence look like? In summary:

• the hard evidence for a robust correlation between good social or financial performance is weak
• the area of social performance which has been most strongly linked to good financial performance is related to employee’s welfare
• there is little evidence that good social or environmental performance leads to poor financial performance.

[contributed by Adrian Henriques, Professor of Accountability and CSR at Middlesex University and Director of JustAssurance, minor alterations based upon comments by Michael Hopkins]

Dear Michael,

Many thanks. I have a great admiration for Adrian Henriques, but I think he
is here building on sand. Responsibility for stakeholders, expressed in an
explicit set of principles, should be a necessary and prior condition of doing
business without which a business should not start. The spurious ‘business
case’ is only necessary if one is committed to the fallacy that the purpose of a
company (as opposed to a condition of its success) is ‘value to shareholders’.
The logical corollary to this is that if you can’t produce a ‘business
case’ you ignore your social and environmental impacts. Adrian rightly points
out that economic, social and environmental are inseparable in practice (as any
good manager knows) which illustrates the nonsense of interposing ‘social’
between ‘corporate’ and responsibility’! But of course I also recognise that
in the world we live in it is helpful to show that there can be a correlation
between good behaviour and profit. Let us, though, try and hasten the day
when principle is regarded as needing to precede profit, since otherwise profit
can so easily override principle.

Best wishes.

Geoffrey. 23.06.04

Geoffrey

I think you are quite right that responsibility comes first, and is not justified by business cases. And the corollary of this is that projects should be initiated on social/environmental grounds, with a financial feasibility check. This is the model of social businesses, and I would love to see it as the foundation for all commercial activity.

You suggest that the result of the inverse position (that a company’s purpose is financial) is that if financial goals are not met, then social consequences can be ignored. What this means is that unprofitable projects will not be carried out, however socially beneficial the outcomes might have been. But the converse, which is invoked by your argument, does not follow: that bad social consequences necessarily result from profitable projects. That of course may be (and too often is) the case, but it is not always so.

The current position for major projects is that once financial profitability has been established, then a rather desultory ‘social impact assessment’ is made. One would hope that negative social consequences would at some level result in the cancellation of the project. Yet I am not convinced there are any documented cases where this has been the outcome.

Anyway, apart from the difficulty of constructing a business case, I think the position in which companies find themselves through having failed financially to justify socially beneficial projects, or socially to justify profitable projects, can be helpful. I think it rubs their nose in the issue of the purposes of business.

I hope this is not so much quicksand!

Dear Adrian,

Very good to hear from you. I think, however, that either I expressed myself badly and too compressedly, or you have over-interpreted what I was trying to say. Equally, it may be that you are intellectually in the quicksilver (not quicksand) zone, and I am down in the lead mines. Your ‘inverse’ and converse’ both puzzle and, I think, misinterpret me. I start with a belief that the purpose of business should be to provide a product or service profitably and responsibly. To be profitable is a part of responsibility to society in the efficient use of resources and as the basis for continuity, but so is care for employees and for the social and physical environment impacted by a company’s operations. Any project assessment should be economic, environmental and social and needs to pass tests by all three measures. I don’t believe in ‘projects initiated on social/environmental grounds with a financial feasibility check’, if the implication is that the last is an after-thought. I believe the three things should go hand in hand.

Best wishes.

Geoffrey. 23.06.2004

Geoffrey

I think we agree, really!

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