Once upon a time, I thought that corporate social responsibility (CSR) and sustainability would lead to economic pay-offs. I believed in a win-win scenario: Firms that did good for society and nature would do better economically over time, and higher financial performance would in turn allow these "socially responsible" organizations to do even more good. In fact, some of my early studies sought to provide evidence for such a virtuous cycle.
Today, I am a skeptic. Now I believe that the pursuit of CSR may in fact undermine financial market dynamics. In general, sustainability projects do not change companies' underlying economic fundamentals. And when investors (or other market actors, such as governments) support corporate sustainability unrelated to economic fundamentals, stocks of all companies can be expected to become more volatile. Moreover, the stock of sustainability leaders (so-called "vanguard companies") can become overvalued in what might be called a "sustainability bubble." In turn, broad pro-sustainability (investment and other) movements, combined with further stock price increases, may push companies to increase their spending on sustainability.
Here's why my perspective has changed. More details can be gleaned from this recent publication [PDF].
The law of unintended consequences
We must assume that sustainability creates noise in financial markets for two main reasons:
1. Research cannot show a conclusive business case for sustainability. This case cannot be made because definitions of sustainability are ambiguous and vary so widely; there is no there there. But let's assume for a moment that sustainability can be defined meaningfully. Empirical evidence indicates that neither sustainability nor CSR, in general, change any firm-level economic fundamentals. If these concepts do not change companies' economic fundamentals, more noise is introduced in markets.
2. Investors and other market actors often have inadequate information about a company's sustainability actions. They can easily end up acting on incomplete or inaccurate information and make emotional decisions affected by cognitive heuristics. Consequently, investors' and other market actors' perceptions and decisions are not aligned with firm-level reality about sustainability.
What can be done?
1. Companies should adopt sustainability and CSR initiatives only if they are integral aspects of their overall economic strategies. Where no project-specific strategic or economic case can be made for sustainability, organizational resources (including time) should be allocated to other initiatives that make more strategic sense. The opportunity costs of sustainability must be transparent to executives, because in a world of scarce resources, there is no such thing as a free lunch.
2. Investors should seek the best possible information on corporate sustainability actions and their relationship to economic fundamentals. One way to do this may perhaps consist of relying on more objective, tangible and trustworthy sustainability metrics. For various reasons, I am pessimistic that information asymmetry about value-laden concepts such as CSR and sustainability significantly can be reduced.
Some propose that governments could help ensure that investors have the necessary firm-specific information on sustainability and economic fundamentals. This optimism about government's role is misplaced because every government intervention, of course, has unintended consequences as well. Governmental decisions and policies are often influenced by pressure from special interest groups and social movements. For example, many governments in the European Union are even more gung-ho about CSR and green investments than investors and the public at large. Some governments are even making CSR disclosures mandatory. This trend toward mandatory reporting only will exacerbate pressures toward ever greater organizational expenditures on sustainability and its associated (costly) data collection, without regard to the underlying economic and strategic fundamentals for each specific firm.
Let's bury the myth that there are no trade-offs between social or green initiatives and a healthy economy. Relationships between sustainability and corporate performance are highly variable and complex. Business executives must become more strategic and economically rational about "socially responsible" actions. We need to abandon wishful thinking about concepts that engender so many emotional and moral connotations. Financially prudent managerial choices based on economic fundamentals ultimately will be best for society and nature because there is some empirical evidence supporting reverse causality: High economic growth promotes social and environmental progress (see, for example, Benjamin Friedman's "The Moral Consequences of Economic Growth"). It is probably not the other way around as so many CSR advocates seem to believe.
Network for Business Sustainability (NBS) Thought Leaders offer guidance on sustainable business models for the 21st century. Thought Leaders are leading academics and practitioners, world experts on sustainability issues. This post was written by Marc Orlitzky, who has done foundational work on the connection between CSR and financial performance.