CHAPTER 7
The Financial Challenge: Reconciling Social and Environmental Value with Shareholder Value
IN THE FINANCE COMMUNITY, SHAREHOLDER VALUE HAS LONG BEEN the performance metric of choice for academics and professionals. Along with increasing profits, the maximization of shareholder value is viewed by many as the primary objective of corporate managers and is a pillar of most finance courses. As we introduce the importance of SEERS, the immediate question arises regarding how social and environmental sustainability, financial performance, and shareholder value are related. Can these concepts not only coexist but be taught in a cohesive, effective pedagogy? As the importance of developing a SEERS worldview becomes more central for both organizations and entrepreneurial leaders, we have an obligation to try. The task of incorporating SEERS into a finance perspective based on predictive logic, however, can be formidable. To illustrate this challenge, we begin with what appear to be simple questions about sustainability and corporate social responsibility, activities resulting from a SEERS worldview.
The first question relates to the ranking of companies in terms of corporate social responsibility, or CSR.* Each rating approach evaluates a different aspect of sustainability and responsibilities and, for many, the top-rated company can be on the list one year and off the next.
Take Monsanto for example. In 2010 the company was ranked 31 in Corporate Responsibility Magazine’s “best corporate citizen” ranking and was also one of the “least ethical companies” in the Covalence rankings (Cause Integration 2010). There was also a major change in the top 100 “best corporate citizens” from 2009 to 2010: 44 companies from Corporate Responsibility Magazine’s 2009 “best corporate citizen” ranking disappeared from the 2010 ranking, including CSR darlings Agilent (recognized by RiskMetrics Group’s 2010 Global ESG 100, Newsweek’s 2009 Green Rankings, and Corporate Knights’ Global 100) and General Electric (recognized by Ethisphere magazine as among the 2009 Most Ethical Companies, Newsweek’s 2009 Green Rankings, and 2010 Corporate Knights Global 100) (Ravich 2010).
The second question refers to exhibit 7.1, which shows two-year stock returns for four companies: Whole Foods Market Inc., Timberland Co., Exxon Mobil Corporation, and Huntsman Corporation (Fortune magazine’s least-admired American company in 2007 based on social responsibility). Which companies do you think have the positive and negative returns? The two companies with positive stock returns are Exxon Mobil and Huntsman, and the two companies that lost about 40 percent of their value are Timberland and Whole Foods.
Exhibit 7.1 Two-year stock returns for Whole Foods, Timberland, Exxon, and Huntsman
These examples—while admittedly unscientific—highlight two of the impediments to a rigorous reconciliation of SEERS and shareholder value. The first is that there are many ways to define CSR, but there is no single, established method that allows us to quantitatively evaluate and rank companies. In contrast, there are financial standards—GAAP, International Accounting Standards (IAS), and Sarbanes-Oxley—that permit an “apples-to-apples” comparison of corporate financial performance and regulatory compliance across industries and countries (see chapter 6).
The second impediment is that, despite hundreds of empirical studies, there is no clear or consistent evidence that CSR activities produce superior financial returns to shareholders. This lack of an obvious link between social and environmental responsibility and shareholder value creates conflict for investors and corporate managers who must balance their legal and fiduciary responsibilities with the mounting pressure to embrace SEERS.
Finance educators and professionals who rely on predictive logic based in reams of data and economic theory face a quandary. On one hand, the lack of standardized data and the inconclusive connection between CSR and financial performance make it tempting to dismiss SEERS as just another management fad. On the other hand, some managers believe that social and environmental responsibility matter but are unsure how it connects to profitability and shareholder value. As educators, we face heightened student awareness and interest in social and environmental responsibility and evolving questions about the role and the responsibilities of corporations. The combination of these factors is why we should strive to better understand the topic and educate our students—the world’s future entrepreneurial leaders—in how to engage a SEERS worldview from a finance perspective.
Rather than try to justify social and environmental sustainability on philosophical or moral grounds—as some advocates do—the finance perspective contends that SEERS needs to be considered and evaluated within the shareholder value framework. Certain social and environmental activities are not at odds with increasing shareholder value. Indeed, focusing on these value-creating activities allows us to avoid throwing the baby out with the bathwater. We hope to convince the reader and our finance colleagues that by evaluating SEERS activities with financial analytical rigor embedded in prediction logic, we can focus on those practices that are aligned with shareholder value and at the same time improve both the content and the effectiveness of our teaching.
Financial Framing of SEERS
We begin by highlighting some of the challenges to incorporating social and environmental value creation into the world of finance. It may also help explain why both finance academics and industry professionals have often viewed social and environmental responsibility skeptically. We believe that the difficulties of reconciling CSR with shareholder value creation fall into three broad areas: defining CSR, measuring and evaluating CSR, and assessing the relationship between CSR and financial performance.
Defining Corporate Social Responsibility
The definition of socially responsible corporate behavior is not clearly developed.* The possible behavioral activities range from obeying environmental laws to reducing the carbon footprint of the supply chain, from obeying local labor laws to providing health insurance, and from making charitable donations to producing antiracism public service announcements. It is therefore difficult to classify companies as having “good” or “bad” CSR.
For example, is McDonald’s a responsible corporate citizen for using recyclable packaging materials when its products are nutritionally suspect and its suppliers practice large-scale corporate agriculture? Are Monsanto’s genetically modified seeds the answer to global famine or a threat to biodiversity? Should Archer Daniels Midland be praised for its role in expanding ethanol production or pilloried for the fact that corn-based ethanol may actually contribute more to the problem of climate change than comparable amounts of fossil fuels? Should these companies be praised for certain activities and criticized for others? Is there a way to evaluate a company’s net contribution to society? And how do the shareholders react to these different types of activities?
Measuring and Evaluating CSR
Chapter 6 discusses the challenges associated with CSR reporting and the lack of consistent standards to guide it. There are a variety of reporting guidelines and standards for CSR, and each measures something different. In addition, there are many rankings and lists that purport to provide evidence on a company’s CSR or sustainability activities, yet the methodologies behind some rankings are subjective at best. A similar problem is the lack of a mandatory disclosure requirement for companies to provide information about their social and environmental activities, and when they choose to report there are few consistent standards.
Contrast this with the financial data available to investors, corporate managers, and academics wishing to evaluate corporate performance. Every public company is subject to mandatory quarterly financial disclosure requirements. The content and the format of those disclosures are clearly defined and subject to Securities and Exchange Commission requirements and the rules of GAAP or IAS accounting standards. These issues are similar to the challenge of providing reliable and relevant data (see chapter 6). There is no question that the information available for assessing financial performance is more clearly defined and readily available than data on social and environmental performance. For those leaders who are used to making decisions based on reliable and relevant measures of future financial implications, it is challenging to incorporate social and environmental activities, which can be more difficult to measure.
Another challenge for finance is the focus on shareholder value creation. A focus on social and environmental value means broadening the managerial focus to include other stakeholders, such as employees, suppliers, customers, and the local community. When this happens, the objective becomes maximizing aggregate stakeholder welfare rather than simply share price. The problem is that stakeholder theory, at least in its current state of development, does not clearly define aggregate welfare or explain how to quantify the tradeoffs among competing stakeholders.
Therefore even when companies assess and report their social and environmental activities, there is no effective way to compare the information across companies. It is therefore not surprising that many companies fail to report their activities in any quantitative way or that their CSR reports have limited information. Companies may choose to present only the positive outcomes for stakeholders rather than the tradeoffs that were made. The CSR report can become more of a means of improving the company reputation and brand image than an accurate assessment of its actual performance.
The Disconnect between CSR
and Financial Performance
Perhaps the biggest challenge in reconciling corporate social responsibility with a financial model is that there is inconsistent evidence that CSR produces better financial performance for a firm. We can evaluate this issue from two perspectives. The first reviews the link between CSR and individual firm financial performance, and the second looks at the returns from socially responsible investing (SRI). While there is some evidence of a relationship between CSR and corporate financial performance, it is neither consistent nor conclusive.
Orlitzky et al. (2003) used meta-analysis to review 52 academic studies of the link between CSR and corporate financial performance (CFP), concluding that corporate social performance (CSP) is positively associated with CFP. The researchers found little evidence of causality, however, concluding, “The relationship seems to be bidirectional and simultaneous.” In other words, companies with high CFP also have high CSP. Does good financial performance permit companies to do good, or does doing good lead to better financial performance? We do not know.
Margolis and Walsh (2003) examined 127 published studies of CSR and CFP between 1972 and 2002. The majority (109 studies, or 86 percent) model CSR as the independent variable predicting CFP. Of these, 54 report a positive relationship, 7 a negative relationship, and 48 no relationship or mixed results. For the 22 studies that modeled CFP as the predictor of CSR, 16 (73 percent) found a positive relationship—that is, good financial performance led to more CSR. It is difficult to draw definitive conclusions, however, because the remaining 109 studies measure CFP in 70 different ways and assess CSR based on 27 different data sources. Margolis and Walsh concluded, “A definite link between CSP and CFP may turn out to be more illusory than the body of results suggests.” How can we determine a link between social responsibility and financial performance when CSR is not well defined or measured?
Another way to assess the link between corporate social responsibility and financial performance is to consider the performance of socially responsible investing funds. SRI has grown dramatically in the United States and around the world. In 1995 there were 55 SRI mutual funds managing $12 billion and total SRI assets of $639 billion. By 2010 those numbers had grown to 493 funds and $569 billion, and total SRI assets were $3.07 trillion, or 11 percent of the $25.2 trillion under professional management (Social Investment Forum Foundation 2010).
In Europe between 1995 and 2005, the number of SRI mutual funds increased from 54 to 375, with $30 billion of assets under management (Renneboog, Ter Horst, and Zhang 2008, 1726). Total European SRI assets increased from €2.7 trillion to €5 trillion from 2007 to the end of 2009 (Eurosif 2010). Clearly, there is increased demand for SRI funds, and investors may be looking for ways to evaluate the CSR practices of firms so that they may invest in those firms.
While we know that the popularity of SRI funds has increased, we need to consider whether SRI funds outperform other funds. Renneboog, Ter Horst, and Zhang (2008) provide a comprehensive review of the academic research on SRI investing. Their empirical evidence shows little difference in SRI performance in the United States, the United Kingdom, Canada, and Australia and underperformance by SRI funds in continental Europe and the Asia-Pacific region. Exhibit 7.2 shows the recent performance of two popular CSR indices—the Dow Jones Sustainability World Index and the FTSE4Good Index, compared with the MSCI World Index. The data add support to the claim of no consistent, superior performance by companies with better SRI/CSR metrics.
The lack of a consistent, discernible link between CSR activity and financial performance in this research does not mean that specific CSR activities cannot benefit individual companies. It means that the financial impact of a firm’s social and environmental sustainability activities needs to be critically assessed, just as its other activities and investments must be assessed. In this context the challenge becomes defining the CSR activities most likely to enhance shareholder value. This is the goal of the next section.
Exhibit 7.2 Performance of corporate social responsibility indices
Analyzing SEERS from
a Finance Perspective
Because the social and environmental components of SEERS are currently ill defined, lacking in objective measure, and not yet clearly linked to financial performance, can SEERS still be reconciled with shareholder value? From a financial vantage point, we believe that the answer is a qualified yes. In this section we present an approach that incorporates components of SEERS into financial analysis and education. By focusing on those elements of SEERS with a clear connection to financial performance, we can maintain shareholder value without sacrificing analytical rigor. We believe that such an approach is not only defensible but also reflective of the way social and environmental responsibility is viewed by leaders in many corporations. As this statement from Matt Kistler, senior vice president of sustainability at Wal-Mart, reiterates, “If this was not financially viable, a company such as ours would not be doing it” (Bhanoo 2010).
How do we teach budding entrepreneurial leaders to consider the financial benefits of SEERS activities? From a finance perspective, we believe that entrepreneurial leaders should focus their resources on the social and environmental activities that they believe will have a positive impact on profitability and shareholder value. Based in predictive logic, finance theory allows us to evaluate the financial impact of these investments and activities just as we would other company investments.
Finance theory defines the current value of any asset as the present value of the cash flows it is expected to generate in the future. There are two variables in this analysis: expected cash flows and a risk-adjusted discount rate. Discounted cash flow techniques—the most widely used tools for evaluating investments and valuing companies—are based on this simple concept. With discounted cash flow, two components can increase the value of a company today: one is an increase in the expected future cash flows (through cost reduction or revenue enhancements); the second is a decrease in the risk of those cash flows as proxied by the discount rate.
Thus for SEERS activities to create shareholder value, they must either increase future cash flows (profits*) or reduce the risk of those cash flows. Some individuals might scoff at the need for such a direct connection, arguing that any socially responsible behavior is beneficial in general. Most finance professionals are more pragmatic, however, and not only would understand but hopefully would endorse SEERS activities with a clear link to incremental cash flow or risk reduction. Engaging the predictive logic of finance, we suggest that SEERS activities should be subject to cost/benefit analyses comparable to those that guide most corporate resource allocation decisions.
To facilitate this predictive analysis, we propose three categories to evaluate SEERS activities: cost savings, revenue enhancement, and risk reduction. Of course, the delineation is not always clear and some SEERS activities may fall across more than one category. Our framework for reconciling SEERS and shareholder value is summarized in exhibit 7.3, which shows the three categories of SEERS activities and ranks them based on the estimated strength of their connection to shareholder value. At of the top of the figure are SEERS activities that clearly increase cash flow and are relatively easy to identify and connect with shareholder value. At the bottom are activities that have a weaker connection to financial performance or that are more difficult to quantify in terms of costs and benefits. Although this exhibit and its categories are somewhat subjective, we believe it’s useful for advancing our understanding of how to consider SEERS activities within our current methods of financial analyses. The following discussion describes each type of activity and provides real-life examples.
Exhibit 7.3 SEERS/CSR and shareholder value
Cost Savings
The simplest way to increase profits is to reduce expenses. The link between SEERS and cost reduction can be direct or indirect. If achieved directly, that is, with no additional spending or investment, the benefits are obvious and unambiguous. SEERS activities that fall into this category include a switch to less expensive but more socially responsible production inputs. Examples of direct cost reduction include a newspaper publisher’s switching to recycled newsprint priced below virgin paper and a restaurant’s purchasing locally grown produce that is cheaper than the offerings of its usual distributor.
In practice most SEERS choices have an impact on multiple cost items and may involve significant investment. The savings in these cases are indirect. A common example of this is efforts to reduce energy used in heating, cooling, and lighting commercial buildings. This can be achieved in many ways, including insulation, smart controls, and compact fluorescent lighting. Each of these changes involves an upfront investment that yields future cost savings in the form of reduced energy consumption. The environmental benefit comes from reduced use of fossil fuels and fewer greenhouse gas emissions. For any of these investments, we can estimate future cost savings, use discounted cash flow techniques to weigh them off against the required investment, and make a decision based on the expected impact on shareholder value.
Another example of indirect cost savings can be found in the way companies package their products. Environmentally friendly packaging design can reduce material requirements, cut shipping and warehousing costs, and encourage recycling. Here are three real-world examples:
Procter and Gamble’s redesign of the Folgers coffee container to reduce plastic consumption by 1 million pounds annually
Nestlé’s use of smaller labels on its Poland Spring and Deer Park bottled water brands, which saved 20 million pounds of paper
Coca-Cola’s change of the Dasani water bottle shape to reduce material usage by 7 percent (Demetrakakes 2007)
Each of these activities reduced cost due to material savings and decreased shipping expenses due to lighter weight and reduced size. There are costs involved in the redesign process, and there may be additional investment in equipment, but, again, we can quantify the costs and the expected benefits using the traditional tools of financial analysis.
There are many examples where SEERS reduces costs and enhances revenues. Wal-Mart attributed more than $100 million of its 2009 revenue to its decision to switch to recyclable cardboard when shipping to its 4,300-plus stores in the United States. Now it sells the cardboard to a recycler rather than pays to ship the waste to a landfill (Bhanoo 2010). In this case, Wal-Mart reduces its disposal costs by switching to recyclable cardboard, which it then sells to generate new revenue. Even if the new cardboard is more expensive, the incremental cost is more than offset by the new revenue and the reduction in disposal costs. Wal-Mart estimated the 2009 environmental benefits as 8,600 fewer tons of cardboard in landfills and 125,000 trees saved (Wal-Mart Stores Inc. 2010, 13).
Another category of cost savings involves the intersection of SEERS and a company’s employees. The premise is that more-loyal employees save a company money by reducing turnover and increasing productivity. Lower turnover means reduced costs for hiring and training, while higher productivity improves profit margins. The first link between SEERS and loyalty is based on the idea that employees are less likely to leave socially responsible companies, which share their values, a claim borne out by survey data.*
As an example, Timberland combines both approaches by shutting down one day a year so that all 5,400 employees can participate in company-sponsored philanthropy. It also allows workers one week off with pay each year to work with local charities, and it offers paid six-month sabbaticals for four employees each year to work at a nonprofit. This is not inexpensive; the one-day shutdown alone costs the company $2 million. Timberland management believes that such expenditures help the company attract and keep the best talent, which benefits the bottom line. In the words of President and CEO Jeffrey Swartz, “People like to feel good about where they work and what they do” (Pereira 2003).
Loyalty and productivity may also improve at companies with socially responsible human resource (HR) policies, which might include paying above-market wages; providing discretionary benefits like healthcare and retirement; offering workplace perks like free lunch, on-site gyms, and childcare; and ensuring safe and fair working conditions globally.
Starbucks, for example, realized early on that its employees (called “partners”) were critical to creating its competitive advantage, the “customer experience.” Being able to attract, train, and retain new employees was also critical to its rapid growth plans. To accomplish this, Starbucks pays above-market wages and offers health and dental benefits, vacation time, a 401(k) plan, and stock options to even part-time employees. The company also provides numerous opportunities for advancement, knowing that its typical hire will want new challenges. Does it work? Turnover of Starbucks baristas is 80 percent annually, whereas the industry average for quick-service restaurants is 200 percent (Weber 2005).
Companies like Timberland and Starbucks believe that their investment in CSR and socially responsible HR practices yields tangible financial benefits by creating a loyal and productive workforce. The question with respect to shareholder value is whether those benefits outweigh their costs.
Revenue Enhancement
For many firms the financial goal of SEERS may be to increase revenue. As with cost reductions, the link between SEERS and revenue can be direct or indirect. The direct link occurs when customers pay a premium for the socially or environmentally responsible characteristics of the company’s products. When companies pursue CSR to attract new customers, the connection to revenue is indirect. The indirect approach has a more tenuous connection to profitability and shareholder value.
Consumers pay a premium for socially responsible products for many reasons. In some cases they believe that the products are superior. For example, some consumers believe that organic produce and free-range meats are healthier and taste better, which justifies a higher price. In others cases the products are of equal quality or functionality but have been sourced in a more environmentally friendly manner or provide social or environmental benefits in use. The electricity from a wind turbine is identical to the electricity from a coal plant; however, generating the former does not produce CO2 or contribute to climate change.
For SEERS-based revenue enhancement to create shareholder value, the additional costs of social responsibility must be offset by the premium customers are willing to pay. Balancing these considerations can be challenging. For example, in 2008 Costco and Sam’s Club introduced a newly designed 1-gallon milk jug. The square container carried significant environmental benefits, including easier stacking, storage, and transportation. It also did away with the need for traditional milk crates. The benefits included significant labor savings, less fuel and water consumption, and a lower price to consumers. Consumers initially rejected the new jugs, however, claiming that they were difficult to pour. The jug was subsequently redesigned, and in-store pouring classes were introduced. The point is that consumers will not accept reduced functionality as a tradeoff for improved environmental product characteristics.
Contrast this example with Dutch Boy’s 2002 introduction of the Twist & Pour paint container. The new container was completely recyclable and stacked more efficiently for transportation and storage. It also provided tangible benefits to the consumer, including an integral pouring spout, a twist-off lid that better preserved the paint, and an easy-to-grip handle. Even though the container cost $2 more than a traditional metal paint can, sales at Dutch Boy tripled in the first year (Bishop 2008). By improving both performance and environmental characteristics, Dutch Boy was able to increase its total revenues.
Another revenue-enhanced component of SEERS may be the ability to generate additional business from existing customers or to attract new ones. One method of indirect revenue enhancement is cause marketing, which Wikipedia (2010) defines as a type of marketing involving the cooperative efforts of a for-profit business and a nonprofit organization for mutual benefit.
An early example of this was the 1983 partnership between American Express and the Statue of Liberty–Ellis Island Foundation. American Express pledged a one-penny donation toward the Statue of Liberty renovation for each transaction made with an American Express card and $1 for each new card application. The campaign included $4 million in advertising and resulted in $1.7 million being donated toward the $62 million renovation. More importantly for the company, use of American Express cards rose by 28 percent in just the first month, compared with the previous year, and new card applications increased by 45 percent (Adkins 2003, 670). In this example, the implications for company profitability and shareholder value could readily be estimated.
Other ways of engaging SEERS to indirectly increase revenue include charitable giving and involvement in the local community. In some cases these activities may be connected to the company’s product or service. For example, in 2010 Aéropostale donated 15,000 coats from the previous season to nonprofit Cradles to Crayons, which provides clothing to children in need. The benefits of donating these coats exceeded the incremental revenue that Aéropostale might have made from selling marked-down off-season coats.
In other cases such actions may have no direct connection to the company’s products or revenue, but they help build the company’s reputation which, over a longer period of time, might help retain existing customers and attract new ones, indirectly increasing revenues. Examples of this type of activity include McDonald’s Ronald McDonald House and Goldman Sachs’s 2008 pledge of $100 million to “10,000 Women,” a global initiative delivering business education to women in developing countries. Cynics might argue that some of these activities are meant to repair rather than build reputations, but the goal is consistent: to enhance the company’s image in the eyes of employees, customers, investors, and other stakeholders.
In considering the revenue-enhancement opportunities of SEERS activities, organizations must be cognizant that there is a limit to the premium that customers may pay for socially conscious goods and services. The tradeoffs inherent in such decisions can create conflicts with other stakeholders and other core aspects of a company’s strategy.
For example, Wal-Mart complained about the high prices associated with using renewable energy and was concerned that the costs would have to be passed on to consumers, threatening the company’s “always low prices” mantra (Ailworth 2010). Merck, which in partnership with the Gates Foundation launched an initiative in 2000 to improve HIV/AIDS treatment in Botswana, had to balance the R&D costs of developing new drugs and the need for patent protection with the very real social crisis HIV and AIDS were causing in Africa.
Risk Reduction
The final financial classification of SEERS initiatives is that of reducing risk. If the volatility of a firm’s cash flow decreases, so should its cost of financing (Luo and Bhattacharya 2009). Reducing the discount rate in any discounted cash flow analysis increases the current value of future cash flows. Even if it requires new investment or additional expense, a sufficiently large reduction in risk can increase shareholder value.
The first way SEERS can reduce risk is by heading off potentially expensive regulation and taxation. Consider the American Beverage Association’s recent television and print ads showing Coca-Cola, Pepsi, and Dr Pepper employees removing full-calorie soft drinks from school vending machines. The campaign (American Beverage Association, n.d.) touts the collaborative effort among fierce industry rivals and claims, “Together, we’ve reduced beverage calories in schools by 88 percent.” What the ads fail to mention are the recent efforts at both the federal and state levels to impose new taxes on sugar-laden beverages. The taxes would raise revenue that would be used to offset the contribution of these drinks to obesity-related health problems.
Kevin Keane, senior vice president of public affairs at the American Beverage Association, summarized the industry’s perspective as follows: “You’re always in a far better position to be on offense than on defense all the time, and our companies recognize that and are doing bold things in the public policy arena that others will follow” (Zmuda 2010).
In other cases the risk is not of additional regulation or taxation but to the company’s reputation. As mentioned in chapter 4, Nike has had to respond to questions from customers and activists about its social and environmental impacts. When a 1996 New York Times column highlighted the conditions under which Indonesian women were producing Nike products, the company found itself at the center of a public relations nightmare (Herbert 1996). Labor groups protested Nike’s practices and accused it of hypocrisy, noting that the company was in the midst of an ad campaign that touted sports and exercise as a path to female empowerment. Brewing boycotts of Nike products by consumer groups increased the risk considerably. As a result, later in the year the company created a new department to monitor compliance with labor standards by its supply-chain partners. By 1998 Nike had established SEERS initiatives connected to its core business functions in response to the labor crisis and the potential damage to its reputation (Kytle and Ruggie 2005).
The examples of cost savings, revenue enhancement, and risk reduction in this chapter suggest that organizations can connect SEERS to financial value creation. Yet as entrepreneurial leaders use these models, they need to be cautious to avoid value-destroying behavior that occurs when they unilaterally pursue social initiatives that competitors eschew. This type of activity can put an organization in a vulnerable position in either the product or capital markets.
Coining the term supercapitalism, Robert Reich (2008, 10) argues, “Competition is so intense that most corporations cannot accomplish social ends at a cost to their consumers or investors, who will otherwise seek and find better deals elsewhere.” Reich cites numerous examples of companies whose SEERS activities had to be scaled back in the face of declining financial performance. These include Levi Strauss, which almost went bankrupt due to its commitment to domestic manufacturing, and Marks & Spencer, a perennial favorite for its worldwide labor standards, which became the target of a hostile takeover in 2004. The key is that in a competitive marketplace, companies must pay attention to both SEERS and profitability or risk losing both.
In summary, from a finance perspective organizations must consider how SEERS creates value for both their customers and their shareholders. To do so they need to be aware of the competitive landscape and effectively communicate their social and environmental activities and anticipate customers’ reactions to price increases or product functionality changes. Activities that reduce costs or directly increase revenues in a predictable way will yield the most immediate and tangible financial benefits. Furthermore the analyses of the cash flows should consider how these activities increase or decrease the risks.
Refer again to exhibit 7.3, our framework for reconciling SEERS and shareholder value. The figure establishes a context for making the connection between SEERS, financial performance, and shareholder value and also provides guidance on how SEERS might be incorporated into finance education.
Strategies for Integrating SEERS
into Finance Education
Exhibit 7.3 provides a conceptual framework for incorporating CSR into finance pedagogy. The connection between SEERS and the prediction-based financial metric of shareholder value is through changes to cash flows and risk. By focusing on the clearest connections between these, we can incorporate social and environmental value creation into finance education without sacrificing analytical rigor. This means relying on examples and cases that emphasize SEERS impacts on the top half of exhibit 7.3. Today there are still very few cases or exercises that make this connection explicit. Until good teaching materials become more abundant, educators must be creative.
One way to do this is to focus on cost reduction. The easiest business case to make for SEERS is a direct reduction in costs. Our earlier discussion defined this as a cost savings that requires no additional investment or expense and also highlighted their infrequency. The more typical cost savings from social and environmental activity come when the firm makes an investment in new technology and incurs incremental costs or revenues elsewhere.
We use the Acid Rain: The Southern Co. (A) case (Reinhardt 1992) to illustrate this tradeoff. In the case, Southern Company, one of the largest power generators in the United States, is considering several options for complying with new pollution regulations at its largest coal-fired power plant. Although this is an older case, it provides an example of a cap-and-trade system for sulfur dioxide and analyzes new investment, input switching, and incremental costs and revenues. The case also enables students to engage predictive logic to quantitatively estimate the impact of various SEERS choices on profitability, cash flow, and value.
We use several cases on residential energy efficiency to connect financial analyses to SEERS. In one case students evaluate the costs and the benefits of adding insulation to an older home. In another case they compute the expected payback and current value of the investments in and savings from a residential solar photovoltaic installation. Although these activities are at the individual level, it is easy to scale up the exercises for a corporate scenario.
We also connect examples from the popular business news and corporate news releases of companies’ SEERS initiatives that produce cost savings. Many companies issue annual sustainability reports that provide a wealth of ideas for the classroom.* Even though these reports are thin on financial metrics, they can be used to develop budding entrepreneurial leaders’ understanding of the range of SEERS opportunities that companies are pursuing. This discussion can be used to press students about the impact that they think certain activities have on corporate financial performance and shareholder value (and how the connection might be measured).
After cost savings, direct revenue enhancement through SEERS activities has the strongest impact on corporate financial performance. Recall that direct revenue enhancement occurs when companies sell products with socially responsible attributes. These cash flows are more volatile and less certain because we must now incorporate the fickle nature of consumer behavior. To introduce students to these issues, we developed a case on bio-plastics to highlight the challenges of profitably developing and marketing a “green” product (Bliss 2007).
We are also in the process of developing an exercise to quantify the costs and the benefits of owning a Prius. This discussion raises the important question of where boundaries can be drawn when evaluating SEERS initiatives. For example, from the driver’s perspective owning a Prius may reduce fossil-fuel consumption and CO2 emissions. When the entire environmental impact of producing the Prius and manufacturing and disposing of its batteries over the vehicle’s life is included, however, the cost/benefit analysis becomes more muddled. By looking at the issue from multiple perspectives, students are forced to deal with the inherent ambiguity of analyzing SEERS using predictive logic.
As we proceed downward in exhibit 7.3, the connection between CSR and shareholder value creation gets weaker and there are fewer teaching materials that lend themselves to quantitative financial analysis. As such we have not yet focused our financial analyses with students on the link between CSR and indirect revenue enhancement, although we are trying to make these connections. For example, we are considering a case about an investment fund that purports to have CSR screening metrics that identify superior future stock returns. This case will make a contribution to the discussion regarding socially responsible investing and the ability to pick better-performing stocks using a combination of financial, social, and environmental measures.
Given the challenges of linking corporate social responsibility and shareholder value, we do not have a proven method based in predictive logic for quantifying the impacts of risk-reducing CSR activities. This is especially true when considering reputation risk. There are, however, many cases that highlight how a company’s bad CSR practices negatively affect reputation. In the case of BP and the 2010 Deepwater Horizon oil rig explosion and spill, for example, there was a clear direct reduction in cash flow due to the cleanup and the legal expenses associated with the spill. The consumer boycotts and the damage to reputation also acted to indirectly reduce cash flow via lost revenues. In these instances the impact of poor corporate citizenship on shareholder value is both direct and indirect.
The final way that finance educators can help students develop their predictive logic assessment of SEERS activities is by including materials that may not emphasize the shareholder value connection quantitatively but that simply revolve around companies selling environmentally friendly products and services. For example, the topic of venture capital funding is popular with students, and using a green company for financial discussion can indirectly raise SEERS awareness with no loss of financial rigor.
Conclusion
The topic of SEERS should not generate anxiety or fear for finance educators. By using predictive logic and proven analytical tools with which we are already comfortable, SEERS and the existing tenets of finance can coexist with little conflict. The clearest connection between social and environmental initiatives and shareholder value are activities that directly increase cash flow.
There are numerous SEERS initiatives that reduce costs and increase revenues, and for these we can easily estimate their impact on corporate financial performance and shareholder value. By evaluating social and environmental investments in the same way we analyze other investments, we provide a rigorous financial assessment of the costs and the benefits of SEERS activities. Nonetheless we recognize that other aspects of SEERS are more difficult to connect to value creation. This is because their impact on a firm’s cash flow—which ultimately is a key determinant of value—is less clear. For these SEERS activities, companies may need to postpone their adoption until there is more certainty around the financial implication and the impact on shareholder value.
When we discuss social and environmental issues and their economic impact in a free market, we believe that there will always be inherent tensions among these three dimensions. By subjecting the most extreme viewpoints—that is, that all SEERS activities are either universally good or bad—to a modicum of scrutiny and analysis, we can foster a fruitful and enlightening discussion and produce students who better understand how SEERS connects to shareholder value. These discussions, along with those suggested by our accounting colleagues, can raise awareness of a variety of SEERS issues and their financial implications and produce future entrepreneurial leaders who understand both the tensions and the potential synergies of social, environmental, and economic responsibility and sustainability.
References
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