It is not obvious why a business should be sustainable. After all, most business firms are structured to achieve high or maximum profits, and not to be sustainable. Understanding how corporations in some situations may become more sustainable is therefore important both for business and society.
The business case for corporate sustainability
The relationship between sustainability and profitability can be negative, positive, U-shaped, or neutral (Brammer & Millington 2008). For the positive relationship, the theory is that (more) sustainable firms become more profitable because sustainability gives advantages such as more loyal customers willing to pay higher prices, lower costs of financing, less waste (and costs), more motivated employees, better general reputation, or more innovations. The negative relationship is based on belief that sustainable operations are more expensive, and that few customers are willing to pay the extra price.
Meta-analysis says yes, but have problems
Whether sustainability is profitable is a topic for thousands of research studies. Meta-analyses, statistical summaries of multiple scientific studies, have generally found a relatively small but positive relationship (correlation 0.09-0.18) between corporate social responsibility (CSR) or sustainability, and financial performance (Friede et al 2015, Margolis et al 2009, Orlitzky et al 2003).
One of the challenges of these meta-analyses is that they mainly summarize cross-sectional studies. If we observe that sustainable firms are more profitable, we cannot conclude that it is the investments in sustainability that cause the profits. It may be the other way around (more profitable firms invest in sustainability), or it might be other, unobserved factors causing both (high-quality management invest in sustainability and causes profitability).
Another question is how to measure sustainability or CSR. These are complex concepts, with no simple measurement. Many of the studies use rankings of firm sustainability developed by consulting companies, relying on public and company-provided data on different indicators of sustainability. It is not clear whether these are good measures of sustainability (Chatterji et al 2016).
Publication bias also poses a problem. If studies finding a positive relationship are more likely to be published, either because the researcher finds it more worthy to continue working on such projects or because journals are more likely to publish them, the meta-analyses will be biased. This can account for most or all of the positive relationship found in such analysis.
Quasi-experimental research also says yes, but also have problems.
To truly establish causality, we would like experiments where firms are randomized to be either more sustainable or not. If we then observe that the sustainable firms become more profitable, we can be pretty sure. However, it is difficult to commit firms to such experiments, and from what I know it has never been done.
The best alternative then is to rely on quasi-experiments where we compare firms that for random reasons are different on sustainability, but that are similar on all other factors. In one article, the authors compared 90 companies that had adopted sustainability policies in 1993 and 90 companies that had not, but that were extremely similar in all other ways. They found that the sustainable companies outperformed the non-sustainable financially in the years after (Eccles et al 2014). However, it has recently been argued that the method and data used in the article was incorrect, and a correct analysis shows no difference in the financial outcomes of the two types of firms (King 2023).
A clever study compared firms where investments in CSR were just approved in a firm’s annual general meeting (50-55% voted yes) with firms with the investments were just not approved (45-50% voted yes). These groups should be very similar in most ways. The study finds that firms that invest in CSR become more profitable (Flammer 2015). A critique of this study is that the effects are small and that projects getting 55% of votes may be different from projects getting 45% of votes. The potential problem of publication bias also exists in these studies, it is for instance not clear whether Flammer would have (got) published her study if the findings were negative or undecisive.
No simple answers
Those looking for simple answers then will not find them in the research on sustainability and financial results. My take on the question is that not all investments in sustainability are profitable and that there is a large amount of heterogeneity. An oil company reducing oil exploration due to climate change will become less profitable. A consumer goods company making moderate investments in sustainability might gain a little due to improvements in perceived quality of its products and improved corporate reputation among customers and other stakeholders.
Sustainability because it is regulated
The behaviour of firms is heavily influenced by laws and regulations of many different types coming from many different levels in society. Many of these regulations directly or indirectly shape how sustainable a firm is. Pollution permits, fishing quotas, and CO2 emission taxes are obvious examples in the environmental domain. Human rights laws, gender quotas and anti-discrimination laws influence a firm’s social sustainability.
Some recent laws also directly or indirectly try to influence corporate sustainability more generally. The EU has for instance introduced several new regulations:
- The Corporate Sustainability Due Diligence Directive requires very large companies to do due diligence in their own operations and in their supply chain to identify and address human rights problems and the environmental impacts of their activities. The companies are also required to have a plan to limit their carbon emissions in line with the 1,5 degrees maximum increase from the Paris agreement.
- The Corporate Sustainability Reporting Directive requires large companies to report on their social and environmental performance and processes.
- The Green Claims Directive requires sustainability claims from businesses to be substantiated and science-based, and sustainability labels used to be public or publicly approved.
The Transparency Act (Åpenhetsloven)
The Norwegian Transparency Act was introduced in 2022. Companies above a certain size (2 out of 3: Sales more than 70 mnok, balance more than 35 mnok, more than 50 employees) must do due diligence in their supply chains to discover human rights and decent work problems, implement measures to rectify such problems, implement these processes in their operations, and inform about their work on these issues. They have to publish an annual report about their due diligence work, findings, and measures taken. Consumers have the right to get information about the company’s results or efforts (also regarding a specific product) if they contact the company.
Has the law led to any changes? Some businesspeople feel that the intentions were good but that the law mainly has led to more documentation and paperwork, but that it will lead to few actual changes in the field. Some companies say that the law has led to more attention on human rights internally. The effects of the laws are now being evaluated by researchers and by a consultancy, and the law may be adjusted following this evaluation.
While laws and regulations influence firms, firms have considerable leeway on how to deal with laws and regulations. In many cases rules are very general or/and monitoring is lax, meaning that the company has room to decide how much they want to follow the rules. Also, firms shape laws and regulation through lobbying and other types of political actions.
Sustainability because of outside pressures
Different stakeholders can put pressure on the company to become more sustainable
- Customers may require companies to improve their sustainability practices. This is especially the case for large corporate buyers or public procurers, who can hold considerable power over suppliers. Individual customers may have less direct power, but can buy more ethical products (or boycott buying), and may join activist groups and raise their voice on social media
- NGOs and media may put the spotlight on unsustainable behaviours and uncover scandals and poor performance. The company may therefore choose to engage in more sustainable practices.
- Shareholders may invest in sustainable companies and divest from unsustainable ones. They may also try to influence the company through voting at shareholder meetings.
- Employees may choose sustainable companies and avoid unsustainable ones. On the job they may try to influence the company from the inside by raising their voice on sustainability issues or letting sustainability influence decisions
Many of these pressures are also related to financial results (scandals uncovered by the media may for instance reduce the share price, stable & competent employees give profitability over time etc), but not always.
Sustainability to get legitimacy
Companies are not only concerned with making profits, it is also important for them to be seen as good and deserving members of society. All companies need legitimacy, which is “a generalised perception or assumption that the actions of an entity are desirable, proper, or appropriate within some socially constructed system of norms, values, beliefs, and definitions” (Suchman, 1995, p. 574).
To get legitimacy, companies act in ways that do not necessarily increase profits directly, but that makes them look good or acceptable. Since society and groups in society expect companies to act on matters of sustainability, companies then must do this. However, sustainability initiatives can be both substantive (actually have an effect) or symbolic (looks good, but has no clear effect) (Delmas & Montes-Sancho 2010).
Sustainability because it is right
Should not companies be sustainable because this is the morally right thing to do? For many issues in business sustainability, it seems that it normally is a question about prioritizing profits for the company and owners over what is right.
The main ethical normative theories are consequentialism (an act is right if it has the best consequences) and duty/deontological ethics (our acts must follow some duties, like telling the truth). Many unsustainable practices (think about greenwashing, serious pollution, slave labour…) are pretty wrong from both ethical perspectives. In a Rawlsian perspective (imagine you would design social institutions from a “veil of ignorance”, not knowing your position), business contributes to unjust inequality, often taking from the poor and giving to the rich.
While many companies are unsustainable, there are differences across industries and companies, and many companies work towards sustainability, at least partly because they are more concerned with what is right. In small companies in particular the owner’s personal values may influence how they operate. In large companies the values of the CEO may influence decisions and actions. There is also room for individual action, many sustainability managers work as internal champions for sustainability.
Support for “Fritt Ukraina” Fritt Ukraina is a Norwegian organization that supports Ukraina in the war against Russia. The organization raises funds and organizes shipments of equipment to Ukraine. The organization is run by the founder, member of parliament Peter Frølich (conservative party), his brother, and several business people. So far they have raised more than 130 million NOK. Several companies have donated to the organization. Some of the companies that have donated are listed on the webpage, while others have chosen to remain anonymous. Sources: Newspaper article in DN, frittukraina.no
Reflection questions
- How can the Transparency Act potentially make sustainability more profitable?
- Why do you think many business organizations have donated to Fritt Ukraina?
Electric vehicles in Posten/Bring. For a sustainability investment to be profitable it needs to increase revenue or reduce costs or both. Posten/Bring have the goal to reduce Scope 1 and 2 emissions with 85% from 2022. This will mainly be done by replacing fossil fuel vans and trucks with electric ones. At the end of 2023 52% of light vans were fossil free (mainly electric, a few run on biogas), and Posten have ordered more. The heavier trucks are more complicated to replace, since the batteries are heavy, the range of heavy electric trucks is limited. In 2023 Posten had 71 electric trucks. An electric truck is about 2 mnok more expensive than a fossil truck. The realistic driving range with load is around 300 kilometres (less in winter). Charging costs are lower than fuel costs, a truck saves about 50% on energy use. Electric trucks need time for charging but this can often be done during the night. Electric trucks should have lower maintenance costs (fewer moving parts!) but more tire wear. There is some uncertainty around how long the batteries will last.
Question: What are the additional incomes and costs of buying electric trucks for Posten/Bring? Under which conditions will investing in electric trucks be profitable?
References
Brammer, S., & Millington, A. (2008). Does it pay to be different? An analysis of the relationship between corporate social and financial performance. Strategic Management Journal, 29(12), 1325–1343. https://doi.org/10.1002/smj.714.
Chatterji, A. K., Durand, R., Levine, D. I., & Touboul, S. (2016). Do ratings of firms converge? Implications for managers, investors and strategy researchers. Strategic Management Journal, 37(8), 1597–1614. https://doi.org/10.1002/smj.2407.
Eccles, R. G., Ioannou, I., & Serafeim, G. (2014). The Impact of Corporate Sustainability on Organizational Processes and Performance. Management Science, 60(11), 2835–2857. https://doi.org/10.1287/mnsc.2014.1984.
Flammer, C. (2015). Does corporate social responsibility lead to superior financial performance? A regression discontinuity approach. Management Science, 61(11), 2549–2568.
Friede, G., Busch, T., & Bassen, A. (2015). ESG and financial performance: Aggregated evidence from more than 2000 empirical studies. Journal of Sustainable Finance & Investment, 5(4), 210–233. https://doi.org/10.1080/20430795.2015.1118917.
King, A. A. (2023). Comment and Replication: The Impact of Corporate Sustainability on Organizational Processes and Performance (SSRN Scholarly Paper 4648438). https://doi.org/10.2139/ssrn.4648438.
Margolis, J. D., Elfenbein, H. A., & Walsh, J. P. (2009). Does it Pay to Be Good…And Does it Matter? A Meta-Analysis of the Relationship between Corporate Social and Financial Performance (SSRN Scholarly Paper ID 1866371). Social Science Research Network. http://papers.ssrn.com/abstract=1866371,
Orlitzky, M., Schmidt, F. L., & Rynes, S. L. (2003). Corporate Social and Financial Performance: A Meta-Analysis. Organization Studies, 24(3), 403–441. https://doi.org/10.1177/0170840603024003910.
Suchman, M. C. (1995). Managing legitimacy: Strategic and institutional approaches. Academy of Management Review, 20(3), 571–610.