May 26, 2014
How Ethics Benefits Corporate Profits
By Ron Robins, Founder & Analyst -
Investing for the Soul
This article first featured in Vision magazine,
www.vision.ae
Just as strong ethics are necessary for
beneficial relationships with friends and family, so
they are vital for driving a company’s long-term
financial performance. A company’s strong ethical
culture equates with honesty, respect for employees,
clients and shareholders alike.
I began to understand the value of ethics in company
affairs more than 40 years ago. As a financial analyst
for a Canadian investment management firm, I saw that
companies with an ethical corporate culture appeared to
have above average profits. Over time, this “ethical
culture” became identified and branded as corporate
social responsibility (CSR). However, my belief that
companies with strong ethics have higher profits was not
academically confirmed until 2004.
That research, conducted by the University of Iowa,
found a significant positive association between
corporate social performance (CSP) and corporate
financial performance (CFP). It also discerned a
virtuous circle whereby CSP increased CFP, then CFP
increased CSP, and so forth.
As an analyst, I know that the calibre and tenacity of
management and workforce are probably the most
important determinants for corporate success. And
companies with good reputations are likely more
successful in attracting them, as the findings in a 2013
CR Magazine & Allegis Group Services survey illustrates.
Of 1,010 US adults surveyed, “69 per cent of Americans
would not take a job with a company that had a bad
reputation, even if they were unemployed”.
Another factor I have observed is that robust CSR
policies often grant firms a lower cost of financing,
with investment in good employee relations,
environmental policies and product strategies rewarded
with a reduced cost of equity.
Strong ethics and CSR positively influence supplier
relations, too, and so help maximise profits. It has
been observed that the quality of a firm’s network
partners can decline after the commission of an
unethical act. Equally, litigation costs resulting from
bad ethics can destroy profits. This has been evident
for banks in recent years. My view is that these legal
penalties have been insufficient to date. But there is
hope of further substantial justice forced by markets.
Some would argue that a focus on ethics can actually
impair a company’s profitability. But a study published
by the US National Bureau of Economic Research in 2011,
revealed something really fascinating. It found that out
of 3,000 publicly traded companies, the more a company
is corporately “irresponsible” (might equate with being
unethical) the more it tries to be corporately socially
responsible.
If CSR activities were not beneficial to corporate
finances, then why would irresponsible companies turn to
CSR? And why do most large public companies today engage
in CSR? Because they believe that CSR enhances
reputation and improves corporate performance and
profitability.
Thus, I predict ever-higher ethical and CSR standards
for companies everywhere. Furthermore, companies will
need to issue standardised and independently audited CSR
reports to meet the demands of their stakeholders,
including shareholders and stock analysts who
increasingly value this information. Everyone will be
able to evaluate the effectiveness of a company’s ethics
and CSR activities as they relate to its operations and
profitability.
We see that a strong culture of ethics – required for
successful personal relationships – similarly benefits
corporate profitability in many ways. This includes
attracting and retaining a loyal workforce, optimising a
firm’s reputation, reducing a company’s cost of equity,
enhancing supplier relations, and mitigating litigation
and associated costs. Yes, higher corporate ethics is a
requirement for all companies interested in driving
their financial performance. And it is a caring
capitalism. |
