How Ethics Benefits Corporate Profits

How Ethics Benefits Corporate Profits

By Ron Robins, Founder & Analyst – Investing for the Soul

This article first featured in Vision magazine,

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.

May 23, 2014

© Ron Robins 2014

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