Umair Haque: Why Betterness Is Good Business

Lately, there's been a raging debate in the comments here. One camp's refrain: who is this snot-nosed idealist? Why is he telling us to do betterness instead of business, pursue awesomeness instead of innovation — and maximize good, instead of quarterly profits? What kind of expertise is that? We've got the hardest of noses — so where's the real-world evidence?

Here's the score: Striving to do more good is associated with greater profitability, equity and asset returns, and shareholder value creation. But that's still not good enough. Today, the bar is being raised: success is itself changing. Those are yesterday's metrics of success — more importantly, maximizing good lets companies outperform on tomorrow's measures of success. Increasingly, investors are using ethical/social investment criteria like the KLD score, corporate governance ratings, and other metrics we'll examine below. More and more, investors aren't just looking for near-terms financial returns: they're looking for financial returns *plus.* Why? Because the *plus* makes returns less risky, more defensible, and, the biggie, more meaningful. As the expectations of people, communities, society, and investors change, the definition of outperformance itself is changing.

Every year, the Ethisphere Institute identifies its most ethical companies and then tests their performance. In 2008, ethical leaders outperformed the growth of the S&P 500 by 40%. In 2009, again. In 2010, by 35%. Its drivers? CSR Magazine found a shareholder value performance gap of about 10% between, for example, the most and least transparent companies. No, neither are iron-clad tests. But they begin to hint at a relationship — one that, these days, most CEOs would give their eyeteeth for.

Here's a more powerful result. The mean Market Value Added of the top 100 Corporate Citizens is $36 billion, more than four times the Mean Market Value Added of the remaining companies — which is less than $8 billion, finds Curtis Verschoor of the SRI. In term's of Businessweek's ranking of Total Financial Performance — a composite of eight criteria, like sales growth, profit growth, and return on equity — the top 100 Corporate Citizens outperform by 10.4 percentiles. Both these relationships are statistically significant.

At Berkeley's Haas School of Business, Margarita Tsoutoura came up with even more interesting results: she found that companies who rated highly on the KLD rating score — socially responsible companies — had significantly higher profit margins, returns on equity, and returns on assets. Here's another pioneering study I like — one which, yet again, concludes responsibility fuels advantage, because it's risk management: better insurance against adverse future events. Those were a small studies; here's a huge one. Marc Orlitzky, Frank L. Schmidt, and Sara L. Rynes found that responsibility was significantly positively correlated with financial performance: "corporate virtue," in their words, "is likely to pay off." Their work was a meta-analysis of 52 studies, with over 33,878 total observations. Whew: that's a whole lotta outperformance.

In People and Profits?, a landmark book reviewing decades of research, Joshua Margolis and Jim Walsh found that "when treated as an independent variable, corporate social performance is found to have a positive relationship to financial performance in 42 studies (53%), no relationship in 19 studies (24%, a negative relationship in 4 studies (5%), and a mixed relationship in 15 studies (19%)". They say, pithily: "the findings might be encouraging for advocates of corporate social performance and problematic in the eyes of opponents and critics." In a recent interview, Margolis says: "there have been 80 academic studies in the last 30 years attempting to document the relationship between social enterprise activities and corporate financial performance. The majority of results (53%) point to a positive relationship, and only 5% of studies indicate a negative impact on the bottom line."

No wonder, then, that the alarm clock's going off for investors. At least 538 institutional investors use social criteria when making decisions that used to be purely financial. Social investors manage assets of $2.71 trillion, already more than 10% of the $25 trillion of the economy's total assets under management. And that's not a groundswell. It's an explosion: fifteen years ago, the number was just $640 billion.

The tectonic shift to social investing going mainstream is going to amplify the effects above as it gathers strength. It will ensure that every marginal bit of good creates even more shareholder value — and every marginal bit of bad destroys even more. It's nothing less than the retuning of the global economic engine itself.

Yet, the next thing Margolis says is "we caution against drawing hasty conclusions." Why? Well, "responsibility" can be, as Michael Porter argues, a vague, often meaningless concept — and so discovering "how" it fuels outperformance is complex. The studies above have methodological limitations. Here's a paper, for example, that argues that not investing in alcohol, tobacco, and nuclear power brings socially responsible investment returns down to market averages — hinting at that complexity. Here's a killer paper from Michael Toffel about whether responsibility ratings actually do measure social responsibility in the first place. It's not as simple, then, as fashion: merely signing up to the latest supplier standards, buying into the newest set of audits, and being included in the latest list of ethical companies.

That's why I took a different tack in my forthcoming book: considering not just whether companies are "responsible" in the sterile, often easily gamed terms above, but whether they're maximizing good: creating authentic economic value. My starting point wasn't just "social" outperformance — but, more deeply, antisocial underperformance: the, well, market itself. Business as usual is intellectually, ethically, and morally bankrupt. Surprise: it's also economically bankrupt. The S&P 500 created no value over the noughties Not a penny. If we factored in negative externalities, like, for example, the costs of the banking bailout? Trillions in value would have been destroyed. Over the last decade, business as usual is net negative in terms of creating authentic economic value.

In the starkest of contrasts, what I call Constructive Capitalists — a set of companies who meet a Mount Everest-level bar for good, not just "social responsibility" — have outperformed by hundreds of percent. While business as usual has been busy going economically bankrupt, in the middle of the most turbulent, volatile, and downright nasty decade in recent history, companies who are doing the stuff we discuss on this blog have thrived, disrupted, and prospered.

The future of advantage is never seen with perfect clarity. Yet, its shape is more and more visible. Economics ain't physics. The debate's not 100% resolved and perhaps it never will be. Yes, there is much work to be done untangling relationships, directionality, and causality. Here's the kicker. By the time the evidence is totally, irrefutably, conclusive? Well, by then, the great shift will, by definition, be over. Too late: you'll probably be one of the fatalities being studied by researchers. A Constructive Capitalist with a betterness model, pursuing awesomeness, doing radical good, who had your creaking industrial-era empire squarely in his or her crosshairs, will likely have already have dug your grave.

The evidence already strongly suggests that good is better. It's crucial to understand the nuance in that statement. Not just because it leads to better profits, equity returns, asset returns, and shareholder value, though it does. Today, those are just table stakes, an industrial-era definition of success that's increasingly out of date. Good is better also because companies are being judged against a whole new set of criteria, by customers, governments, communities, and investors. They're already asking, "So you made a profit — yawn — but did you actually have an impact?"

Good, the evidence suggests, is the very opposite of Utopian idealism. The real utopia? That was the one economists, bankers, and titans of industry promised: in a world of perfect markets and infinite leverage, companies who blindly maximized profit would lead everyone, ineluctably, to unstoppable prosperity. It didn't work out that way. Just ask Wall Street, Big Food, Big Media, Detroit, Greece, Spain, Dubai, or anyone from the American homeowner to the Chinese migrant worker. Today's real idealism is this: pretending that business as usual is good enough for companies, countries, the world, or the future. It isn't.

It's time to get real: good is as sharp as a razor, as hard as a hammer blow. That's what decades of research suggest. That's why companies as different as Google, Wal-Mart, Pepsi, Lego, Starbucks, Nestle, Apple, Patagonia, Timberland, GE, Tata, are all, in their own ways, taking steps small and large towards it — and why customers, governments, and investors are joining hands with them on the way. Welcome to 21st century business. It's a movement to do meaningful stuff that matters the most — and if you're not part of it, well, the hard-nosed chance is: you're kissing your future goodbye.

I don't advise you to do this stuff because I'm a communist. It's because I want you to outperform — today and tomorrow. And I know you can. Umair Haque