Investing in CER when it is profitable

September 1, 2011 | 2 min read

Much is said about investment in corporate environmental responsibility (CER) and its effect on corporate profits. Advocates of CER argue that corporate executives shortchange shareholders by investing too little in CER, underestimating the benefits of being environmentally responsible or overestimating its costs. They argue that corporate executives would increase their companies’ profits by increasing CER. Critics of CER argue that corporate executives shortchange shareholders by investing too much in CER, overestimating its benefits and underestimating its costs. Or perhaps corporate executives invest too much in CER so they might enjoy the accolades of their communities at the expense of shareholders.

A study by Meir Statman and Yongtae Kim proves both advocates and critics wrong. Statman is the Glenn Klimek professor of Finance at Santa Clara University and Visiting Professor at Tilburg University. Kim is an Associate Professor of Accounting at Santa Clara University. Their paper, “Do Corporations Invest Enough in Environmental Responsibility?”, has recently been published in the Journal of Business Ethics. They found that corporate executives act as reliable agents of profit maximizing shareholders. Executives adjust CER levels up or down to maximize corporate profits and stock returns.

Statman and Kim measured changes in levels of CER by changes in CER ratings by KLD Research and Analytics. They measured changes in profitability by changes in returns on assets, and they measured stock returns by changes in Tobin’s Q, the ratio of the market value of a company to the replacement value of its assets.

CER as a tool

Statman and Kim found that, on average, companies that increased their levels of CER from one year to the next or over several years, improved their profitability and increased their stocks returns in the years that follow. Yet they also found that, on average, companies that decreased their levels of CER from one year to the next or over several years, improved their profitability and increased their stocks returns in the years that follow. This indicates that companies consider CER as investments, and are guided by the likelihood that these investments would be profitable.

Sometimes, executives turn out to be wrong, investing too little in CER. This is what BP did when it invested too little in equipment and training that would have prevented the recent disastrous and expensive spill of oil in the Gulf of Mexico. Yet we know of such instances, where companies invested too little in CER, mostly in hindsight, after a disaster accompanied by newspaper headlines and incriminating photographs. We do not know as easily instances where companies invested too much in CER, such that they could have prevented accidents even if they were not to invest as much as they did in preventive equipment and training.

All of us, including advocates of CER and critics, should take comfort in the findings of Statman and Kim. We, as a society, waste precious resources when we invest too little in CER. But we also waste precious resources when we invest too much in CER.

This study received an Honorable Mention in the 2011 Moskowitz Prize competition (awarded by the Center for Responsible Business at the Haas School of Business, in cooperation with the Social Investment Forum, the Moskowitz Prize promotes the concept, practice, and growth of socially responsible investing).

References

This article may be reproduced according to our terms of use with attribution (and link, if online) to www.tias.edu. To be cited as: “Investing in CER when it is profitable’ homeowners”, Yongtae Kim and Meir Statman, www.tias.edu, September 1, 2011.

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