Springer 2007

Journal of Business Ethics (2007) 75:285–300 DOI 10.1007/s10551-006-9253-8

Sustainable Development and Corporate Performance: A Study Based on the Dow Jones Sustainability Index

ABSTRACT. The goal of this paper is to examine whether business performance is affected by the adoption of practices included under the term Corporate Social Responsibility (CSR). To achieve this goal, we analyse the relation between CSR and certain accounting indicators and examine whether there exist significant differences in performance indicators between European firms that have adopted CSR and others that have not. The effects of compliance with the requirements of CSR were determined on the basis of firms included in the Dow Jones Sustainability Index (DJSI), and specific accounting indicators were applied to measure performance. For the purposes of this study, we selected one group of firms belonging to the DJSI and another comprised of firms quoted on the Dow Jones Global Index

Lo´pez Pe´rez, M. Victoria received PhD in Economics and Business and working as Assistant Professor, University of Granada (Spain). Victoria has recently published in Corporate Ownership & Control, Gestio´n. Revista de economı´a, and Revista Espan˜ola de Financiacio´n y Contabilidad. Victoria’s research interests are Corporate Social Responsibility, Corporate Governance and Innovation. Garcı´a Santana, Arminda is a Lecturer, University of Las Palmas de Gran Canaria (Spain). Arminda has recently published in Corporate Ownership & Control, Gestio´n. Revista de economı´a, and Workshop on International Strategy and Cross Cultural Management (EIASM), Vienna (Austria). Arminda’s research interests are Corporate Social Responsibility, Corporate Governance and Diversification. Rodrı´guez Ariza, La´zaro received PhD in Economics and Business. La´zaro is a Chair Professor and Chairman of the Business School of Andalusia Foundation, Granada (Spain). La´zaro has recently published in Corporate Ownership & Control, Lectures Notes in Artificial Inteligence, Gestio´n. Revista de economı´a and Revista de Contabilidad. La´zaro’s research interests are Corporate Social Responsibility, Entrepreneurship and Innovation.

M. Victoria Lo´pez Arminda Garcia Lazaro Rodriguez

(DJGI) but not on the DJSI. The sample was made up of two groups of 55 firms, studied for the period 1998–2004. Empirical analysis supports the conclusion that differences in performance exist between firms that belong to the DJSI and to the DJGI and that these differences are related to CSR practices. We find that a short-term negative impact on performance is produced. KEY WORDS: competitive advantage, value creating, sustainable development, performance, Dow Jones Sustainability Index

Introduction The search for competitive advantage is a priority for firms that operate in a complex global environment, to ensure the capacity to create value in the longterm. Currently, it is thought that advantages are often linked to the adoption of socially responsible behaviour. Interest in these issues has led to the emergence of sustainability indexes linked to the financial markets. Our research, therefore, is focused on the Dow Jones Sustainability Index (DJSI). In this study, we seek to determine whether there are significant differences in performance between two groups of 55 firms; those in the first group have adopted sustainability practices, ratified by their belonging to the DJSI, while those in the second are not included in the DJSI because they have not fulfilled its requirements. We used a total sample of 110 firms for the period 1998–2004 and analysed the relevant accounting indicators. Empirical analysis reveals differences in performance between the DJSI firms and those firms not included in this index. This paper is organized as follows: First, it presents the study’s objectives. Second, it describes some antecedents and the theoretical framework. Third,

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it describes the empirical procedures used and the research hypotheses and reports the results. Finally, conclusions are given.

Study objectives Organizations constantly seek elements to differentiate them from their competitors, since such elements could become resources that generate long-term sustainable competitive advantages (Collin and Porras, 1994; Gladwin et al., 1995; Makower, 1994; Scott and Rothman, 1994). These advantages would enable organizations to survive as well as to obtain an acceptable profitability rate and economic equilibrium. It is often argued that firms’ adoption of sustainability strategies should grant them competitive advantages over firms that do not adopt them (Adams and Zutshi, 2004, p. 34; King, 2002). Currently, successful businesses are beginning to be defined by their integration of concepts such as management quality, environmental management, brand reputation, customer loyalty, corporate ethics and talent retention. These concepts constitute common CSR practices. It can be said the CSR strategies are related to sustainable development.1 Specifically, the measures derived from adopting ethical codes, better environmental practices or human capital development – measures included in the term CSR – are usually considered a good strategy that should lead to better corporate management and thus performance (Orlitzky et al., 2003, p. 405). The information on sustainability practices that the firm develops and discloses should facilitate the development of better systems of internal control, decision making, and cost saving (Adams, 2002). Thus, efficient management of resources would facilitate the development of capabilities that enable longterm sustainable competitive advantages. The perspective of sustainability provides a framework from which we can study the practices adopted to create value. Value creation refers both to achieving sufficient profit and to satisfying the requests of a diverse group of stakeholders.2 Firms and investors recognise that investing in accordance with sustainability principles has the capacity to create long-term value (Bebbington, 2001; Sage, 1999). These principles constitute a differentiating element in establishing investment

portfolios, as stakeholders believe accredited practices in CSR lead to good economic–financial performance for a specific firm. Currently, expectations in the capital market are apparent as a positive differential in stock market indexes developed with sustainability criteria in mind. Although these ideas have taken root in the U.S., they are still quite new in Europe. Based on the foregoing, we sought to obtain empirical evidence that the adoption of sustainability practices does in fact influence accounting indicators and not only advances this argument from a theoretical perspective. We determine the link between performance indicators and CSR practices, in order to analyse how these practices affect corporate performance. It is most likely that a potential correlation can be shown in the long-term, when the policies have been integrated into corporate management and are capable of creating competitive advantages. Should such a correlation not appear in the shortterm, we could deduce that the effects of sustainability practices do not translate into significant variations in the indicators of performance, at least in the short-term. If this correlation appears, we will observe which sign it takes and whether it endures over time. If there is such a relation, we shall determine whether there are significant differences in the evolution of accounting indicators between firms that adopt sustainability criteria and those that do not, and whether these differences are preserved over time. We test whether the adoption of sustainability practices affects the evolution of such indicators and thus will be able to understand the repercussions they have on corporate performance. Measuring by means of variations in accounting indicators enables us to determine whether the adoption of sustainability practices causes significant differences in the firms analysed. The factors from which sustainability strategies are articulated could subsequently become a source of competitive advantages. It would be difficult to justify an assertion that CSR influences performance if differences were not observed in significant performance indicators. In the short-term, adopting sustainability practices can lead to changes in the criteria applied for the use of existing resources. The time frame considered in this study leads us to contrast this effect – that is,

Sustainable Development and Corporate Performance whether changes are produced – measured by means of their effects on indicators of performance. In the short-term, the firm will only be able to apply existing resources to sustainability practices, since the time frame is insufficient for obtaining additional financing. In long-term planning, the resources needed to carry out CSR strategies can be predicted and financing obtained to achieve them. If the changes endure over time, they may create differentiating elements that become long-term competitive advantages. In the longer-term, performance is affected by differentiation and use of new technologies, for which the firm will need to make investments, and also gradually by changes in the corporate culture (Gladwin et al., 1995, p. 897). Our study focuses on European firms, where the degree of development of sustainability strategies is similar, i.e. it follows the same philosophy. In Europe, sustainable development focuses on proactive policies related to the environment and human resources. However, in the U.S., sustainability policies focus on the control of issues like tobacco, alcohol, gambling, environmental impact, and human rights (Social Investment Forum, 2003, p. 39). In the U.S. there is also a tendency to direct social activity toward investments in the local communities in which the firms develop their activity. We wish to study this issue in European firms, where the tradition of disclosure of information on sustainability practices is much more recent.3 There is at present no empirical support in European countries for determining the effect of decisionmaking in firms using sustainability criteria on corporate performance. This means that there are no studies in the European area that use a multidimensional construct and take into account different sectors of activity. We seek to examine the way in which these practices affect firms in the European area and whether they have an effect similar to that found in the U.S. In general, the studies performed taking sustainability as a multidimensional construct have used data from American firms (McWilliams and Siegel, 2000; Preston and O’Bannon, 1997; Waddock and Graves, 1997). Furthermore, until recently, there was no multidimensional measurement in Europe with widespread support from business. We seek to study the repercussions of a phenomenon for which there were no commonly used indicators until the early

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2000s and also to analyse the impact of a phenomenon for the first years in which these indicators have been used. We have chosen a series of variables to analyse the possible variations in wealth that could occur as a result of the adoption of sustainability practices. We have also chosen some indicators that are frequently used to measure performance, such as profitability and revenue.

Antecedents The conceptual and cultural evolution from classical theory to the incorporation of sustainability criteria as an element of value creation can be studied through the different theories developed, responding to and explaining the reality of sustainable development. From the empirical perspective, there are antecedents for analysing the effects of the social and environmental policies on economic–financial indicators.

From classical economic theory to sustainable development In the last decade, society has begun to demand that firms carry out policies that move toward sustainable development. Sustainability philosophy assumes that we abandon a narrow version of classical economic theory4 and develop corporate strategies that include goals that go beyond just maximizing shareholders’ interests. Attention is directed to the demands of a wider group of stakeholders, since the firm’s success depends on stakeholders’ satisfaction (Buchholz and Rosenthal, 2005; Freeman, 1984; Hardjano and Klein, 2004; Michael and Gross, 2004). Companies are becoming aware that they can contribute to sustainable development by reorienting their operations and processes. This position assumes that the firm obtains economic results that are sufficient to enable the business’s viability, since the company’s first concern must be its survival. Current opinion holds that long-term profits for shareholders are ensured by means of corporate management applying both economic and sustainability criteria (Michael and Gross, 2004, p. 34). The growing complexity of economic activity, the impact of the activity performed and market globalisation have created certain expectations and

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reactions in society, stimulating the development of information and the incorporation of these social factors in management (Adams and Zutshi, 2004; Agle et al., 1999; Frooman, 1999). What at first seemed a passing fashion is becoming a cultural dimension of business. Changes in values and an expanding normative framework are modifying companies’ risk profiles, as they are being asked to become more involved in solving environmental and social problems. According to legitimation theory, it is necessary to achieve society’s approval in order for the company to survive (Campbell et al., 2002; Deegan, 2000; Deegan and Gordon, 1996; Deephouse, 1996; Guthrie and Parker, 1989; Patten, 1992). Legitimacy is a status that comes from the harmony between a corporation’s value system and that of society. The absence of such harmony may cause the firm to disappear (Lindblom, 1994, p. 2). To avoid this threat, organizations tend to accommodate themselves to the cultural requirements of the communities in which they develop their activities (Bansal, 2002, p. 124). It is currently accepted that indefinite, exponential and material growth is not possible but that growth can be achieved by means of technology, training and education and advances in society (Dovers, 1989, p. 33). Sustainable development is obtained through the management of environmental, natural, economic, social, cultural and political factors. These issues are interrelated and therefore should not be considered independently (Sage, 1999, p. 196). They are part of the concept of CSR and have a voluntary character. They can be grouped into economic, social and environmental areas (the ‘‘triple bottom line’’). The management of these factors takes concrete form in strategies of sustainable development. It is thought that these strategies constitute a way of creating value (Blyth, 2005; Hart and Milstein, 2003) and of increasing a company’s worth (Frankel et al., 1995; Lang and Lundholm, 2000; Marquardt and Wiedman, 1998).

Sustainable development and accounting indicators There is no single concept of sustainability; nor is there a commonly accepted way of measuring it.

However, it is necessary to define and measure sustainability if we wish it to become a source of value creation. Although CSR is a multidimensional measure, many authors use only one dimension in their operationalizations (Baucus, 1989; Bromiley and Marcus, 1989; Chen and Metcalf, 1980; Davidson and Worell, 1988; Fogler and Nutt, 1975; Hoffer et al., 1988; Reed et al., 1990). This makes it difficult to compare the results obtained. Studies that use multidimensional measures take into account different issues, each of them related to a set of different dimensions (Griffin and Mahon, 1997; Stanwick and Stanwick, 1998; McWilliams and Siegel, 2000; Wenzel and Thiewes, 1999). Our study uses a multidimensional construct, specifically the DJSI, which is based on economic, environmental and social indicators. This index uses issues that we consider relevant to measuring CSR and that enjoy widespread social backing. As to the effect that adopting these practices has on corporate performance, it is clear that this influence is difficult to measure and quantify in monetary terms (Adams and Zutshi, 2004; Bernhut, 2002; Carroll, 2000; Evans, 2003; Serageldin, 1994). Nevertheless, many attempts have been made to analyse the link between corporate performance and sustainability indicators. The various studies performed report different and even contradictory results. This is explained by the fact that they have different objectives and follow different methodologies (Griffin and Mahon, 1997; Simpson and Kohers, 2002). Some are weak or partial measures of sustainability and are based on over-determined parameters (Carroll, 2000, p. 474). From the perspective of corporate management, it is crucial to clarify the link between a firm’s strategic resources and its future results. Several studies have examined the possible link between indicators of performance and those of sustainability (McWilliams and Siegel, 2000; Preston and O’Bannon, 1997; Stanwick and Stanwick, 1998). We analyze whether the adoption of sustainability practices influences accounting numbers. Sustainability policies must influence the accounting indicators if we are to be able to speak of impact on performance, that is, if adopting sustainability practices involves changes in performance that can be measured by its most significant accounting numbers. This will enable us to know whether these practices are profitable (Gladwin et al., 1995).

Sustainable Development and Corporate Performance Over a longer period of time, it can be determined whether these practices have managed to produce new strategic resources, improve the quality of existing ones, construct others or exploit existing resources for other uses. Thus, we will be able to decide whether they were really a potential source of differentiation (Markides and Williamson, 1994, p. 150). For CSR policies to endure, they should be strategic, be integrated into the policies and key issues of business and be present in every important decision that the firm makes. Only thus will they enable the management and control of inherent risks and achieve lasting positive consequences.

A study based on the Dow Jones Sustainability Index The interest that sustainability practices awaken in investors as a criterion to be considered in the configuration of their investment portfolios has led to the emergence of indexes linked to financial markets. Among these are the Dow Jones Sustainability Group Index, the FTSE4Good and the Domini Social Index. These indexes have been developed by organizations of recognised prestige and have given credibility to the notion of investment in firms that employ corporate sustainability criteria. The idea underlying these indexes is that sustainability practices constitute a potential element for long-term value creation from which shareholders will benefit. These practices help to develop opportunities and manage economic, environmental and social risks. Many investors consider this a crucial value for success (Cheney, 2004, p. 14; Hart and Milstein, 2003, p. 57). The concepts selected to measure CSR in the DJSI are similar to those proposed by the most frequently used CSR guides (GRI, Global Compact) and are used by a large number of European firms to develop and disclose their sustainability reports. The DJSI introduces a number of indicators that allow us to see what the firm is doing, such as the evaluation of intangible assets, development of human capital, organizational issues, strategic plans, corporate governance and investor relations. Firms adjust their sustainability reports to the requirements of the entity that evaluates them. One study performed by SustAinability (2004) shows that in the DJSI the requirements con-

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cerning sustainability aspects are further reaching than in other sustainability indexes. The DJSI permits us to observe data compiled over the last 7 years, while the other indexes used in Europe were created more recently.5 This index is constructed from the universe of firms present in the DJGI.6 The DJSI includes 10% of the firms that belong to the DJGI, conduct their activity in terms of corporate sustainability and are leaders in their respective activity sectors. The companies must fulfil the criteria imposed in three areas: economic, environmental and social. These criteria are defined and weighted. A rating is assigned to each firm to identify the leading firms in sustainability in each sector. The index analyses various issues, which are revised annually to ensure their currency and include the best practices in corporate sustainability. These criteria have an effect on the economic–financial management of the firm that can be seen in its accounting indicators. The criteria for index development are identified for each dimension and sector of activity of the firm. These criteria are determined by a general procedure applicable to all sectors and by specific criteria for each of them.7 A priori, we can say that a differentiating element exists between the firms that belong to sustainability indexes and those that do not: the latter do not fulfil the requirements for information disclosure on sustainability. To belong to sustainability indexes, firms are required to develop and disclose information that reflects the criteria adopted in matters of sustainability; this information usually appears in their sustainability reports. The practices that follow sustainability criteria shape firms’ investment and financing decisions and provide us with a good perspective for observing corporate management. The Sustainable Asset Management Group (SAM Group) audits and ensures compliance. For the firms that disclose this kind of information, transparency takes precedence over other issues. It is assumed that disclosing this information will have generalised positive repercussions. Information disclosure could thus constitute a purposeful action where the goal is to influence the different participants’ conduct and to create better conditions than those of their competitors (Dye, 1985; Verrecchia, 1983), while also being advantageous

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from the perspective of operations, finance and reputation (Blyth, 2005, p. 29). The disclosure of social and environmental information becomes a significant element in management, and one that is increasingly present in corporate strategies. Information disclosure may enable the firm to structure the available information so that it can be useful in decision-making.

adoption or otherwise of sustainable practices is, thus, the difference between the two groups of firms we examined.8 We introduced control variables for size, sector of activity and risk to ensure the homogeneity of the two groups analysed. The study covers the period from 1998 to 2004. The economic data were obtained from the database AMADEUS and the financial statements and other corporate disclosures are available on the Internet.

Methodology Sample selection

Variables and statistical tools used

We compiled accounting information published by sample firms (Gray et al., 1995, p. 83). From the firms belonging to the DJSI, we chose those that develop their activity in Europe, in order to obtain a sample that was homogeneous as to tradition and period of disclosure. The total sample is composed of two groups of firms and includes 110 firms of similar size and capital structure. The first group is composed of 55 European firms that have been included in the DJSI from the time this index was constituted. The second group is composed of 55 European firms that have belonged to the DJGI for the same period but are not and have never been included in the DJSI. The relative weight of each country is the same in both groups. In order to use firms with similar characteristics in size, economies of scale and markets of operation, we chose a sample that is homogeneous as regards firm size and activity sectors. The

In developing our research, we selected a series of variables to measure a firm’s performance,9 focusing on analysing the growth of profit before tax (PBT) and the business evolution, measured by the growth in revenue (REV). We also considered other variables such as assets, capital (cap), profit margin (marg), return on earnings (roe), return on assets (roa) and cost of capital (kmpc), that are commonly used to measure performance (Cochran and Wood, 1984; Korac-Kakabadse et al., 2001; Simpson and Kohers, 2002; Wenzel and Thiewes, 1999; Wokutch and McKinney, 1991).10 In this paper, we have used accounting ratios rather than market ratios.11 Market indicators include the perception that the market can have of a differentiating factor, such as the adoption of CSR practices, but other macroeconomic factors as well, such as speculation, may also have an influence. A firm’s behaviour could be explained using market

TABLE I Variable definitions for regression equations Variable name Dependent variable PBT Independent variables REV CSR Control variables SIZE RISK IND

Variable description

profit/loss before taxes, variation for period t with respect to baseline revenue, variation for period t with respect to baseline dummy variable, 0 if the firm belongs to DJGI and 1 if it belongs to DJSI assets, variation for period t with respect to baseline risk (debt/total assets), variation for period t with respect to baseline activity sector, determined by 4-digit SIC

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TABLE II Variable definitions for non-parametric test Variable name assets cap rev pbt marg roe roa kpmc13

Variable description assets, variation for period t with respect to baseline capital, variation for period t with respect to baseline revenue, variation for period t with respect to baseline profit before tax, variation for period t with respect to baseline profit margin (pbt/rev), variation for period t with respect to baseline return on earnings, variation for period t with respect to baseline return on assets, variation for period t with respect to baseline cost of capital, variation for period t with respect to baseline

indicators, but accounting data is considered less noisy, since it indicates what is actually happening in the firm. Furthermore, it would be difficult to justify the conclusion that CSR practices influence corporate performance if there were no differences in the most significant performance indicators. To achieve the study’s goals, we use two different statistical tools. First, we examine the possible link between CSR practices and corporate performance, measured by performance indicators, using regression analysis. Second, we consider whether there are differences in the evolution of these performance indicators between firms that adopt sustainability criteria and those that do not and apply a nonparametric test to determine whether these differences endure over time.12 Tables I and II show the variables used in these analyses. Analysis of the relation between performance and CSR We analyse whether there is a direct link between performance and CSR practice. The growth of profit before tax (PBT) is used as a measure of corporate performance. The model proposed includes PBT as a dependent variable (Ho, 2005) and revenue (REV) and CSR as independent variables. Size, risk and industry are also included as control variables to keep these firm-related factors constant. Thus, total assets are recorded as a measure of size (SIZE), debt to assets as one of risk (RISK), and sectors of activity of the firm as a measure of the industry (IND). The specific regression model tested was:

PBT ¼ b1 þ b2 REV þ b3 CSR þ b4 SIZE þ b5 RISK þ b6 IND þ e The results are expected to show a significant link for REV, since PBT depends on this variable. In addition, we seek to analyse whether the other variables have an explanatory value in the model. Specifically, we shall examine whether CSR influences corporate performance. The results in the literature are diverse, differing according to the theories underlying them (Simpson and Kohers, 2002). In our study, the expected coefficient for CSR is negative, since insufficient time has passed for these measures to influence consumers’ attitudes, and we assume that short-term cost savings are not made. As to size, we have taken total assets (SIZE) as the control variable, although we do not expect this to influence the model, since the firms constituting our sample groups are of similar size. The industry variable might exercise some influence (Schmalensee, 1985). However, even though the ‘‘sector’’ factor contributes to explaining a significant part of the variability of the results, these are more strongly affected by the specific characteristics of the firms (Rumelt, 1991). It will thus be necessary to analyse the results obtained for each sample. Results obtained In the time period in question, the adoption of sustainability criteria can bring about changes in governance and in production and management systems, which may cause a redistribution of available resources (Hart and Milstein, 1999, p. 25) and

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M. Victoria Lo´pez et al. TABLE III Regression coefficients and statistics

Independent and control variables REV CSR SIZE RISK IND Adjusted R Square F-Statistic Probability

Dependent variable PBT (99–01)

Dependent variable PBT (02–04)

0.578 (0.000)** )0.042 (0.603) )0.070 (0.378) )0.093 (0.237) )0.072 (0.369) 0.328 54.267 0.000

0.575 (0.010)** )0.171 (0.030)** )0.135 (0.088)* )0.064 (0.407) )0.045 (0.564) 0.358 21.286 0.000

** P £ 0.05 * P £ 0.10

could affect performance. In the next section, we obtain the accounting variables for the differences arising from the application of sustainability practices. Some of these differences are related to profitability. Let us now analyse the link between CSR and performance, introducing control variables for size, risk and industry. We studied two time intervals of 3 years: 1999– 2001 (in which no differences were found in the non-parametric test – see below); and 2002–2004 (when there were differences between the two groups of firms). We establish the relation between performance and CSR for PBT, the variable in which the differences were most consistent in time. Table III shows the results obtained for each time interval. For the period 1999–2001, in which no differentiation exists between firms that disclose information on sustainability practices and those that do not, there is no relation between PBT and CSR. For this period, the relation between CSR and performance is negative, though the value is not significant. As expected, there is a positive and statistically significant relation between REV and PBT. The relations between the other variables considered and PBT are not significant. For 2002–2004, the period in which there were significant differences between the two groups in the sample, we found a direct relation between CSR and performance. Specifically, for the DJSI sample, there is a negative relation between CSR and performance. The introduction of the philosophy of sustainability involves a cost or reallocation of resources that

negatively affects the firm’s performance. Firms that engage in socially responsible activities provide more informative and extensive disclosures than do those, which are less focused on advancing social goals (Gelb and Strawser, 2001, p. 11). This involves costs such as training, product quality and safety (Waddock and Graves, 1997). In the time frame considered, the expenses can be greater than the incremental revenue that these measures generate (Simpson and Kohers, 2002. p. 102). Another factor is that assigning resources to investments that take into account sustainability criteria depends on the availability of surplus funds (McGuire et al., 1988; Orlitzky et al., 2003, p. 406), or on the allocation of resources that were destined a priori to another purpose. This may affect PBT, since the availability of funds is limited. Only in the long-term can the firm plan to obtain new funds to finance practices that require larger investments. For this period, and for the DJSI sample, the control variables are not statistically significant; we were unable to establish any relation between these variables and PBT, a finding that is consistent with other studies (Gomez and Rodriguez, 2004; Rodriguez and Gomez, 2002).

Differences in performance indicators when sustainability criteria are adopted To obtain empirical evidence as to whether there are significant differences in profitability between firms that apply and disclose CSR practices and those that do not, we investigated all the firms and activity

Sustainable Development and Corporate Performance sectors as to whether significant differences occur in the evolution of the accounting numbers. The following hypotheses were proposed:

H1:

There are no significant differences related to revenue trends between DJSI and DJGI firms.

Changes in management practices should be reflected in the profit and loss statement, produced by increased business volume and changes in resource allocation. The former can be measured by changes in revenues. If the goods or services offered by the firm possess elements that differentiate them from those of competitors, this will produce differences in sales and turnover. Firms that develop sustainability practices usually introduce differentiating elements into their products, processes and organization as a result of the change in values. However, the transmission of these values to society occurs slowly. Traditional consumers need time to change their consumption patterns and to introduce ethical criteria into their decisions (Alexander, 2002; Ingram et al., 2005; Vitell and Muncy, 1992). Thus, sales may not be affected in the short-term, despite the changes introduced by the firm. The effects of these changes might become evident only over a period longer than that considered here (Ogrizek, 2002). However, when the firm receives a negative impact from its actions, the influence on sales is usually faster. Most studies have focused on this negative impact, on the scandals created by firms’ actions (Zyglidopoulos, 2002), and specifically on how they deal with the impact of damage to their reputation and trading results, and how companies minimise risks and combat consumer boycotts (Adams, 2002). Some studies claim that sustainability practices favour stakeholders’ legitimation, offering a positive image of the firm and improves its reputation (Adams, 2002; Hedstrom et al., 1998; Fombrun and Shanley, 1990; Orlitzky et al., 2003; Weigelt and Camerer, 1988). This may create a differentiating effect between firms that follow sustainability practices and those that do not. H2:

There are no significant differences between DJSI and DJGI firms concerning profitability trends

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The adoption of sustainability criteria by DJSI firms is thought to produce improved performance. This increased profitability could be observed as better exploitation of available resources, which may be reflected as greater profit growth than that enjoyed by firms that do not belong to the DJSI. If this occurs, it would be due to cost savings, since we believe the time frame is insufficient to produce competitive advantages that affect sales. This could mean that firms are able to create more value from fewer resources (Hedstrom et al., 1998; Majumdar and Marcus, 2001). However, the differences between the two groups of firms in the sample may be negative. Sustainability practices can mean additional expenses are incurred in research, training and risk prevention. Engaging in sustainability-related activities may require time, effort and investment and cause a short-term decrease in profitability. Subsequent variations in performance ratios would be significant in DJSI firms, reflecting a difference in the degree of exploitation of available resources and a strengthening of their competitive position (Kettinger et al., 1994; Preston and O’Bannon, 1997; Waddock and Graves, 1997; Wenzel and Thiewes, 1999). Many studies have discussed the relation between sustainability and profitability (e.g. Griffin and Mahon, 1997). Analysis of the significant differences observed between the two groups of firms The following temporal sequence was used to study the above hypotheses. Firstly, we checked that no significant differences related to performance indicators existed between the two groups of firms before sustainability standards were applied (1998–1999). Secondly, we tried to determine the moment in time when the differences began. In this phase of the study, we confirmed that the two groups of firms analysed were similar, in terms of the above-described performance indicators, at the time CSR practices began to be applied in one of the groups. Panel A in Table IV shows that there were no statistically significant differences (at P £ 0.05) between DJGI and DJSI during the period 1998–1999 for any of the accounting variables used in this study. By accepting the null hypothesis, it follows that we began with two similar sets of firms, which presented comparable accounting characteristics

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TABLE IV Panel A: Variations produced in the period considered (probability and statistics) Variables var_asset Mann–Whitney Z Probability var_cap Mann–Whitney Z Probability var_rev Mann–Whitney Z Probability var_pbt Mann–Whitney Z Probability var_marg Mann–Whitney Z Probability var_roa Mann–Whitney Z Probability var_roe Mann–Whitney Z Probability var_kmpc Mann–Whitney Z Probability

1998–1999

1998–2000

1998–2001

1998–2002

1998–2003

U

1281.00 )1.384 (0.166)

275.00 )1.153 (0.249)

1445.00 )0.404 (0.687)

1445.00 )0.404 (0.687)

1302.00 )1.25 (0.208)

1263.00 )1.492 0.136)

U

1397.50 )0.692 (0.489)

300.00 )0.700 (0.484)

1351.50 )0.963 (0.336)

1241.00 )1.623 (0.105)

1497.00 )0.093 (0.926)

1453.00 )0.356 (0.722)

U

1392.00 )0.720 (0.471)

328.00 )0.183 (0.855)

1250.00 )1.569 (0.117)

1347.00 )0.989 (0.322)

1386.00 )0.756 (0.450)

1372.00 )0.840 (0.401)

U

1497.00 )0.093 (0.926)

317.00 )0.384 (0.701)

1192.00 )1.916 (0.055)*

1170.00 )2.048 (0.041) **

1122.00 )2.334 (0.020)**

1127.00 )2.305 (0.021)**

U

1460.00 )0.314 (0.754)

320.00 )0.329 (0.742)

1242.00 )1.617 (0.106)

1192.00 )1.916 (0.027)**

1198.00 )1.880 (0.060)*

1199.00 )1.874 (0.061)*

U

1414.00 )0.589 (0.556)

322.00 )0.293 (0.770)

1263.00 )1.492 (0.136)

1242.00 -1.617 (0.013)**

1132.00 )2.275 (0.023)**

1212.00 )1.796 (0.072)*

U

1357.00 )0.930 (0.353)

313.00 )0.458 (0.647)

1213.00 -1.790 (0.073)*

1156.00 )2.131 (0.033)**

1158.00 )2.119 (0.034)**

1191.00 )1.922 (0.055)*

U

1475.00 )0.224 (0.823)

1108.00 )2.418 (0.016)**

1481.00 )0.188 (0.851)

1503.00 )0.057 (0.955)

1213.00 )1.790 (0.073)*

1281.00 )1.384 (0.166)

Panel B: Summary of the results obtained in non-parametric testing Periods analysed 1998–1999 1998–2000 1998–2001 1998–2002 1998–2003 1998–2004

Significant differences (at P £ 0.05) pbt; marg; roa; roe pbt; roa; roe pbt

Associate variable: sustain_dp ** P £ 0.05 * P £ 0.10

No significant differences All variables analysed All variables analysed All variables analysed asset; cap; rev; kmpc asset; cap; rev; marg; kmpc asset; cap; rev; marg; roa; roe; kmpc

1998–2004

Sustainable Development and Corporate Performance with respect to the variables considered. This leads us to inquire whether the application of sustainability practices by the DJSI firms leads to long-term differentiation, which could provide them with competitive advantages vis a` vis the DJGI firms. We repeated the analysis for the periods 1998– 2000, 1998–2001, 1998–2002, 1998–2003 and 1998–2004. A summary of the results obtained is given in Panel B of Table IV. We performed the analysis both for the group as a whole and after grouping the firms by sectors, and we arrived at the same conclusions. The firms formed part of the same universe until 2002 (at P £ 0.05), which is when differences began to appear. These differences, measured by means of performance indicators, continue for the periods 1998–2003 and 1998–2004. The principal differences occur in the profit and in the profitability indicators. As there are no differences in revenues, the differences must be produced by the costs; thus, resources are being exploited in different ways. It is apparent that the 110 firms analysed were similar, in terms of the performance indicators examined, until the year 2002, when we begin to see significant differences between the variables related to profitability, margins, return on assets and return on equity. After 2001, the policy of creating long-term value through the development of sustainable strategies began to have positive effects in Europe. During the 7 years covered by the present study, the only significant changes observed were in profitability and in profit indicators such as margins and return on assets and equity. Since there are no significant differences in the variation of revenues, we conclude that the differences in performance are due to changes in costs. Over a longer period of time, other, more structural factors (such as volume of assets and capital) could influence value creation, as might other factors that require more time to develop, such as the creation of a characteristic firm culture or the development of new organizational processes. Furthermore, there might be other changes, such as the development of new products, the differentiation of current ones, the development of technology and the diversification of activities. Sustainability strategies take specific forms in these factors, such that each choice could produce an effect on other economic–financial indicators.

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By 2004, the differences corresponding to the magnitudes related to income and profitability had become less significant. This could be attributed to the fact that the standards applied by DJSI firms have now been incorporated by those in the DJGI, which reduces the advantages obtained by the former (Adams and Zutshi, 2004; Bansal, 2002, p. 126; Bond, 2005; Burgess, 2003; Ogrizek, 2002), although regression analysis shows that the effect of CSR practices was negative in the short-term. It seems that the differentiation is not consistent and does not increase over time. The reduced differences could also derive from the fact that when these practices were first applied, the effect on performance was negative. The firms in question would have acted to reverse these negative effects. Even if the effects of these differences were positive, they could have been weakened, due to the fact that CSR strategies are easily imitable or perhaps because the customer focus is transient.14 Greater normative pressure drives companies to adopt these practices, which could cause a reduction in the differences between the two groups analysed. Although the firms were differentiated initially, this differentiation did not persist in the last period analysed, probably because the competitors imitated the competitive advantage. This study shows that the differences mentioned only occur during a specific period in time and later become less significant. We found no differences between the DJSI and the DJGI firms as to variations in total assets, capital or revenues. Decisions concerning investment and financing are not linked to the sustainability practices required by the DJSI, at least for the period considered. We also calculated the cost of capital in order to determine whether greater transparency translates into a reduction in the cost of capital. Previous studies have shown that disclosure can have effects on the cost of capital (Fishman and Hagerty, 1989; Dye, 1985; Gelb and Strawser, 2001; Sengupta, 1998; Simpson and Kohers, 2002, p. 103; Verrecchia, 1983). However, we only found differences in the cost of capital between the two groups of firms studied in one year (at P £ 0.05). There was no apparent regularity in this result and we believe the difference to have been coincidental. In our opinion, although investment policies may differ in their objectives and strategies, their effects are not significantly different in relation to total

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capital and assets in the period considered. A longer time period would mean the creation of a new firm culture and the development of technologies that might lead the firm to search for new resources.

Conclusions Both firms and investors believe that strategies that take sustainability criteria into account have the capacity to create long-term value. Such actions have awakened investors’ interest and have led to the appearance of sustainability-related indexes linked to financial markets. These indexes enable us to analyse whether there exist significant differences in performance between DJSI and DJGI firms. We selected a group of DJSI and DJGI firms whose performance-indicator results were similar prior to the creation of the DJSI index. Three years after one group of firms had applied the sustainability strategies required by the DJSI, we confirm that differences exist in various profitability measures obtained by DJSI firms with respect to DJGI ones. The elements immediately affected by the adoption of these strategies are related to operating activity and are included in the magnitudes that compose or are derived from the firm’s profit. The income results reflect the different degrees of exploitation of resources by the two groups of firms. Decisions on investments and financing are not linked to the sustainability policies reflected in the DJSI, at least for the time period and sample considered. Nor did we find significant differences between the two groups with respect to the cost of capital. We analyzed the link between the performance indicators and CSR, and found that the link between these variables is negative, which leads us to affirm that the effect of sustainability practices on performance indicators is negative during the first years in which they are applied. In the context of the time frame considered in this study, we confirm that differentiation in the exploitation of resources exists and that it is negative. At first, the firms did not make budget provisions for new assets for sustainability practices. A longer-term view is necessary for new policies, i.e. sustainability criteria, to be reflected in the budgets. Firms must use their current resources, which may involve a different allocation

of resources or increased expenses such as those for training, safety, pollution prevention, non-polluting technologies and recycling. The management may need to look past these short-term effects in order to lead the corporation forward. In this paper, we see that the above-mentioned differences only occur during a specific period and are not robust over time. In the time frame considered, we did not find grounds for claiming that the adoption of sustainability practices will have positive repercussions on performance indicators. The expenses that firms incur as a result of their socially responsible actions can place them at an economic disadvantage with respect to other, less responsible firms, at least in the short-term. However, it seems that the negative impact on performance, as measured by the variation in performance indicators, is self-correcting, since the differences diminish over time, as shown in the results of the non-parametric test. It will be necessary to examine a longer time frame to see whether these practices acquire continuity and begin to influence corporate performance positively. The above-mentioned negative short-term effects may inhibit others from adopting CSR practices. We believe the government could play a very important role in promoting sustainability practices, by legislation or by financial incentives. Finally, we must take into account social demands on firms with respect to their actions and practices in matters of sustainability. The cultural changes that are taking place in this respect do not seem to be going away. In society, changes in values are increasing the normative demands related to CSR. This means another way must be sought of understanding the goals of business and that the objectives they pursue must be reformulated. Only if CSR practices are integrated into the strategic decisions taken in business will positive consequences be achieved. This kind of change in corporate philosophy will have fundamentally qualitative repercussions, for example in reducing environmental impact, increasing employee satisfaction, retaining talent, enhancing the company’s reputation and playing a full, positive role in the local community. Such social and corporate changes, however, will not always have a quantitative effect on economic– financial indicators.

Sustainable Development and Corporate Performance The present paper only provides a start, and further research into the issue is required. Showing that CSR is associated with performance should subsequently lead us to search for a way to measure its effect on corporate performance and on stakeholders’ satisfaction.

Notes 1

Sustainability development can be defined as ‘development that meets the needs of the present without compromising the ability of future generations to meet their own needs’ (WCED, 1987, p. 8). 2 Under value creation, we consider issues such as pollution control, transparency, business responsibility, the incorporation of new technologies, and employee and customer satisfaction (Hart and Milstein, 2003, p. 59). 3 The financial tradition in the U.S. is different from Europe. Generally, the European tradition can be defined as a bank-based financial system and that of the U.S. as a market-based financial system. Furthermore, the legal systems are defined as civil law and common law, respectively (Nobes, 1994, p. 3). European firms do not usually adopt a practice until they are legally required to do so, and the influence of the Stock Exchange is not strong. American firms, in contrast, are encouraged to adopt sustainable standards as a demand of the market-based financial system. The American indexes were created in the early 90s and began to influence management then. In contrast, the European indexes began in the late 90s. Most European firms begin to disclose sustainability information in the early 2000s. On the other hand, the DJSI follows different selection criteria for American and European firms. It distinguishes between American firms, European firms and those in emergent countries. 4 This theory indicates that companies should only respond to shareholders’ interests, their only social responsibility being the maximization of company value. From this perspective, any positive social act undertaken by the firm is associated with costs that would reduce profit and prejudice shareholders. It would not, therefore, be opportune (Friedman, 1970). 5 Although the firms making up DJSI Stoxx are European, this index began to be developed in 2001 and thus would not be useful for the purposes of this study. The FTSE4GOOD database was established in 2002. The Domini Social Index was created in 1990 and is a benchmark for sustainability investment in American firms. We used the DJSI, which is an index

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composed of firms in the global arena, since its starting date is earlier than that of the other indexes developed in the European area (1999). We chose the European firms where we wished to focus our study from the total number of firms belonging to the DJSI. 6 DJGI covers 95% of free-float market cap at the country level and includes large-cap, mid-cap and small-cap sub-indexes for American firms. For developed European and emerging markets, the selection methodology creates indexes that represent 95% of freefloat market cap at the aggregate level. The DJSI is made up of firms that are leaders in sustainability practices and are the top 10% of the firms in the DJGI. Firms in the DJSI are required to fulfil sustainability requirements. The firms that belong to the DJSI are audited by the Sustainable Asset Management Group, which monitors DJSI firms to ensure they observe economic, environmental and social criteria (the ‘‘triple bottom line’’). 7 The criteria considered in each of the dimensions can be consulted in the guidelines corresponding to the indexes considered at www.sustainability-indexes. com. 8 Although the possible differences cannot be associated exclusively with sustainability practices, if there were no differences between the two samples, we could affirm that the adoption of these practices would not have a differentiating effect, at least on the variables analysed during the period studied. 9 We use variations in the indicators because we wish to contrast whether the adoption of sustainability practices affects performance. Furthermore, by studying the variations in the indicators considered, we can show the possible significantly different changes in strategy that might occur, i.e. the possible changes in strategy that might be apparent through the existence of significant variations in performance indicators. The sample is made up of firms that follow different accounting rules, since the application of the Fourth Directive related to Annual Accounts of Companies with Limited Liabilities has led to very different accounting criteria in different European countries. This prevents us from comparing the data in absolute terms. By studying the variations in the indicators we can identify the relative changes in the variables and compare them, thus avoiding problems that could arise if we took the variables in absolute terms. 10 Griffin and Mahon (1997) provide a review of financial indicators used in previous studies. 11 By this, we refer to ratios often used by analysts, such as market to book, payout and price to earnings ratio (PER).

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12

Since we cannot assume that the distribution of economic–financial data will fit a normal distribution, we use a non-parametric procedure, specifically the Mann–Whitney U-test for two independent samples, as an analytical tool. This can be used when we have two independent samples and enables us to determine whether the distributions have the same form and dispersion, that is, whether they belong to the same universe. 13 kmpc = rd*D/V + rsse*E/V, where rd is the Financial expenses/Liabilities; D, the Liabilities; V, the Total Assets; re, the return on shareholders’s funds; E, Shareholdrres’ funds. 14 States of opinion are generated (Bendell and Kearins, 2004, p. C3) that drive other firms to adopt this type of strategy, whether by imitation or from the firm’s own demands on other parts of the chain of suppliers and customers (Adams and Zutshi, 2004; Bond, 2005; Burgess, 2003; Ogrizek, 2002).

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M. Victoria Lo´pez, Arminda Garcia and Lazaro Rodriguez Department of Financial Economy and Accounting, University of Granada, Campus de la Cartuja s/n., Granada, 18071, Spain E-mail: [email protected]