Working with Harvard professor George Serafeim, we examine how companies are better managing their impacts on society and the environment.Download
- Companies are investing heavily in efforts to manage their impacts on society and the environment, which translates to real benefits for businesses and investors.
- The public has formed social expectations that have guided the corporate sectors’ increased involvement in contributing to social and environmental solutions.
- Economic motives are among the key drivers of companies’ social sensitivity.
- Corporations are assuming broader responsibilities that increasingly affect their valuation in the stock market and their value to society.
In this report, the first of the Calvert-Serafeim Series, we explore the evolving role of the corporation in society, recognizing the large capital concentration represented by companies and their increasing engagement in environmental and social activities. Companies are investing heavily in efforts to manage their impacts on society and the environment. This report examines how these investments can translate to real benefits, both for businesses and investors.
The 500 largest companies in the world comprise approximately 50% of the world’s stock market capitalization. This is an astonishing statistic considering that there are close to 50,000 unique publicly listed and actively traded companies around the world. Given this concentration in financial value, most institutional investors own a piece of the equity of these companies. Our estimates suggest that institutional investors (defined as institutional asset managers and asset owners) hold on average 84% of the outstanding shares of these firms, with the rest being held by retail investors, management, and other corporations. Figure E1 shows holdings by investor type. As a result, institutional investors’ equity shares in these 500 firms are worth approximately $24 trillion.
Figure E1: Equity Holdings in the World’s Largest Firms, by Investor Type
Note: The figure presents the average percentage of outstanding shares held by different types of institutional investors at the end of 2014. We evaluated share ownership data from Bloomberg and considered 441 of the 500 corporations that showed the largest market capitalization as of December 31, 2014, and for which we were able to obtain data. Bloomberg's "Investment Advisors" category includes, but is not limited to ownership of shared by mutual funds, separate accounts, SMAs, CITs, and VITs.
At the same time, these corporations are increasingly engaged in environmental and social issues ranging from climate change, biodiversity, civil rights, and conflict minerals, to labor conditions, diversity, corruption, and affordable access to products. They are vocal about social and environmental issues, they commit more and more resources to address these concerns, and they are increasingly transparent about their impact on society and the environment. This engagement influences a corporation's identity, which, in turn, is reflected in the identity of what we receive when we purchase shares of the company.
Why are companies investing resources to address environmental and social issues?
Our analysis documents both moral and economic reasons for these investments. Global societies are facing increasing pressures due to environmental degradation and social inequality, among other factors. In many cases, corporations are seen as having contributed to the exacerbation of these problems. Indicators of corporations’ vast global footprint illustrate their growing social and environmental impacts:
- As of 2012, more than 3.6 million corporations were registered globally. 
- In the United States, 5.7 million businesses employ 115.9 million people with an annual payroll of $5.4 trillion.
- In 2013, the combined activities of agricultural and industrial companies accounted for approximately 88% of worldwide fresh water withdrawals.
As a result of these impacts, the public has formed social expectations that have guided the corporate sectors’ increased involvement in contributing to social and environmental solutions. Notwithstanding the moral argument, the economic argument suggests that environmental and social-related investments could protect or enhance shareholder value. To the extent that this is the case, corporate managers are creating value for all stakeholders. In contrast, where trade-offs between “doing good” and “doing well” exist, managers face tough choices over how to optimize long-term financial value subject to constraints.
Recommendation: Corporate investments in environmental and social issues are likely to be part of the license to operate moving forward. As a result, both companies and investors need to develop their ability to assess the impact of those investments.
Can companies address such issues? Why are company activities important to our ability to achieve better social and environmental outcomes?
Over time, companies have accumulated increased power relative to other stakeholders. This power has given corporations a license not only to operate, but also to grow and reach a wide diversity of stakeholders across geographies. The largest 500 corporations in the world directly employed more than 43 million people, indirectly controlled hundreds of millions of workers in their supply chain, paid more than $700 billion in taxes, sold products and services worth over $22 trillion, controlled assets valued at more than $100 trillion, and in 2014 spent more than $1.6 trillion and $400 billion in capital and research and development expenditures, respectively. The higher financial, human, and technological capabilities of companies compared with the limitations of governments due to indebtedness, inability to attract human capital, and the lack of jurisdiction in a global marketplace uniquely position corporations to respond to environmental and social challenges.
The emergence of the large corporation in society and the accumulation of profits and power have resulted from two centuries’ worth of important legal, regulatory, and macroeconomic trends. Google and Walmart provide two examples of leading companies that significantly influence a wide range of stakeholders:
- Google’s Gmail product serves approximately 900 million people, more than the population of Europe. The Google search engine’s 5-minute service lapse in August 2013 caused global internet traffic to drop by 40%.
- Walmart hosts more than 250 million customers in its stores each week and approximately 80% of all U.S. consumers at some point during a typical year.  The company uses approximately 0.5% of all electricity produced in the United States, ranking it ahead of 12 states in electricity consumption.
Companies address social and environmental concerns through several types of activities:
- Firm-specific Initiatives – Unilever’s Sustainable Living Plan aims to double the size of company’s business, while simultaneously reducing its environmental footprint and improving its social impact.
- Industry Self-Regulation – Gap, H&M, and other apparel brands have implemented codes of conduct that attempt to self-regulate business activities and influence working conditions in overseas factories.
- Working with Governments and NGOs – The Extractive Industries Transparency Initiative (EITI) unites national governments, natural resource extractives companies, and civil society organizations to enhance transparency and accountability in the extractive industries.
- Emerging Markets Engagement – Grupo Bimbo responded to the Mexican government’s health-focused regulations by improving the nutritional profile of its snack food products.
The ability to act also adds another element in answering the first question of why corporations engage with environmental and social issues.
Recommendation: Corporate managers should understand their power relative to different stakeholders and recognize the responsibilities emerging from this power.
How do companies address these issues in relation to their financial performance? Do such investments add or create value, detract value, or have a neutral impact?Economic motives are among the key drivers of companies’ social sensitivity. Investors can evaluate companies’ investments in this space by understanding their implications on firm value. These investments can impact firm financial value through numerous mechanisms (Figure E2). The mechanisms range from operational efficiency and protection of brand value, to revenue growth enabled by new products and customer loyalty, to lower cost of capital through enhanced disclosure. Investors can use this framework to understand the value relevance of different investments.
Figure E2: Financial Relevance of Sustainable Business Practices
We present novel analyses using recent data both from equity and fixed income standpoints. Overall, we find that sustainability leaders enjoy a valuation premium in both equity and fixed income markets.
- Environmental, social, and governance (ESG) performance correlates with better management or business model quality. Valuations of firms with better ESG performance reflect higher expected growth and lower cost of capital.
Figure E3: Market Value Over Book Value of Equity: Firms with Low, Medium, and High ESG Performance
Source: Barra, MSCI, Calvert-Serafeim Research. Firms ranked by their ESG score. Illustrated is the average market-to-book value of equity ratio in each portfolio.
- Investors expect higher growth and require lower cost of capital from firms with higher ESG performance. These firms trade at higher valuation multiples in equity markets.
Figure E4: Equity Valuation of Profitability: Firms with Medium and High ESG Performance Versus the Overall Sample
Source: Thomson Reuters ASSET4, Calvert-Serafeim Research. Firms ranked by their ESG score. Illustrated is the estimated valuation multiple on profitability in each portfolio.
- Firms with better ESG performance have lower credit default swap spreads.
Source: MSCI, Calvert-Serafeim Research. Firms ranked by their ESG score. Illustrated is the average credit-default swap spread in each portfolio.
Recommendation: Given the value relevance of companies’ investments in environmental and social issues, investors should update valuation models and engage with corporate management when they see opportunities for improvement in companies’ performance on environmental and social issues.
Large corporations in society have a purpose, and that purpose extends beyond simply making profits. Rather, corporations are assuming broader responsibilities that increasingly affect their valuation in the stock market and their value to society. Because corporations are the world’s most powerful engines for growth and prosperity, this behavior is a positive development with global impact. By understanding corporations’ environmental and social activities and integrating this understanding in investment decisions, investors can advance and benefit from companies’ creation of long-term value.