IT'S BEEN OVER 20 YEARS since Gro Harlem Brundtland coined the phrase “sustainable development” in the landmark publication, Our Common Future. Since then, few terms have been so widely applied and produced such positive change, yet been so misunderstood.
To pursue sustainable development, companies must minimize their environmental footprint, while simultaneously working to create social and economic value. Although many corporations embrace sustainable development, practitioners often wonder whether this commitment adds value to their bottom line.
To address this question, companies need to approach sustainable development from three perspectives. First, they should determine why sustainable development, when properly applied, is good for their business. Second, they need to calculate the potential impact of sustainable development on share price. And third, they need to compare the share-price performance of a portfolio of large capitalization companies that are top-tier practitioners of sustainable development, with the share price of those not particularly recognized for their sustainable development practices.
There are numerous reasons why a company may embrace sustainable development, though two or three are usually most applicable to a particular industry and company. For example, the key reason for most mining companies may be to ensure that they are welcomed into a host community, whereas a primary driver for the hospitality sector may be to build customer loyalty.
To move beyond the anecdotal evidence that sustainable development is good for business, the effect of sustainable development initiatives can be isolated from other business variables and expressed in quantitative financial terms.
Performing such an analysis is a three-step process:
1. Assess and identify environmental, social and economic parameters that are readily translated into financial terms (e.g. energy-efficiency programs, charitable giving, local procurement mandates).
2. Translate these parameters into financial terms employing commonly used techniques, such as ratio analysis, discounted cash flow analysis, economic value-added analysis, and options pricing.
3. Isolate the additive value of sustainable development in financial terms, including overall corporate valuation.
The sdEffect is an initiative aimed at advancing integration of sustainable development into investment decision making. Employed to assess the impact of 10 sustainable development performance parameters reported by Canadian mining companies, this analysis demonstrated that, for example, Placer Dome’s (now Barrick Gold) community enhancement programs added approximately 5.5 per cent to the company’s share price (based on discounted cash flow analysis). Similarly, Noranda/Falconbridge’s (now Xstrata) energy-efficiency program had an impact on share price equivalent to an improvement in nickel or copper prices of about 1.5 per cent. Although sustainable development parameters are oftentimes assumed to be hard to quantify in financial terms, this is not the case.
If sustainable development creates value for a company, then a portfolio of companies that embrace sustainable development should outperform a benchmark made up of companies that are not so inclined.
The Dow Jones Sustainability Index World (DJSI World), the longest-running sustainable development global index, comprises the top sustainable development companies drawn from a worldwide pool of 2500 large-capitalization corporations. Companies are selected based on a systematic assessment that identifies the sustainability leaders in each of 58 industry groups. The underlying research methodology accounts for general, as well as industry-specific, sustainability trends, and evaluates corporations based on their climate change strategies, energy consumption, human resources development, knowledge management, stakeholder relations and corporate governance.
As of 2007, there were 318 companies in the DJSI World, with the three largest being General Electric Co., Procter & Gamble Co. and BP PLC. Between 1999 and 2007, the DJSI World yielded a total return of 14.2 per cent, whereas the benchmark Morgan Stanley Capital Index World returned only 11.2 per cent.
The answer to the fundamental question – does a company’s commitment to sustainable development have a positive impact on its bottom line? – seems to be yes. A key step for corporate practitioners of sustainable development, therefore, is to educate the financial community about the merits of factoring sustainable development into corporate valuations.