Philosophy

According to the most recent study by the merchant bank Ocean Tomo, intangible assets accounted for 80% of the value of the S&P 500 in 2010. Yet most investment analysis is focused on the 20% of company value represented in financial statements. All companies have an ecosystem of intangible assets that helps to explain this increasing gap between book value and market value: those companies with the most highly engaged employees are known to consistently outperform their less engaged peers in shareholder return; companies rated as highly innovative have been shown to outperform the S&P 500 index by in excess of 40% over time; companies adept at managing all their intangible assets have posted significant returns in excess of the broad markets over long periods.

However in the realm of intangible assets we believe customer relationships are king. It is relatively indisputable that for most businesses, future cash-flow is entirely dependent on having customers who will continue to buy your products, and the company’s ability to service those customers in an economically profitable manner. While most investment managers wage a bloody fight for alpha in the red waters of physical and financial assets, the Customer Value Index
allows investors to access a relatively unchartered approach to assessing the most important intangible asset - engaged, loyal and economically profitable customers - Helping to uncover this powerful upstream predictor of sustainable cash-flow creation, long-term value and investment alpha.

Our investment thesis rests upon; the unassailable importance of the customer’s perception of value when interacting with companies and brands; the notion that social media has the ability to accelerate the value creation process for customer-centric companies and the consistency with which management at these companies engage customers while achieving healthy levels of economic profit. Companies that excel in these areas are able to lower their risk profile and to employ their core customer engagement capability as a growth catalyst in the following three areas:

• Growing existing revenue
• Expanding revenue sources
• Launching new concepts and new markets

From a DCF (Discounted Cash Flow) perspective, as a result of better risk management and opportunity identification, the simultaneous decrease in a company’s assumed discount rate and increase in its expected growth rate could lead to a positive multiplier effect and expansion in its value.


Studies Supporting the CVI Approach

The studies below focus on a number of stakeholder issues that impact a company's performance with customers, suppliers, employees and shareholders.


• In a study entitled, “Does the Stock Market Fully Value Intangibles?” Alex Edmans of the Wharton School at the University of Pennsylvania analyzed the relationship between employee satisfaction and long-run stock performance. An annually rebalanced portfolio of Fortune magazine’s “Best Companies to Work For in America” earned 14% per year from 1998-2005, over double the market return. Controlling for risk using the Carhart four-factor model, this translates into a statistically significant monthly alpha of 64 basis points. Returns remain significant when calculated over industry-and characteristics-matched benchmarks, when adjusting for outliers, and when controlling for a large number of other characteristics known to affect returns. The outperformance continues to hold when extending the sample back to 1984, when the “Best Companies” list was published in book form only and not in Fortune magazine. These findings imply that the stock market does not fully value intangibles, even when independently verified by a publicly available survey.

• In their 2007 book, Human Sigma, authors John Fleming and Jim Asplund reveal the findings from a study conducted by The Gallup Organization that showed stock values of companies that successfully engage their customers were better insulated from the impact of severe economic fluctuations. Customer engagement scores were collected for companies in five different industries in August 2000. Each company’s customer engagement scores were compared to the change in the company’s stock price from its closing values on Sept. 10, 2001 to its closing value after the market close on Sept. 17, 2001. The customer engagement scores collected one year earlier proved to be powerful predictors of each company’s vulnerability to this significant market event.  The higher the company’s August 2000 customer engagement score, the smaller the percentage decline in the company’s stock price on the day the markets reopened. The correlation was 0.70. An examination of historical as well as forward-looking stock performance revealed that customer engagement scores were significant predictors of stock price changes stretching as far back as September 2000 and as far forward as August 2006.

• Another Gallup study was conducted to answer the question, “Which Comes First, Employee Engagement or Higher Performance?” The study involved 2,178 business units from 10 companies within six different industries. Employee engagement was found to be a better predictor of performance in key areas—including customer engagement, employee retention, sales and profit—than performance predicts employee engagement.

• A longitudinal meta-analytic study of causal direction analyzed 7,939 business units to assess the link between employee engagement and business outcomes of customer satisfaction, productivity, profit, turnover and accidents. The results indicated that higher levels of employee engagement were associated with greater customer satisfaction, productivity, and profit, and decreased turnover and accidents. This equated to increased profits of $80,000 to $120,000 on average. (Harter, J. K., Schmidt, F. L., & Hayes, T. L. 2002. Business-unit-level relationship between employee engagement and business outcomes: A meta-analysis. Journal of Applied Psychology, 87(2), 268-279.)

• A global study by Towers Perrin shows a convincing connection between employee engagement and financial performance. It is the largest study of its kind with input from a survey of almost 90,000 workers from 18 countries. The study also drew on an employee normative database that contains over two million employee records and the financial performance records of their companies. In one three-year study of 40 global organizations, high employee engagement companies enjoyed significantly better financial results on measures such as operating margin, net profit margin, revenue growth and earnings per share growth than low employee engagement companies. In a 12-month study across 50 companies, companies with the largest percentage of highly engaged employees had a 19% increase in operating incomes and a 28% increase in earnings per share. Over the same year period, companies with the lowest employee engagement rates showed a 33% decline in operating incomes and an 11% decline in earnings per share. A three year study that followed 41 companies showed a 3.7% rise in operating margins in companies with engaged workers versus a 2% drop in operating margins in companies with less engaged workers. Only one fifth (21%) of all employees in the study were determined to be highly engaged employees.

• In their 2007 book, Firms of Endearment, authors Raj Sisodia, David Wolfe and Jag Sheth identify 17 public companies as exemplars of the multi-stakeholder management system. After identifying these companies as exemplars, the authors then evaluated performance over 3, 5 and 10-year time horizons. Over 3 years, the 17 companies returned an aggregate 73% versus 38% for the S&P 500. Over 5 years, exemplars returned 128% versus 13% for the S&P 500. Over 10 years, the difference was 1,026% versus 122%.

• Governance Metrics International (GMI) a corporate governance research and ratings agency, found a positive correlation between governance ratings and firm performance, return on capital, return on assets and return on equity and an inverse relationship between governance and cost of capital. Companies rated 10.0 overall in GMI’s 2003 summer release (large cap U.S. firms) outperformed their benchmarks over a 4-year period measured (08/01/03 – 07/31/07). Companies rated 10.0 overall returned an average 20.5% compared to the Dow 30 (11.08%) S&P 500 Index (12.12%) and The Russell 1000 Index (12.57%). A similar study conducted by AXA Investment Managers and published in Pensions World (February 2008) found a positive relationship between GMI’s corporate governance (CG) scores and earnings growth and return on equity. Between 2003 and 2007, companies that were upgraded for CG scores were more likely to outperform the benchmark index and vice versa. Companies with higher CG scores also tended to outperform those with lower scores when the economic backdrop was more uncertain. Finally, companies with higher CG scores tended to have lower volatility, lower beta and lower value at risk than those with lower scores.

• Harvard Researchers John Kotter and James Heskett note that successful, visionary companies share a stakeholder perspective: “All their managers care strongly about people who have a stake in the business (customers, employees, stockholders, suppliers).” Their study showed that over an 11-year period, stakeholder-balanced companies showed four times the growth in sales when compared to shareholder-biased companies.

• Verschaar and Murphy (2002) found "unbiased and rather conclusive empirical evidence that firms committed to social and environmental issues that are important to their stakeholders also have superior financial performance." These findings are based on the Business Week financial rankings of U.S. corporations and the Business Ethics rankings of corporate social performance to test for a relationship between corporate social performance and financial performance.

• A 2005 study published in Human Resource Management International Digest explored whether companies perform best when they introduce diversity initiatives not simply to comply with the law, but to use people's different viewpoints, talents and experiences to improve decision-making and problem solving. The results, from a survey of more than 3,000,000 employees showed that organizations that create an environment of inclusion can expect their business to be one that fosters innovation, creates a safer work environment, drives employee engagement, commitment and pride, sees a positive impact on customer satisfaction, and benefits in terms of financial performance.

• Berman et al (1999) conducted research to determine which kinds of CSR behaviors were more strongly tied to ROA. They found that CSR behaviors that dealt with the company’s relationships with employees and customers had significant direct effects on ROA.

• Hillman and Keirn (2001) found that some types of corporate responses to stakeholders are more important than others; specifically, their analysis of S&P 500 firms revealed that, while stakeholder management leads to improved shareholder value, mere participation in social issues (e.g., making charitable contributions) can detract from that value. (To measure corporate financial performance, they used market value-added or MVA.)

• Cheng and Wu of ISS (2005) found “Companies with better corporate governance have lower risk, better profitability, and higher valuation.  More specifically, these well run companies outperform poorly governed firms in return on investment, annual dividend yield, net profit margin, and price to earnings ratio.”  They show companies with a high CGQ score (ISS’s Corporate Governance Quotient) outperform over 2002 to 2004.

• Russell Investment Group has tracked the stock price performance of publicly quoted companies on the FORTUNE “100 Best Companies to Work for” list for several years and its findings are persuasive. Someone who invested equal dollar amounts at the beginning of 2005 in publicly quoted companies on the list would have ended the year up 12 percent, versus 4.93 percent for the S&P 500. Russell also found that the 100-best portfolio, adjusted annually to reflect changes to the list from 1998 to 2005, provided an annualized return of 15 percent, versus 5 percent for the S&P 500.

• Jeff Anderson, portfolio administrator at Mellon Financial Corporation and Gary Smith, Professor of Economics at Pomona College, published the results of a study in the Financial Analysts Journal, Volume 62, Number 4. The study looked at the stock performance of the top-10 companies identified each year by Fortune magazine as the “most admired companies in the U.S.” for 1983 through 2004. The Fortune portfolio was initially formed on 1983’s trading day; for each year thereafter, the portfolio was liquidated on that year’s trading day and the proceeds were reinvested in that year’s most admired companies. A portfolio of these stocks outperformed the market by a substantial and statistically significant margin. (In this study, the success of the portfolio does not appear to be attributable to the effects of market, size, value or momentum.)

• Brown and Caylor (2004), in a paper titled “Corporate Governance and Firm Performance” find good corporate governance leads to firm outperformance.  “We relate Gov-Score (ISS database) to operating performance, valuation, and shareholder payout for 2327 firms, and we find that better governed firms are relatively more profitable, more valuable, and payout more cash to their shareholders.”

• Eisenhofer and Levin (2005), in a paper titled “Does Corporate Governance Matter to Investment Returns?” state that “an increasing body of evidence suggests that enhanced governance equals enhanced performance.”

• In January 2008, Audit Integrity, an accounting and governance risk rating agency, published a study on equity returns using Accounting and Governance Risk (AGR) scores over a 10-year period. The results show that corporate integrity, as measured by the AGR rating, is a significant factor in equity returns. A returns disparity of 17.5% was found between the highest and lowest-rated companies across all market cap groups. The disparity narrows to 8.9% annually for large caps.

• Aggarwal and Williamson (2006), using data from ISS to measure corporate governance and using Tobin’s Q as a measure of firm performance, found that, “after controlling for size and industry, we still find a positive and significant relationship between governance and value.”

• The Human Capital Index (HCI) is a methodology Watson Wyatt used to calculate the correlation of human capital and shareholder value. The study definitively shows that the higher a company’s HCI score, the higher its shareholder value. The low group averaged a 21 percent five-year return. The medium group averaged 39 percent. Those with high HCI scores returned 64 percent over five years. Responses were matched to objective financial measures, including market value, three- and five-year total returns to shareholders (TRS), and Tobin’s Q, a ratio that measures an organization’s ability to create value beyond its physical assets. To investigate the relationship between human capital practices and value creation, a series of multiple regression analyses were conducted, identifying a clear relationship between the effectiveness of a company’s human capital practices and shareholder value creation. Thirty key HR practices were associated with a 30 percent increase in market value.  Summary HCI scores were created for individual organizations so that results could be expressed on a scale of 0 to 100. An HCI score of zero represents the poorest human capital management, while a score of 100 is ideal.

• The Global 100 is an assessment of companies’ performance on governance, social and environmental issues. The top 100 are culled from a universe of over 1800 firms from around the world. A benchmarking study that accompanies the list demonstrates that the Global 100 outperforms Morgan Stanley Capital International, Inc. (MSCI) World Index by 7.11%.

• In a prize-winning research paper, Sandra Woddock and Samuel Graves established the link between stakeholder relations, financial performance, and quality of management. Their analysis of the Fortune 500 reputation survey results shows that building positive stakeholder relationships is not a zero-sum game, but that solid financial performance is consistent with good treatment of other stakeholders such as employees, customers, and communities. They also found companies that treat their stakeholders well are also rated by their peers as having superior management.

• A study by Max Clarkson, director of the Centre for Corporate Social Performance and Ethics at the University of Toronto, indicated that over the longer term, firms that rate highest on ethics and corporate social performance make the most money. His research suggests that companies that concentrate exclusively on the bottom line often make poorer decisions. The primary cause is a lack of stakeholder information to anticipate opportunities and to solve problems before they become large and costly to remedy.

• A 1997 national study of consumer attitudes conducted by Cone/Roper found that 76 percent of consumers would be likely to switch to a brand associated with a good cause. In 1993, 63 percent responded this way.

• In their May 2006 study entitled “Is What’s Best for Employees Best for Shareholders?” Olubunmi Faleye and Emery Trahan of Northeastern University studied the effect of labor-friendly corporate practices on shareholder outcomes using firms selected by Fortune magazine as the “Best 100 Companies to Work for in America” over 1998-2004. They found that investors react positively to the list’s announcement and that list firms subsequently outperform a size and industry-matched control group on productivity, profitability, and value creation. Human capital dependent firms are more likely to make the list and the benefits of improved performance accrue mostly to such firms. Their analysis of excess executive compensation and forced turnover suggests that top management derives no pecuniary benefits from labor-friendly practices. They therefore interpret their results as consistent with rational choice, noting that the benefits of devoting significant resources to employee welfare appear to outweigh the costs, especially for firms that depend more on human capital.

• A 1995 survey of Canadian consumers by the Market Vision Group indicated that 26 percent of Canadians were actively involved in boycotting goods or services for reasons that had nothing to do with price or quality (the companies were simply viewed as bad corporate citizens).

• Companies ranking in the top 10% of 2843 tracked in the Intangible Asset Management Index (IAMI) returned 19% to shareholders in a 28–month period ending February 2008. Those in the bottom 25% lost 29%. The median return for the broad market, excluding dividends was –4%. The intangible asset management index defines intangible assets as comprising business processes, patents, trademarks, reputation for ethics and integrity, quality, safety, sustainability, security, and resilience.

• A study conducted in 2004 suggests investors would be well served by considering firms’ human capital investment strategies as an integral part of their investment decision. The approach used in this study was similar to a previously and widely used approach for estimating the effects of R&D investments (Griliches, 1998, Hall 1999, Eberhart, Maxwell and Siddique). A firm level data set was generated by the American Society for Training and Development (ASTD) which collected 1996 to 1998 data on a sample of over 400 U.S. publicly traded firms to obtain detailed training information, including dollar expenditures on training and training content. The main outcome measure was the percent change in the firm’s stock return. The research evidence as well as evidence from an investment strategy that has deployed the research (see next summary), strongly suggests that the return on firms’ investments in “human capital” (as measured by their spending on employee education and training) generate super-normal returns. The study authors partly attribute this return to investments in human capital (specifically employee training) being a non-reported “investment” that is buried in SG&A “costs.” Hence, all but the most diligent investors are unable to ferret out which of these “costs” are, in fact, investments that might be expected to generate future profitability. This has the effect of causing “high investment” firms to be under-valued in the short-run. Source: “The Impact of U.S. Firms’ Investments in Human Capital on Stock Prices,” Laurie Bassi, Bassi Investments, Inc.; Paul Harrison, Federal Reserve Board of Governors; Jens Ludwig, Georgetown University; Daniel McMurrer, Bassi Investments, Inc., June 2004.

• After 10 years of research, Laurie Bassi, director of McBassi & Co., a human resources consultancy and investment firm, discovered that companies that make large investments in employee training subsequently earn extraordinary returns. To prove her point, Bassi set up a fund that invests only in companies that make significant investments in their people. Started in 2001 in the middle of a sharp market downturn, an investment of $50,000 in the fund was worth $82,900 not including custodial and management fees on March 1, 2006. The same sum invested in the S&P 500 would be worth $76,700.

• In April 1997, the results of a study conducted by J. Laitamaki and R. Kordupleski were published in the European Management Journal. The two economists concluded that all stakeholders are well served through profitable growth strategies based on customer value added. They tested this thesis by selecting 13 companies including Nike, Wal Mart, Roadway Express, Federal Express, and Southwest Airlines among others. At the time of this study, the sample companies had consistently distinguished themselves as extraordinary creators of customer value. A time frame from 1989 to 1993 was used to compare the sample group with their industry peers and the S&P 500 index. Key performance metrics analyzed were revenue growth, return on assets, operating profitability and market value creation. The size of the gap between customer value companies and their competition was much larger than the researchers anticipated. For example, the customer value companies grew 3.2 times more rapidly than their industry peers and when compared to the S&P 500 Index, their share price growth was 4.3 times better than competitors. Operating profitability for the sample companies was twice the industry average while return on assets were five times higher. The widest divergence was in market value growth which led Laitamaki and Kordupleski to conclude that “this leaves little room for doubt: when companies create extraordinary value for their customers, they simultaneously create above average wealth for their shareholders; so the perception that a company must choose to serve one constituency or the other—whether Main street or Wall Street is false.”

• In one of the largest studies of the satisfaction link between contact center employees and customers, Manpower surveyed over 200,000 contact center callers and more than 18,000 contact center representatives. The group found that contact centers that have high employee satisfaction also have high customer satisfaction. Alternatively, contact centers with low employee satisfaction also have low customer satisfaction.   Source: "Contact Center Employee Satisfaction & Customer Satisfaction Link" by Mike Desmarais of SQM Group for Manpower, 2005.

• The global consulting firm ISR found in a 2006 study that a dramatic difference in bottom-line results shows in companies with highly engaged employees when compared to companies whose employees had low engagement scores. Most dramatic among its findings was the almost 52 percent gap in the one-year performance improvement in operating income between companies with highly engaged employees versus companies whose employees have low engagement scores. Other findings include a 13.2 percent improvement in net income growth over a one-year period for companies with high employee engagement, while seeing a 3.8 percent decline in net income over the same period for companies with low employee engagement. Companies with high employee engagement also demonstrated a 27.8 percent improvement in EPS growth, while companies with low employee engagement reported an 11.2 percent decline in EPS over the same period.

• Using data from both the American Customer Satisfaction Index (ACSI) and Fortune Magazine’s lists of “Best Companies to Work For,” Daniel H. Simon and Jed Devaro of Cornell University examine the relationship between making the “Best 100” list and customer satisfaction. Based on a subset of the Best 100 in each year from 1994 to 2002, they found strong evidence that firms on the list earn higher customer satisfaction ratings than firms not on the list. This result is stronger for firms in the service sector than for those in the manufacturing sector. Their analysis also suggests that the increase in customer satisfaction resulting from “Best Company” status yields about a 1.6 percent increase in return on assets.

• In a study of the 2007 Fortune "100 Best Companies to Work For" list, Deloitte & Touche USA found that companies on the list outperformed the S&P 500 in total shareholder value return over a 10-year period, 18.9 percent to 8.4 percent.

• In a 2006 study, Kati LaBeaume, Senior Statistician with HR Solutions, Inc. using extensive employee data (from over 10,600 completed Employee Opinion Surveys from 18 organizations, all surveyed within the last three years) discovered a correlation between diversity satisfaction and Overall Job Satisfaction/Engagement. The findings indicate that a positive and significant relationship does exist between job satisfaction and employees’ satisfaction with diversity.

• A large number of empirical studies have explored the relationship between the social and economic performance of firms. A comprehensive review by Margolis & Walsh (2001) showed that when treated as an independent variable, corporate social performance was positively related to financial performance in 42 studies (53%), unrelated in 19 studies (24%), negatively related in 4 studies (5%), and with a mixed relationship in 15 studies (19%).

• A 2009 report by consultant firm AT Kearney found that companies with strong environmental, social and governance (ESG) practices are the ones that outperform their industry peers during a recession. The report covered 18 industries and looked at companies that were part of the Dow Jones Sustainability Index (DSJI) and the Goldman Sachs SUSTAIN focus list. It was found that over a 3-month period the ESG companies outperformed the market by 10 percent, which increased to 15 percent over a 6-month period.

• In January 2004, the New York research group, Catalyst, released a study that examined the financial performance of 353 companies for four out of five years between 1996 and 2000. Catalyst found that the group of companies with the highest representation of women in their senior management teams had a 35 percent higher Return on Equity (ROE) and a 34 percent higher Total Return to Shareholders (TRS) than companies with the lowest women's representation. This mirrors the results of a longer-term study led by Roy Adler, a professor at Pepperdine University and executive director of the Glass Ceiling Research Centre. This study tracked the number of women in high-ranking positions at 215 Fortune 500 companies between 1980 and 1998. The 25 companies with the best record for promoting women to senior positions, including the board, posted returns 18 percent higher and returns on investment 69 percent higher than the Fortune 500 median of their industry. Similarly, the Conference Board of Canada tracked the progress of Canadian corporations with two or more women on the board from 1995 to 2001.  The Conference Board found that these companies "were far more likely to be industry leaders in revenues and profits six years later."

• “A number of researchers have found that revenue-based measures of business unit performance, for example, sales and profitability, are significantly correlated with employees’ work-related perceptions. The evidence suggests that business units in which employees’ collective perceptions are relatively favorable perform better. For example, Ryan, Schmit, and Johnson (1996) demonstrated that average levels of job/company satisfaction, positive perceptions of teamwork and (lack of) stress in the branches of a finance company, are associated with superior market share, reduced debt delinquency, and fewer credit losses. Similarly, Koys (2001) found that levels of employee satisfaction/commitment in the outlets of a restaurant chain were positively related to profitability. In the retail sector, perceptions of a strong service climate have been linked to enhanced store financial performance (Borucki & Burke, 1999), and positive job-related attitudes to increased sales (Leung, 1997), and to revenue growth (Rucci, Kirn, & Quinn, 1998). In addition, George and Bettenhausen (1990) found links between the positive mood of store managers and sales volume. To date, the largest study of employee perceptions and business unit performance is a meta-analysis of 7,939 work units in 36 companies, conducted by Harter, Schmidt, and Hayes (2002). These authors found small but significant correlations between business unit productivity and profitability, and a composite of items they call employee engagement. Patterson, Warr and West (2004) have recently reported significant associations between company climate and subsequent productivity in a sample of 42 manufacturing companies. Average job satisfaction was a mediator of this relationship. Overall, these results suggest that positive employee work experiences, as reflected by elevated business unit scores on a variety of attitudinal and climate measures, are associated with enhanced financial performance.” (Test of a service profit chain model in the retail banking sector by Garry A. Gelade and Stephen Young, Journal of Occupational and Organizational Psychology (2005), 78, 1–22)

• A 2006 report of the United Nations Environmental Programme Finance Initiatives (UNEP FI), “Show Me the Money,” summarizing some of the evidence to date on the correlation between sustainability performance and financial performance, concluded with commentary from financial consultant firm CRA Rogers Casey, stating: “(W)e were impressed by the quantity of reports that showed a strong link between ESG issues, profits, business activities and, ultimately, stock prices.” (United Nations Environment Programme Finance Initiatives, Show Me the Money: Linking Environmental, social and Governance Value, Geneva, United Nations, 2006)

• A 2007 report from the UNEP FI reinforces the findings of groups like Innovest, Watson Wyatt, and Goldman Sachs. This report, written by Mercer Consulting, reviews 20 academic studies that examine the impact of ESG variables on financial performance. The studies chosen all met several criteria, including publication in peer review journals. Of the 20 studies, 10 found that good ESG performance was positively related to financial performance, 7 found no significant effect (i.e., no difference in performance of portfolios incorporating ESG factors, compared with more traditionally constructed portfolios), and 3 found a negative association. Again, the overwhelming weight of the data demonstrated the financial materiality of ESG or sustainability performance. (United Nations Environment Programme Finance Initiatives, “Demystifying Responsible Investment Performance: A Review of Key Academic and Broker Research on ESG Factors,” Asset Management Working Group and Mercer, October 2007)

• The Haas Business School at Berkeley and the Social Investment Forum award an annual prize to an academic paper that is considered outstanding in its quantitative examination of socially responsible investing. The 2005 prize-winner paper, entitled “The Economic Value of Corporate Eco-Efficiency,” concluded that the most eco-efficient firms do better than the laggards, earning an “abnormal return” – the term investors use to describe performance above average – of between 2.8% and 5% over the period from 1997 through 2004. (Nadja Guenstera, Jeroen Derwalla, Rob Bauer, and Kees Koedijka, “The Economic Value of Corporate Eco-Efficiency,” August 2006)

• A study done by Innovest Strategic Value Advisors, a financial research firm, referenced in a recent Watson Wyatt paper, simulated the effect of incorporating Innovest’s environmental ratings into portfolios of large U.S. pension funds by adjusting, on a month-by-month basis, portfolio weightings according to those environmental ratings – in other words, overweighting the best environmental performers. Over a three-year period (2002-2004), these environmentally weighted portfolios outperformed the actual portfolios for every scenario (low, medium, and high tilt) in almost every asset class examined. The results were similar over longer timeframes as well. (Watson Wyatt, “What is Sustainable Investment?,” January 2007)

• Another paper showed that returns were higher for companies that ranked highly on Innovest’s eco-efficiency measures over a period of more than seven years, outperforming both a market proxy and companies with lower rankings. (Nadja Guenstera, Jeroen Derwalla, Rob Bauer, and Kees Koedijka, “The Economic Efficiency Premium Puzzle,” Financial Analysis Journal” (61:2), 2005)

• In 2007, Goldman Sachs introduced GS Sustain, a focus list of companies that Goldman’s analysts believe are attractive from an integrated ESG/financial perspective. While Goldman Sachs states that ESG analysis alone does not necessarily add value, the integration of ESG with financial metrics does: the sustainability “winners” identified by Goldman outperformed the MSCI World index by 25% over the two years between the summer of 2005 and summer of 2007. (Goldman Sachs Global Investment Research, “Introducing GS SUSTAIN,” September 2007)

• On May 21, 2008, Mercer announced that it will henceforth include ESG questions in all of its manager searches and rate all managers in its database on the extent to which they “behave as active owners of capital and whether they reflect the materiality of ESG in their investment decision making.” Tim Gardner, Global Chief Investment Strategist for Mercer, stated that there are a growing number of institutional asset owners “who believe these issues can have an impact on long-term investment performance.” (Mercer, “Mercer manager research developed to consider environment, social and governance factors,” May 21, 2008)

• A February 2009 study assessed whether stock returns are systematically related to Audit Integrity’s Accounting Governance and Risk scores, or in other words, whether adding AGR improves the systematic pricing properties of traditional multi-factor models. Empirical tests all confirm that stock returns indeed reflect the firm’s corporate integrity as measured by its AGR score. Firms with higher AGR scores earn higher excess returns even after including all of the extant risk factors found in the academic finance literature including (i) a stock’s co-movement with the market as a whole and sensitivities to risk factors associated with its (ii) size, (iii) market-to-book ratio, (iv) momentum and (v) market liquidity. This relation was both statistically as well as economically significant. The analysis regressed, on a firm-by-firm basis, a stock’s excess return over the month subsequent to it’s AGR score being updated against various factors prevailing at the beginning of the month as well as the AGR score itself. These regressions were run over three different sample periods to assess the robustness of results: the last ten years of data (1998-2007 sample period), the last five years of data (2003-2007 sample period) and the last three years of data (2005-2007 sample period). Source: The Pricing Properties of Audit Integrity’s AGR Measure, Walter N. Torous, Lee and Seymour Graff Endowed Professor, UCLA Anderson School of Management, February 1, 2009.

• Two scholarly works, The Service Profit Chain and The Value Profit Chain, produced by James L. Heskett, Earl Sasser and Leonard Schlesinger describe some of the key organizational elements embedded in a multi-stakeholder management system. The authors establish the relationships between profitability, customer loyalty, and employee satisfaction, loyalty, and productivity. The foundational premise is that profit and growth are stimulated primarily by customers’ perception of value created by satisfied, loyal, and productive employees. In turn, employee productivity requires high-quality support services and policies that enable employees to deliver results to customers.

• Credit Suisse’s quantitative research group examined the alpha-generating characteristics of a strategy based on Fortune magazine’s yearly Most Admired Companies list. Fortune has published its list of most admired companies annually since 1983. Investing in these companies has offered a performance advantage over the S&P 100 benchmark. In dollar terms, the most admired companies strategy produced over twice the return of the S&P 100 over 1983-2009. An investment of $100 in the portfolio would have grown to $2,544 versus $1,153 in the S&P 100. The strategy’s annualized return was 3.3% greater than that of the S&P 100.

• The 2007 – 2008 Towers Perrin Global Workforce Study confirms the strong correlation between employee engagement and company performance. One analysis looked at 50 global companies over a one-year period, correlating their employee engagement levels with financial results. The companies with high employee engagement had a 19% increase in operating income and almost a 28% growth in earnings per share. Conversely, companies with low levels of engagement saw operating income drop more than 32% and earnings per share decline over 11%. A similar study over a longer time horizon—involving 40 global companies over three years—found a spread of more than 5% in operating margin and more than 3% in net profit margin between the companies with high employee engagement and those with low engagement.

• A 2010 study of investment applications for The Corporate Library’s governance ratings showed outperformance in 2003-2010 for three hypothetical portfolios benchmarked to the Russell 1000. The highest level of outperformance—275 annualized basis points—was found for the portfolio applying the strictest governance screens. Performance attribution indicates that 121 basis points of the annualized outperformance for this portfolio were directly attributable to the ratings.

• Risklab GmbH conducted a study showing significant portfolio risk reduction or return enhancement can be achieved by allocating equity investments into companies that proactively deal with ESG risks over an extended time frame (20 years). (Dr. Steffen Hörter, Dr. Wolfgang Mader, Barbara Menzinger, E.S.G. Risk Factors in a Portfolio Context: Integrated Modeling of Environmental, Social and Governance Risk Factors, November/December, 2009)

• In 2008 A.T. Kearney conducted analysis to determine whether companies engaging in sustainable practices may be protected from value erosion during a financial crisis by comparing the performance of sustainability-focused companies against market indices over defined spans of time. In 16 of the 18 industries examined, companies recognized as sustainability-focused outperformed their industry peers by 10% over 3 months (September to November 2008) and 15% over 6 months (May to November 2008).

• Sponsored by the CICA’s Canadian Performance Reporting Board, Stakeholder Relationships, Social Capital and Business Value Creation is a joint initiative between the Centre for Innovation in Management, Simon Fraser University, and the Schulich School of Business, York University. Throughout six comprehensive chapters, the distinguished project team:
  - Explores how, and in what ways, positive stakeholder relationships create “social capital” and business value.
  - Examines case studies from three different industry sectors, investigating how good stakeholder relationships have contributed to a desired outcome in the company’s business strategy.
  - Presents a model depicting how business value is created through positive stakeholder relationships.

“A company's primary responsibility is to serve its customers.”
Peter Drucker, 1954
The Practice of Management
 








“The might of their [Coke & Gillette] brand names, the attributes of their products, and the strength of their distribution systems give them an enormous competitive advantage, setting up a protective moat around their economic castles. The average company, in contrast, does battle daily without any such means of protection.”
Warren Buffett, 1993
Berkshire-Hathaway Annual shareholder letter