Are Ethical Companies More Profitable? (Part II of IV)
Forgive me for starting with a rhetorical question and for another in my series of profound grasps of the obvious.
The answer, as we all know, to the posed question is a resounding yes. Without getting into the details (which I will do below), ethical companies are more profitable for numerous reasons – employees are more productive; employees are less likely to leave a company; consumers respond positively to companies that are perceived as ethical; vendors and suppliers prefer to deal with ethical companies; and ethical companies attract higher talented executives and employees. All of these factors contribute to the bottom line conclusion – ethical companies are more profitable.
The focus now on ethical companies is not just a response to the aggressive enforcement environment. During the financial crisis of 2008-2009, a number of ethical companies skated through the financial downturn because they avoided some of the more risk practices, especially in the financial industry (e.g. US Bancorp). As a result, companies that avoided risky, and some may argue unethical products and markets, were able to survive the financial meltdown with profits.
In the past, when the issue of ethics came up, many business leaders rolled their eyes, zoned out or just ignored the importance of the issue. That is fast changing in today’s marketplace.
Innovative business leaders now see the connection between ethics and profits as an “either/or” issue, meaning that increasing resources for ethics and compliance does not reduce profits. Instead, forward-thinking corporate leaders recognize that ethics and compliance increases profits.
For years, the research on the financial performance of ethical companies has been undeveloped. It is not an easy issue to identify and measure. There are numerous ways to identify “ethical” companies and there are a variety of financial measures of “profitability.”
Much of the research started in the 1990s. It increased in the 2000s, especially after Sarbanes-Oxley and increased focus on corporate governance.
In one of the most significant and influential studies on this issue, the United Kingdom’s Institute of Business Ethics (IBE) concluded that ethical companies are more profitable because of their ethical culture. The report “Does Business Ethics Pay” is available here.
The IBE took a sample of FTSE 350 firms and demonstrated that those companies with an “ethical culture” outperformed those that made no such claims in three important financial measures: (1) market value added (MVA); (2) economic value added (EVA) and (3) price/earnings ratio.
The IBE study concluded: “[T]here is strong indicative evidence that large UK companies with codes of business ethics/conduct produced an above-average performance when measured against a similar group without codes.”
A difficult question is this area is how to identify “ethical companies.” In the past this was easier because many companies made no effort to adopt any ethical codes or performance requirements. The bar on this issue has changed as more companies are putting into place ethics programs but few are implementing the programs.
On the financial connection between ethics and profits, the IBE study was very positive. Not only were companies more profitable but price to earnings ratios were more stable for ethical companies.
More research is needed in this area, especially on distinguishing among companies based on implementation of a code of conduct and factors that demonstrate commitment to ethics and compliance in the implementation of specific programs.
No one can doubt however the basic premise – when ethical values are embedded in a company’s culture, followed in the company’s operations and decision-making, and reflected in the trust among managers and employees in an organization, the company’s profitability will increase.