Source: http://www.businessstandard.com/common/storypage_c.php?leftnm=10&autono=307659
Ethics and valuation
Market Insight
Devangshu Datta / New Delhi December 16, 2007
A study of 500 companies tries to draw a correlation between CSR and valuations. However, for concrete results, a larger sample size is needed.
The concept of ethical investing goes beyond being honest in investment methods and holding only financially transparent businesses. An ethical investor will only support companies that strive to do good. Or at the least, do no evil.
Ethical investors don’t touch manufacturers of armaments, tobacco, alcohol, etc. They abjure sweat-shoppers and pharmaceuticals or FMCGs indulging in unnecessary animal testing. They avoid paper-makers that don’t replant pulped trees and chocolate manufacturers that cause forest destruction. They pay a premium for corporates that display social responsibility.
Wonderful in theory. In practice, corporates are only likely to become more socially responsible if they believe ethical corporations can get higher valuations, sell more or charge premiums on the basis of the ethical branding. Quite cynically, more investors would also be ethical if they thought that it generated higher returns.
Perhaps this is true, in the first world where there is a strong green movement. Ben & Jerry’s for instance built an ice-cream business on the concept of being ethical in sourcing ingredients. Nike, Nokia and other consumer-centred businesses are terrified of being nailed as sweat shoppers. United Brands (now Chiquita Brands) saw dropping valuations when accused of supporting Latin American dictatorships. No first world jeweller wants to be indicted using conflict diamonds.
But even in the First World, it’s tough to draw clear statistical linkages that suggest ethical businesses receive better valuations or outperform in terms of profit or sales growth. In the Indian context, the connection may be even more tenuous if it exists at all.
Many necessary businesses cannot be “ethical”. Pharmaceuticals for example, involve not just animal-testing but also double-blind tests with humans where people die because they are denied life-saving drugs or given dangerous, untested ones.
Most agri-businesses (not just tobacco) damage the environment. So do chemical businesses. And of course, the energy industry’s entire value-chain from mining, to internal combustion engines and power plants, is destructive and dirty.
But it is possible for any company to put profits back into social causes. This is good PR and may be necessary sometimes. If for example, a company is to attract workers to live onsite a long way from urban fleshpots, it must improve local amenities.
Similarly, a company located where there is local resistance to its operations, can improve its image by running free hospitals, improving local roads, or coming through in crises. Post Kutch-earthquake for instance, a huge number of companies pitched in to support relief operations. In another well-known case, a Gujarat-based major augmented water supply during a drought affecting an entire district.
But does better CSR translate into higher valuations? Most Indian corporates don’t seem to think so. Quite recently, Karmayog, a Mumbai-based non profit organisation ran a study on Corporate Social Responsibility. It assessed the CSR quotient of India’s top 500 ranked by turnover according to Dun & Bradstreet. That sample generated an impressive Rs 14,56,352 crore in 2005-06 turnover and a net profit margin of about 9.7 per cent.
According to the CSR study, as many as 231 out of this sample does no CSR at all or at least, doesn’t bother to advertise any it may do. Another 92 do the bare minimum to try and rejuvenate its own operating environment and repair damage. Some 177 companies do more than that and just four, HDFC, Infosys Technologies, Tata Steel and Titan Industries do enough to get a decent rating on Karmayog’s methodology.
If ethical investing does generate excess profits or higher valuations, these four should get higher valuations than their peers. Actually, they do in the first three cases and Titan doesn’t really have a peer. But this is too thin a sample to make a judgment call – especially since these four also have superior financials.
I’d like to dig down deeper into this list and see if the next 173 also get superior valuations or have higher growth rates, etc. But in order to be meaningful, one really needs a CSR study with a much larger sample. These 500 are all alphas and get good valuations because they are market leaders – it’s tough to attribute causality of high valuations to CSR, as and where it exists. If the study or something similar encompassed say, the next 1000 companies as well, it would be easier to see if high CSR led to a discernible valuation edge.