| by Simon Webley & Elise More Executive
Summary 'Does business ethics pay?' is a question that some
would say is a wrong one. Behaving ethically, they argue, is what you do because
it is the right thing to do. Nevertheless, there is a continuing requirement
for reliable indicators to measure the performance of corporations in the non-financial
areas of a business and to link these to business success. Concepts such as integrity
and fairness are, however, generally only measurable using indirect indicators.
This study was undertaken to explore some indicative measures of ethical
commitment/corporate responsibility and then to compare them against financial
performance measures over a period of four years. In this way, the research set
out to investigate whether it can be shown that a commitment to business ethics
does pay. For this research, seven indicators were chosen - four of corporate
financial performance [Market Value Added, Economic Value Added, Price Earnings
Ratio and Return on Capital Employed] - and three of corporate responsibility
[having a code of ethics, ratings for managing socio/ethical risks and being cited
consistently in the annual list of Britain's Most Admired Companies]. The
sample consisted of between 41 and 86 companies taken from the FTSE 350 for which
full and comparable company data was available for the years 1997-2001. It was
divided into two cohorts: those who have had codes of ethics/conduct/principles
for five years or more and those who explicitly said they did not.
Findings
A review of similar research shows that the relationship between
good financial performance and other indicators of corporate responsibility (environmental
management, corporate social responsibility, sustainability etc.) is positive
but not definitive. However, Verschoor's work in the US, on whose methodology
this research is based, showed that there was superior Market Value Added in companies
which referred to their ethics' programmes in the annual report, compared with
those who did not.
Before testing the validity of Verchoor's conclusion
for the UK, this study sought to find out whether or not the presence of an ethical
code could be used as an indicator of genuine ethical commitment. Good practice
for a sample of UK companies with and without a code was tested by looking at
a) a rating for risk management and b) a peer evaluation which included, for example,
competent management, financial soundness and quality of goods and services. A
positive relationship was found. Having an accessible ethical code was then used
to investigate the relationship between ethical commitment and financial performance
over the four year period. - Regarding financial performance, from
three of the four measures of corporate value used in this study (EVA, MVA and
P/E ratio) it was found that those companies in the sample with a code of ethics
had, over the period 1997-2001, out performed a similar sized group who said they
did not have a code.
- Companies with a code of ethics generated
significantly more economic added value (EVA) and market added value (MVA) in
the years 1997 - 2000, than those without codes.
- Companies with
a code of ethics experienced far less P/E volatility over a four year period,
than those without them. This suggests that they may be a more secure investment
in the longer term. Other research has suggested that a stable P/E ratio tends
to attract capital at below average cost; having a code may be said to be a significant
indicator of consistent management.
- The indicator that showed
a different result pattern to the others was Return on Capital Employed. No discernable
difference was found in ROCE between those with or without a code for 1997-98.
However, from 1999 to 2001 there was a clear (approximately 50%) increase in the
average return of those with codes while those without a code fell during this
period.
The data also indicates that in the years 1997-2001,
those with an explicit commitment to doing business ethically have produced profit/turnover
ratios at 18% higher than those without a similar commitment (see note on profitability
in Appendix 5).
The general conclusion from this study is that there is strong
evidence to indicate that larger UK companies with codes of ethics, e.g. those
who are explicit about business ethics, out perform in financial and other indicators
those companies who say they do not have a code. Having a code of business ethics
might, therefore, be said to be one hallmark of a well managed company.
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April 2003 | 
