The Impact of ESG-Score on Turnover Growth

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The Impact of ESG-Score on Turnover Growth

A Cross-Sectional Study of US IPOs

Sebastian Johnson, William Sandberg

Department of Business Administration

Civilekonomprogrammet med inriktning mot handel och logistik Degree Project, 30 Credits, Spring 2020

Supervisor: Catherine Lions

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Abstract

This thesis study is based on the research question ‘Does ESG-scores affect turnover growth in companies with recent IPOs in the US?’. With four multiple regression models, we tested our hypotheses. Additionally, we made a box-plot analysis to look for trends between groups of companies, where the groups were constructed based on ESG-scores. We believe that we came up with a, yet vague, answer to the question after analyzing the results of the research. For the companies in the sample, ESG-scores do affect Turnover Growth negatively, however we want to stress that we claim it with great caution, as it cannot be concluded with any statistical significance. This study also shed some light on whether or not a manager should spend time and resources, after initiating an IPO in the US, on implementing sustainability in their business model to achieve a high ESG-score to satisfy the demands of the higher number of stakeholders which comes with going public.

Conclusively, and generally, we found that a manager should focus strictly on financial performance rather than both financial- and sustainability performance closely following the initiation of an IPO in the US.

Keywords: ESG, Growth, Turnover, Financial Performance, Sustainability Performance, IPO, US

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Acknowledgements

We would like to first and foremost send gratitude towards our supervisor Catherine Lions, Senior Lecturer (Associate Professor) at Umeå School of Business and Economics, for her hard but fair constructive feedback and

willingness to help at all times. We would also like to send gratitude to Micael Öhman at LTU for help and constructive feedback during the

statistical testing.

Umeå, May 13, 2020

Sebastian Johnson William Sandberg

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In the light of the strange times that this spring has offered, ending with the universities across Sweden shutting down due to a global pandemic caused by a virus – formally known as SARS-CoV-2 – in the midst of the process of writing this degree project, we would like to quote one of our personal heroes

that gave us the strength to carry on in the most challenging of times.

“Improvise, adapt, overcome.”

- Bear Grylls

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List of Figures

Figure 1. Johnson-Sandberg ESG-Growth IPO-Model ...5

Figure 2. Refinitiv ESG-Scoring Methodology ... 10

Figure 3.”The Relationship Between Resource Heterogeneity and Immobility, Value, Rareness, Imperfect Imitability, and Substitutability, and Sustained Competitive Advantage” ... 15

Figure 4. The Deductive Process ... 22

Figure 5. Unadjusted Dependent Variable, Change in Turnover from 18-19 ... 42

Figure 6. Unadjusted vs Log10 Adjusted Independent Variable, ESG ... 42

Figure 7. Unadjusted vs Log10 Adjusted Independent Variable, ENV ... 43

Figure 8. Unadjusted vs Log10 Adjusted Independent Variable, SOC ... 43

Figure 9. Unadjusted vs Log10 Adjusted Independent Variable, GOV... 43

Figure 10. Unadjusted vs S&C Adjusted Control Variable, PROF ... 44

Figure 11. Unadjusted vs Log10 Adjusted Control Variable, SIZ ... 44

Figure 12. Unadjusted vs Log10 Adjusted Control Variable, INNO ... 44

Figure 13. Unadjusted vs Log10 Adjusted Control Variable, LEV ... 45

Figure 14. Residuals vs Fitted Values - Regression Model including ESG ... 47

Figure 15. Residuals vs Fitted Values - Regression Model including ENV ... 47

Figure 16. Residuals vs Fitted Values - Regression Model including SOC ... 48

Figure 17. Residuals vs Fitted Values - Regression Model including GOV ... 48

Figure 18. Distribution of the Error Term ... 49

Figure 19. Box Plot Analysis of ‘Change in Turnover from 18-19’ by ‘Grouped ESG’ ... 56

List of Tables

Table 1. List of Keywords ... 26

Table 2. List of Journals Used... 28

Table 3. Sector Spread for Companies within Sample ... 39

Table 4. Descriptive Statistics for Non-Adjusted Variables ... 40

Table 5. Correlation Matrix of Adjusted Variables ... 45

Table 6. Descriptive Statistics for Adjusted Variables ... 46

Table 7. Mean of Error Term ... 49

Table 8. Correlation of Residuals vs Independent Variables ... 50

Table 9. VIF-Test for all 4 Regression Models - ESG, ENV, SOC & GOV ... 51

Table 10. Regression Model including ESG as Independent Variable ... 52

Table 11. Regression Model including ENV as Independent Variable ... 53

Table 12. Regression Model including SOC as Independent Variable ... 54

Table 13. Regression Model including GOV as Independent Variable ... 54

Table 14. Analysis of Variance... 56

Table 15. Group Means ... 56

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1 1. Introduction

Investments are made by companies to first and foremost obtain return on the investment.

However, engaging in sustainable investments is growing globally to ease the company’s impact on the environment and to improve working- and societal conditions in the proximity of the company’s sites. As demand from stakeholders of companies to better their practices increases, it is harder to neglect making sustainable investments. Quantifying and measuring company sustainability is a rather new phenomena although its rapidly growing interest among different stakeholders is hard to disregard. Refinitiv is one of the companies doing this by combining and grading Environmental, Societal and corporate Governance aspects of the company in a so-called ESG-score (Refinitiv, 2019). This study aims to help managers of companies whether or not to make the decision to invest in sustainable actions.

This by showing what impact ESG-scores have on turnover growth on companies with recent US IPOs.

1.1 Problem Background

To establish company longevity, growth is inevitable. A report by INNOSIGHT (INNOSIGHT, 2016) about turnover in the S&P 500 companies suggests that 50% of them will be replaced in the coming 10 years due to organizational inertia and lack of long-time visions. A survey brought up in the report points out that executives believe too many companies lack long-term growth strategies and that the strategies are being undermined by day-to-day decisions. Sustainability can be argued as a way for companies to increase growth. Sustainable Business Network (2018) lists viable arguments as to why a company should consider becoming more sustainable, where several of the arguments can be directly linked to increased financial performance. When a company is taking action to become more sustainable and communicate this in an appropriate way to its customers, sustainability becomes a marketing tool and a way to improve brand image and thus creates goodwill.

Increased goodwill is considered a valuable asset for firms and it can be a unique selling point (USP) that is difficult for competitors to imitate (Johnson et al., 2017, p. 102).

According to Aguilar & Vlosky (2006, p. 1106) and Hustvedt & Bernard (2008, p. 496) consumers are often willing to pay a premium for products that are more sustainable. This would lead to increased turnover for the company. Other benefits of having a more sustainable business model can be more connected to the internal factors of the company.

For example, if a company decides to minimize their material waste in their production it is fair to assume that they will decrease costs of goods sold, ultimately increasing the company's margin. Also, a safe and ethical work environment can result in costs for injuries on workers drastically decreasing. According to Miller (1997), injuries both on and off the worksite cost U.S. employers approximately 1.700 USD per employee a year. If an employer takes action to minimize the absence from work due to injury, costs can be saved and production increased.

Theoretically, one of the main reasons according to Celikyurt et al. (2009) for going public is the need for capital to fund growth. When a company goes public via an IPO, the amount of stakeholders that have influence over the company’s governance increases. As the amount of stakeholders increases, stakeholder pressure should arguably also increase.

Stakeholders are now more concerned about sustainability and are putting more pressure on companies to act sustainably on all the aspects of environmental, social and governance (ESG) criterias. In a worst case scenario, they can sell their shares if the company does not fulfill their commitments to improve sustainability. Thus lowering the value of the stock but also hindering the possibility to further fund growth. This forces companies to change and adapt to the demands of their stakeholders when making sustainable investments, which is

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2 clearly shown when in 2018 a great majority of the companies listed on the S&P 500 were publishing sustainability reports (G&A institute 2019).

The United Nations General Assembly established 17 sustainable development goals (SDG) to address major challenges facing humankind in order to address the interests from sustainability advocates (UN, 2015). The goal of the SDGs is to improve the future of the global population via sustainability by tackling different concerns, such as environmental, social and corruption problems and the goals are interconnected since several of these have similar solutions (United Nations, 2018). In order to create a more sustainable world for future generations, financial gains must be more equal to gains in environmental and social aspects. Organizations and ordinary people must work together and investments and programs must have a long-term mindset in order to reach the SDG goals. Here, companies have a large responsibility and sustainable investments is one way to achieve this.

According to Clark et al. (2015, p. 12), sustainable investments, in the form of a well executed ESG commitment, are both good for sustainability and profits. With the global awareness and extent of the problem, new phrases and words have been coined, where Responsible Investments have become one of the most important ones in the financial sector.

Responsible investments have become popular and have increased rapidly in popularity since Principles for Responsible Investment’s (PRI) launched in 2006. The PRI is the world’s leading advocate of responsible investment. The goal with PRI is to explain investment ramifications of the ESG-factors while supporting its international network to integrate these factors into their investment and ownership decisions (PRI, n.d.). The number of signatories has risen to over 2500 and the number of assets under management now exceeds $15B (PRI, n.d.). Responsible investments can be conducted in several ways and it does not require a predetermined strategy or product. All that must be included is ESG information as a foundation in decision-making and stewardship practices for investments. This is to make sure that factors important for assessing risk and return are regarded (PRI, n.d).

Firms that do not act in a responsible way, or firms that commit to engage according to ESG principle but neglect to live up to expectations may suffer great consequences. Notable recent examples frequently discussed are Facebook and Volkswagen (PRI, n.d). In 2018, the Cambridge Analytica scandal was revealed, where data from 87 million facebook users personal data was used to influence the 2016 US presidential election without consent. And in 2015 it was revealed that Volkswagen had lied about their diesel emission-levels (PRI, n.d). These examples show social and environmental violations as to how a firm shall not act according to ESG-standards respectively, which resulted in large declines in both of their market values, and in Volkswagen's case also a €27.4 billion fine (PRI, n.d).

On the other hand, an analysis of more than 2000 academic studies on the impact of ESG factors and how it plays out in corporate financial performance showed that an overwhelming majority of research results points towards that ESG-commitment has a positive effect on corporate financial performance (Friede et al., 2015).

1.2 Research Purpose

The general purpose with this study is to examine if ESG-scores have any relationship with companies turnover growth. The data that will be examined will be a pool composed of companies which recently went public on the US stock markets. As an IPO is a crucial part, in terms of a growth-stage of the company, we found using recently-gone-public companies

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3 to serve well as the target sample for this particular study. To be more precise, the focus of the study will thus be that of the investigation of the relationship between ESG-scores and turnover growth on companies with recent IPOs in the US. As we are writing this thesis in a company/manager perspective, in addition to our general purpose, we also aim to shed some light on recently-gone-public companies on the US stock market as to whether or not managers should implement sustainability in their business models to achieve a high ESG- score. We find the two conceptions to be rather intertwined and we seek out to provide results and argumentation with substance to both of the above mentioned matters.

1.3 Problematization

As the awareness regarding sustainability increases, the demand for more sustainable options arise in our everyday choices. For instance, from choosing eco-friendly everyday consumables to choosing to invest your assets in sustainability.

With sustainability becoming a more crucial aspect to take into consideration when speaking of business, sustainable finance has been studied intensively during the last few decades. As mentioned above, et al. (2015) found that there is, on an average, a positive relationship between ESG and corporate financial performance. In their overview of the studies, some of the studies used growth metrics as measurement for corporate financial performance. However, it was not disclosed how many or which, hence, this thesis study will dig deeper into the efficacy of ESG as a tool to drive growth within the company.

1.3.1 ESG and Growth

As mentioned in the problem background, ESG can be utilized as a method to build competitive advantages and thus create value, ultimately increasing corporate financial performance. In the lense of the theory of the Resource Based View and the theory of Dynamic Capabilities this section aims to show how ESG and Growth are connected.

In short, Resource Based View can be seen as a framework as to how a company can create a sustainable competitive advantage (SCA). The framework builds on the assumption that companies have unique resources spanning in a wide variety of fields, that rightly used can give them competitive advantages (Barney, 1991). However, in order to be considered an SCA the resource must be valuable, rare, non- substitutable and lastly inimitable, meaning that competitors cannot acquire that specific strategy and copy it (Barney, 1991, p. 107). To connect to the ESG factor it can be assumed that a well developed and executed ESG strategy can be an SCA. The goodwill and good reputation the company will get from sustainable investments are path dependent and rely on factors such as company culture, which is near impossible to recreate (Barney, 1991, p. 115). Technical solutions that are both sustainable and that increase turnover can be legally protected by, for instance, patents.

To be the first mover does not automatically mean that the company has an SCA (Barney, 1991, p. 104). However, being first to implement a specific ESG strategy can create a conception in the minds of the customers that the specific company is the best choice in terms of sustainability and that goodwill and reputation can make it very hard for competitors to steal that position (Barney, 1991, p.104). Therefore, the resource based view will be complemented by the theory of Dynamic Capabilities. Teece et al. (1997, p. 515) states that the companies that continuously are leaders in their industries possess the capability to be agile in a managerial manner and flexible in their innovation in changing business environments, which can be referred to as Dynamic Capabilities. The demand for more sustainable technology forces companies in several industries to compete to be the leader in the new paradigm, to have quick and flexible innovations as a way to become the industry standard and thus take market shares from competitors.

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4 1.3.2 ESG and IPO

This section aims to present a brief understanding on how ESG-scores and IPOs are connected. Going public does, as mentioned, equal more external stakeholder pressure - especially now when the awareness for the climate is higher than ever. A way to use this as a momentum for the company is to not only serve its customers, but also serve the society.

Porter and Kramer (HBR, 2006), argues that companies that can maximize corporate social responsibility, e.g maximize ESG, will have a stronger competitive advantage than that of their peers. Furthermore, in the report Factoring sustainability into IPO planning (PCW, 2011), it is stressed how implementing a sustainable business model is of high importance when going public as there will be more and new stakeholders who will demand satisfactory CSR.

The Legitimacy Theory in connection to sustainability will be incorporated as a way to examine whether an ESG-score can create legitimacy for a business model in terms of growth, and ultimately increased return for investors. Furthermore, it can be used to investigate if a high ESG-score equals that of the company being perceived as a legitimate business in the lens of the society, as an IPO gives the public more external pressure on the company to act responsibly. This is how the Legitimacy Theory connects to the IPO-aspect of this study as well.

1.3.3 Growth and IPO

Growth needs funding, and an IPO is many times the right decision to make as a manager.

Theoretically, some of the main reasons as to why companies initiates an IPO are (i) that it creates liquidity for the company’s shares, (ii) that current owners are looking for an exit, (iii) that it provides cheaper access to capital, (iv) that it can fund growth and (v) that it enhances company transparency, among others (Celikyurt et al., 2009, p. 345). Financially speaking, issuing an IPO can be perceived as one of two reasons to serve as the answer in a growth stage. Firstly, as (iv) states by Celikyurt et al. (2009), a successful IPO can fund growth because capital from investors are injected into the company which further can be used for strategic growth decisions that later on will provide higher turnover rates. Secondly, the decision to go public via an IPO can be seen as a positive disruption in access to funds.

Undergoing an IPO gives the company increased access to larger organized financial markets and thus increases the ability to raise equity. Kaserer & Schiereck (2007) suggests in a study, in which they investigate the cost of capital between going public and being public, that having the company’s stock on a trading platform with an organized liquid market lowers the cost of capital. Further, in the paper Why Do Companies Go Public?

Pagano et al. (1998) argues that the reason for undergoing an IPO might not primarily be based on the need for funds to accelerate growth by the means of opportunities presented.

Instead it is suggested that the reason many companies choose to go public is a product of the fact that it has already experienced abnormal growth and need to rebalance their balance sheets after high investments, hence the need to lower the leverage and cost of capital.

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5 1.3.4 ESG, GROWTH and IPO

Figure 1. Johnson-Sandberg ESG-Growth-IPO Model.

How ESG-Growth-IPO theoretically connects to one another has been briefly presented in the problematization. The green center in the picture above highlights the point that this thesis intends to focus on. Going forward, finding research on how ESG can enhance financial performance is not difficult. However, the research is too often generalized when speaking in terms of financial performance. Different studies show different results depending on which parameters have been studied, e.g. return on assets, return on equity, turnover, cost of goods sold, market value and so forth. Academically, the heterogeneous consensus though is that a high ESG-score does actually enhance financial performance, which has recently been shown by Friede et al. (2015) in a literature overview of over 2000 empirical studies on the relationship between ESG and corporate financial performance (CFP).

Conclusively, we have identified a research gap which has not yet been studied, namely the isolation of the growth parameter turnover growth and further investigating its relationship to the ESG-scores of companies with recent IPOs. The US stock market will be chosen as the field of this study because of the high number of companies and IPOs as well as the amount of accessible data.

1.4 Research Question

Our intention with this thesis is to investigate the ESG-score - turnover growth relationship through the following research question:

Does ESG-scores affect turnover growth in companies with recent IPOs in the US?

1.5 Theoretical Contributions

With this thesis we seek to participate in the theoretical discussion around the framework of theories we have constructed in order to analyze ESG-score and company growth on companies with recent IPOs on the US stock market. With no previous research on the isolation of the growth parameter turnover growth to ESG-score relationship, we aim to

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6 contribute to the existing literature by highlighting the possible importance of the ESG- score in terms of turnover growth for companies with recent IPOs on the US stock market.

Higher demands from customers and society at large put pressure on companies to adapt to the changing external environment and we wish to further build on the knowledge around effective adaptation to a more sustainable business model as a possible competitive advantage that drives growth. Sustainability is a fairly new research field and therefore several research-gaps can be identified. We find this field to be important for the future and intend to contribute by filling a small portion of the gaps.

By further adding to the theoretical knowledge regarding ESG-scores and its effects on company growth we aim to contribute to a more extensive explanation on how sustainable investments impact company turnover growth. Given our results, we can provide decent data that can strengthen or discard the conception that sustainable investments are good for company growth, which certainly will help future discussions on the topic. Managers for companies that consider to improve their ESG-score around the time of an IPO can use our study in part when building a theoretical understanding of the pros and cons of investing sustainably to better their ESG-score.

1.6 Practical Contributions

Firstly, this paper can have practical contributions for managers in the sense that it can strengthen managers' theoretical knowledge base for sustainable investment decisions.

Sustainable investments can be a large investment and uncertainty in the outcome can be a reason as to why managers decide not to invest in sustainability. Today, ESG data influences investor decisions more than ever (Hanson et al., 2017). By showing whether ESG has a positive effect on turnover growth among companies with recent US IPOs, managers can make a more rational decision about sustainable investments as a tool to increase turnover if they are in the stages of initiating, undergoing or recently underwent an IPO. With social and environmental responsibilities taking on a more crucial role for companies, it is hard to argue for negligence of taking these factors into consideration when making strategic financial decisions on a corporate level. Secondly, investors can apply this paper's findings when evaluating the risks/benefits of investing in companies that initiate an IPO that also has a high ESG-score. Lastly, other stakeholders such as groups arguing for or against environmentalism or social responsibility can use this paper to strengthen their arguments in order to lobby for their beliefs.

1.7 Limitations

The fact that ESG-scores are a reasonably new phenomenon, the sample will most likely suffer from this in terms of being limited in the number of companies both being public and possessing an ESG-score.

During the time in which this thesis has been written (during late winter and spring 2020), the world has experienced a rarely seen kind of virus formally named SARS-CoV-2, and it has been spread to literally all the corners of the globe. In early March, Sweden's government decided to partially shut down schools and universities. This has put restraints on the availability of our university’s auxiliary means and the university library’s resources, ultimately curtailing the ability to retrieve resources to aid us in this study. This is in no way an excuse, merely an acknowledgement that this thesis has been written under extraordinary circumstances in regards to how external factors usually affect or does not affect the production of a degree project like this.

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7 1.8 Delimitations

We see the three factors ESG, Growth and IPOs as of somewhat equal weights in terms of importance in a company/manager perspective. However, as we wanted to include the three in this study, but at the same time take into consideration the time- and resource restraint put on us, we felt the need to limit the study. We agreed upon to use ESG and Growth as our independent and dependent variables respectively, and companies possessing both an ESG-score and who recently underwent an IPO in the US will serve as our sample. By limiting the study in this way, we are still able to put emphasis on all of the three factors.

We also needed to draw a line as to when to consider an IPO as recently undergone. We drew the line at the issue of the IPO was during 2015 at the earliest to be able to obtain a large enough data sample of companies possessing an ESG-score. ESG-scores are also a relatively new measure so going further back in time could lead to a significantly larger and/or representative sample.

1.9 Choice of Subject and Preconceptions

We are two students from the Business Administration programme with specialization in retail and supply chain management at the Business School at Umeå University, and are writing this as a final degree project thesis. We both are in our first year masters and have decided to specialize in finance and in business development as our majors respectively. As students currently in our fourth year, our theoretical background has given us insights in a wide array of business related subjects. One of us has international experience coming from an exchange semester at a prestigious school in the largest economy in Europe, whereas the other has gathered extensive insights in the financial sector from when working as a private equity intern and continuously working part time for the same private equity firm. Both of us have been engaged in personal savings and stock investments for several years. We find that these experiences and knowledge combined give us a deep understanding in both strategic and financial decision making. Furthermore, we have been molded by narratives of sustainability from an early age and have had sustainability integrated in almost all of our courses at university - this has sparked our interest in this particular field. However, we consider ourselves to be somewhat sceptical to societal trends, i.e ‘The Greta-effect’, hence our decision to include ESG as a sustainability measure in our study in order to convince ourselves that it is not just a trend.

We believe that sustainable business development and favorable corporate financial performance can go hand in hand. Therefore, as we found that business development and financial management in many cases overlap, we believe that we could come up with a subject to study that would (i) satisfy the interests of both of us and (ii) possibly be useful for financial institutions and business managers, where the latter is dependent on the outcome of the study.

Generally speaking, we have the same interests although we might have biases in what we would like the results to look like. However, as one of us have experience as a private equity analyst with practically 100% focus on cash-flow and financial strategies, and the other have comprehensive education in sustainable business development, we consider probable practical preconceptions to be considerably mitigated.

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8 2. Theoretical Point of Reference

This chapter will present a broader view of the tools and concepts connected to our research. In addition, previous research related to our research topic will be addressed to help us identify a research gap of interest. By filling this gap we aim to increase the knowledge within the sustainable investments and sustainable business development research areas.

2.1 Company Growth

With the intention of this study to examine the relationship between ESG-score - growth, a disambiguation of the term growth has to be made. There are many ways to measure company growth. Gupta et al. (2013, p. 2) argues that enterprise growth can be defined by different terms, terms like revenue generation, adding value to the company, business expansion by acquisition in terms of volume. Even measurements of qualitative features can be used to assess enterprise growth, like increased goodwill of the customers.

Enterprise growth measured by revenue generation is often calculated by year-to-year turnover to observe if there is an increase or decrease in turnover from one year to the next.

Value addition, for instance, could be that of hiring staff with highly sought-after knowledge and skills. Business expansion by acquisition entails growth as a product of acquiring a market competitor or even acquisition of a supplier in the supply chain. The qualitative growth feature increased customer goodwill indirectly implies that a good relation with customers increases direct sales to the customer and positive word-of-mouth marketing, ultimately making the company grow.

Using a growth parameter in studies with the intention of trying to explain causes and effects does not come without critique. Defining growth can be quite the arduous work. According to Leitch et al. (2010, cited in Gupta et al., 2013, p. 8) one needs to understand the importance of the growth phenomenon in order to conceptualize it properly and that there is a lack of comprehension of causes, effects and processes of growth. Majumdar (2008) argues that, at least to some extent, growth is a social construct, implying that motives and visions of the manager is influenced by not only internal but also external factors. Company heterogeneity and different manager contexts make studying the understanding of growth an even more formidable task. This has been considered when choosing which parameter to include as the dependent variable in this study’s regression analysis. And considering that, we believe turnover growth is about as homogenous and understandable a growth parameter can be for this type of research, hence the decision to use it in later stages of this thesis when investigating the relationship between ESG-Score - growth in the statistical tests.

According to Mateev and Anastasov (2010, p. 272) in their study on determinants of fast growing SMEs in central and eastern Europe, one of the most crucial challenges for creating and growing an SME is that of the access to financing. One of the most common ways to access financing is by going public, which can be seen as a positive disruption in a company’s growth. Issuing an IPO gives the company access to structured financial markets and ultimately the possibility to access - often, but not always - cheaper funding than issuing bank debt. It is argued that SMEs, because of their size and compared to larger enterprises, are more dependent on bank loans. This is because the banks have less information about the smaller companies which makes lending to these companies more risk associated, hence the shorter maturities and higher interest rates on these loans (Mateev & Anastasov, 2010, p. 273). Conclusively, issuing an IPO is of high importance for companies when pursuing growth, as keeping financing costs as low as possible ought to be in the highest of interests for the managers running the companies.

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9 In terms of differentiating the company’s growth from your non-growing peers, Gupta et al.

(2013, p. 3) states that what is highly determinant is the manager's decision-making. In addition, Gilbert et al. (2006) highlights that the factors taken into consideration when making decisions on growth strategies are important. Be it that the results of this study show that a high ESG-score has a positive relation with turnover growth, this study can add knowledge to managers in terms of what factors should be considered when deciding on growth strategies.

2.2 ESG-Scores & Factors

ESG-scores for companies and countries are conducted by several different actors. These actors are private companies with different opinions on what is to be included in their final upon companies bestown ESG-score. To this date, there is no standardization as to which factors and with which weights should be included when assessing an ESG-score. As there is no standardization nor complete transparency in the scoring systems, ambiguity can arise - both for investors and managers. In this thesis however, we are using aggregated ESG- scores retrieved from Eikon’s Refinitiv (formerly Thomson Reuter) Database. Following sections will consist of explanations of the Refinitiv ESG Scoring as well as the pillars serving as a basis for the ESG-score.

2.2.1 Refinitiv ESG Scoring

Since Refinitiv’s aggregated ESG-score is one of the main factors in this thesis study, we believe it is essential for the reader to thoroughly understand their scoring system. This section is based on Refinitiv’s “Environmental, Social and Governance (ESG) Scores from Refinitiv”-brochure dated June 2019 (Refinitiv, 2019).

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10 Figure 2. Refinitiv ESG-Scoring Methodology (Refinitiv, 2019).

The first step is collection of company-relf reported sustainability measures. These measures are then weighted and analyzed in Refinitiv ESG Data which includes over 400 different measurements. However, the ESG-score is partly determined by 178 critical measures, out of the initial 400, divided into three pillars; Environmental, Social and Governance. In addition to the 178 critical ESG measures, 23 controversy measures are weighed in on what is called ESG Combined Score (ESGC).

2.2.2 The Environmental Score

The Environmental pillar (E) of the ESG-score is built upon and scored on a basis of the company’s (i) Resource use, (ii) Emissions and (iii) Innovation (Refinitiv, 2019, p. 6). The Resource use score is based on the company’s performance on reducing the use of materials such as water and energy as well as the utilization of more eco-friendly solutions in their whole supply chain. The Emission reduction score measures the company’s efficiency and commitment to reduce emissions in their processes of the operational nature. Lastly the Innovation score is based upon the company’s efforts put into using technology and opportunities to offer its customers more eco-friendly products which ultimately reduce the environmental footprints produced by the company (Refinitiv, 2019, p. 16).

2.2.3 The Social Score

The Social pillar (S) of the ESG-score comprises four categories; the company’s (i) Workforce, (ii) Human Rights, (iii) Community and (iv) Product responsibility (Refinitiv, 2019, p. 6). The Workforce condition score is not only measuring the company’s efficiency on job satisfaction and keeping the workplace healthy and safe. It also measures its ability to adapt to and maintain diversification and equality in terms of opportunities at the workplace as well as development opportunities. The Human Rights score reflects the company’s efforts in respecting the conventions of fundamental human rights. The Community score shows the company’s endeavours towards being a good citizen, respecting self-evident business ethics as well as protecting public health. Product

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11 responsibility is scored based on the company’s ability to produce services and products that consider customer health, data privacy and as well as integrity (Refinitiv, 2019, p. 16).

2.2.4 The Governance Score

The Governance pillar (G) of the ESG-score is based on three governance aspects; the company’s (i) Management, (ii) Shareholders and (iii) CSR Strategy (Refinitiv, 2019, p. 6).

The Management score is a measurement of the company’s effectiveness and commitment on conducting ‘best practice corporate governance principles’. The Shareholder score is given to assess the company’s pursuance of equal treatment of shareholders and utilization of anti-takeover devices, commonly known as “poison pills”. The CSR Strategy score is a measurement that assesses the quality of the way the company integrates its communication of economic, social and environmental aspects of their decision making in day-to-day operations (Refinitiv, 2019, p. 16).

2.3 What Drives Corporate Social Responsibility and ESG?

In the digital age we currently live in, information about irresponsible and unethical activities committed by companies are more difficult to cover up and the information spreads quickly to a wide audience. The consequences of wrongdoings are therefore more grave than previously. For this reason, companies arguably put more effort into being more environmentally and socially responsible in their actions to avoid large, long-lasting and damaging periods of bad press. The Facebook and Volkswagen scandals are examples of how damaging and wide-spread these revelations can become.

However, companies do not only pursue higher CSR as a measure to reduce risks, but also to increase company value. There are several reasons for companies to strive for an environmental and socially responsible business model to enhance company value. Dimson et al. (2015) highlights in an overview of CSR engagements of public US companies between 1999-2009 four different channels to increase company value through ESG activism. First, diversified product portfolios and socially conscious consumers increase customer loyalty, ultimately leading to a customer willingness to pay higher prices for the company’s products. Second, companies that maintain employee satisfaction above the average of that of their peers also tend to outperform the market. Third, companies perceived as a legitimate business appear to attract more customers than morally questionable businesses. Fourth, prosperous investor interference indicates improvements in future governance practices.

Further, Bénabou & Tirole (2010) discuss three dimensions to distinguish what motivates CSR engagement in a more psychological aspect which are (i) a “doing well by doing good”-situation, the win-win scenario (ii) the delegated philanthropy and (iii) the Insider- initiated corporate philanthropy.

A win-win scenario is as the name implies a situation where both parties achieve gains from a certain decision. In the sense of committing to improve ESG practises and at the same time increase turnover, it would imply that a company can enhance financial performance, i.e. increase turnover and subsequently adopt sustainable measures to increase the ESG- score. More specifically, the idea is that having a sustainable long-term perspective within the company should fuel greater long-term profits. Keeping a short-term perspective to generate quick profits for shareholders could for example; 1) halt the long-term improvements necessary to increase workforce conditions which in turn would make the company less likely to attract new, talented employees. Or 2) cut down on monitoring of

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12 safety and/or pollution to decrease costs in order to improve profit margins, where the entirety of such a decision possibly could end up in a disaster, economically speaking.

However, the same long-term appliances should be utilized in a vertical point of view and not only internally within the company. Caressing suppliers and making sure that raw materials are obtained from sites with environmentally friendly and socially acceptable practices would strengthen long-term relationships throughout the whole supply chain.

Simply put, the company ought to strive for a sustainable long-term perspective in order to establish company longevity and long-term profits (Bénabou & Tirole, 2010, p. 9-10).

Rather than the company paying for sustainability itself, the Delegated Philanthropy-vision implies that certain stakeholders pay for CSR engagements instead. To some extent, employees, customers and investors have a certain willingness to pay for environmental and social responsibility in terms of lower wage, paying a higher price for products and services or sacrifying a part of returns respectively. For monetary sacrifices by external stakeholders like those implied in the delegated philanthropy to occur, the company needs to present thorough explanations as to why people would want the company to engage in CSR activities on their behalf. Theoretically, it boils down to information and transaction costs.

An individual could on her own send money to banana farmers on the other side of the planet to increase their salaries, but that would require extensive information gathering and considerable transaction costs. She could possibly donate through a charitable organization, but transaction costs would still exist and they most likely also surpass those of the company - who already have a financial connection to the banana farmers. In this sense, delegated philanthropy is a reasonable argument for what drives CSR (Bénabou & Tirole, 2010, p.

10-11).

As opposed to the delegated philanthropy-vision, the Insider-initiated corporate philanthropy-vision implies that the managers or board members of the company initiate CSR engagement rather than demands from other stakeholders. In this scenario, what motivates CSR activities reflects the desire of managers or board members to engage in philanthropy. For instance, managers can decide to conduct sustainable investments in a supplier for their own benefit, or make donations to a charity organization in which a board member of the company has a seat or is a needle mover. This dimension can cause governance issues where dimension (i) & (ii) in this same sense cannot. It can be a question of agency costs where the manager engages in making decisions that fulfil their own desires of philanthropy but at the same time does not necessarily provide any benefits for the company. When CSR is incorporated in the business it is often a strategic decision with the long-term goal of it being profitable in the future (Bénabou & Tirole, 2010, p. 11).

To conclude, what drives and motivates ESG activism and corporate social responsibility can be a singular or a mix of multiple different reasons. Research like Dimson et al. (2015) and Bénabou & Tirole (2010) suggests that motives and reasons for CSR generally are for the good of society. However, some research suggests that greenwashing also serves as a motive for conducting ‘sustainable’ investments and engaging in CSR activities. This will be considered when going forward with this thesis investigation of the ESG-score - turnover growth relationship.

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13 2.4 The Subjectiveness of ESG-Scores

ESG was first coined in 2005 in a milestone study named Who Cares Wins, and 15 years later, ESG investing has rapidly increased in popularity amongst investors to the point that it is estimated at over $20 trillion in AUM (Forbes, 2018). Still, as there is no standardization of metrics nor complete transparency in ESG-score assessment yet, questions whether ESG- scores are subjective arise. To place a score or rating on a company empirically, one must be able to comprehend the basal assumptions, which according to the report Ratings That Don’t Rate - The Subjective World of ESG Rating Agencies clearly are biased (ACCF, 2018). For instance, the report shows that the same company can have a high difference in assessed ESG-score based on which rating agency handed out the score (ACCF, 2018, p.

14). The report conclusively suggests feasible recommendations like standardization of metrics and defined calculation methods. This makes for an interesting future on how to make ESG-scores more empirically applicable, paramountly for investigative studies like the one in this thesis. However, the general consensus of the usage of ESG to measure company sustainability is positive and it has in the latest years matured to be exceedingly used when studying sustainable development and sustainable investments, which gives us confidence in using ESG as our sustainability measure. Regardless of the outcome of the statistical tests in this study, one has to keep in mind that one of the variables used is of the subjective nature.

2.5 Companies on the US Stock Markets

There are several reasons as to why the decision to choose recently-gone-public companies on the US stock market as our data sample has been done. Firstly, as above mentioned, one of the main reasons for going public is the need for capital to fund growth (Celikyurt et al., 2009, p. 345) - which is clearly connected to what we are intending to study. Secondly, the two largest stock exchanges in the world, NYSE and Nasdaq, are American, and thus the american stock market contains the largest data-set accessible for research. Thirdly, the popularity of sustainability is not evenly distributed across the world. Generally speaking, environmental practices are more prominent in European countries than in North America, and the US is one of the worst countries in terms of environmental measures (Peiró-Signes et al., 2013, p. 106). Lastly, we consider the transferability of this studys’ results from the US stock markets to other stock markets to be high because they are not exclusively for american companies, but rather consists of companies from all around the globe.

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14 3. Theoretical Framework

The focus in this part of the thesis is to explain existing theories useful for this study. By examining previous research, we have constructed a theoretical framework which we intend to use in our research. The theories we found to be relevant are: Resource Based View, theory of Dynamic Capabilities and Legitimacy Theory . Further explanation of these theories and their connections to our research purpose as well as critique against them will be presented.

3.1 Resource Based View

The Resource Based View is a model that views resources as the key to superior performance among firms. The resources are not limited to material resources as long as the resource can show to contain the factors Value, Rarity, Inimitability and cannot be substituted. The resources a firm possess enables the company to gain a competitive advantage that can be sustained over time, a so-called Sustainable Competitive Advantage (Barney, 1991).

A resource is defined in Barney (1991, p. 101) as “all assets, capabilities, organizational processes, firm attributes, information, knowledge, etc. controlled by a firm to conceive of and implement strategies that improve its efficiency and effectiveness”. Further, when discussing Resource based view, a sustainable competitive advantage is defined as “When it (a firm) is implementing a value creating strategy not simultaneously implemented by any current or potential competitor and when these other firms are unable to duplicate the benefits of this strategy” (Barney, 1991, p. 102).

Resource based view builds upon two assumptions; that (i) resources are heterogeneously distributed across firms, meaning that companies do not have the same resources and capabilities and (ii) these differences are stable over time, meaning that they cannot be moved from one company to another which in turn means that heterogeneity will be sustained over long time periods (Barney, 1991, p. 101). Barney (1991, p. 103) argues that a firm cannot obtain a sustainable competitive advantage if we were to assume the opposite, that resources were homogeneous and mobility of strategies were perfect. In such a scenario all companies in a specific industry would have that same resources and abilities to exploit them, this means that as soon as one company develops a new strategy all the competitors would soon implement the very same strategy if it showed to be successful. Thus, a company cannot build a sustainable competitive advantage under these circumstances.

As mentioned above, a sustainable competitive advantage must contain elements of value, rarity, inimitability and non-substitutability. Why value and rarity contributes to a competitive advantage is quite self explanatory. What is more important in terms of a sustainable competitive advantage is inimitability and the non-existing threat of substitutes.

Inimitability according to Barney (1991, p. 107) can stem from one of either three ways. 1) unique historical conditions, 2) causal ambiguity and 3) social complexity. Firstly, the conditions during the time and space when a company develops its competitive advantage cannot be recreated by competitors since time and space do not return in the exact same manner, i.e. unique historical conditions (Barney, 1991, p. 107-108). Secondly, when competitors are unable to clearly distinguish the link between the resources controlled by a company and a company’s sustainable competitive advantage and thus do not understand what causes the success is referred to as causal ambiguity (Barney, 1991, p.108-109).

Lastly, sustainable competitive advantages can stem from complex social phenomena, i.e.

social complexity, such as company culture and values, which are impossible to

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15 systematically manage or control. Strategies that are launched thanks to these complex social phenomena cannot be duplicated by competitors (Barney, 1991, p.110). Non- substitutable is referred to as there must be no other strategically valuable company resource that is equivalent to the sustainable competitive advantage of company A, that also fulfil the rare and inimitable criteria controlled by company B that can substitute the sustainable competitive advantage of company A (Barney, 1991, p.111).

Figure 3.”The Relationship Between Resource Heterogeneity and Immobility, Value, Rareness, Imperfect Imitability, and Substitutability, and Sustained Competitive

Advantage” (Barney, 1991, p. 112).

The Resource Based View relates to what we seek out to investigate in the sense that it is a way to increase turnover growth for companies. In our opinion, building a sustainable competitive advantage based on the unique resources possessed by a company will by the definition of Resource Based View be valuable, and thus lead to an increased market share that in turn will increase the turnover growth over a long-term horizon. An ESG strategy can be seen as a sustainable competitive advantage if it is implemented in a way that is in accordance with the Resource Based View. As previously mentioned in chapter 1, companies are moving towards more sustainable business models. The competition to be the leader of new sustainable technologies and to be the company that is on top of mind among customers when it comes to sustainability is fierce. Not doubtfully will there be several proposals by companies as to why they are the best option but only the companies that possess an ESG strategy with a sustainable competitive advantage are able to see the desired growth that comes with not having competitors breaching into one's strategy.

3.1.1 Critique on Resource Based View

Critique on the Resource Based View has been voiced, despite the big impact and recognition the theory has had on management. Kraaijenbrink (2010, p. 350) have voiced three main critiques that challenge the basis of the Resource Based View. First, the limited explanation of competitive advantage. Second, the borderless description of the two central concepts “resource” and “value”. Third, that the Resource Based View adheres to an improper limited neoclassical economic rationality that decreases the possibility of further development of the theory. Also, an overemphasis is put on the control of individual resources and faulty affirmations of the weight of constructing resources and the human involvement in estimating and creating value. For that reason it does not grab the basis of competitive advantage (Kaaraijenbrink, 2010, p. 359).

In addition to the critique from other researchers on Resource Based View, it seems to us that Barney’s view on substitutability and the longevity of an SCA is underestimated.

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16 Technology and demands from stakeholders vary over time, making what will work in terms of a successful sustainable competitive advantage vary too. Teece et al. (1997, p. 513-514) argues that the Resource Based View lacks a well grown perspective on developing new strategies but rather focuses mostly on the resources the company already has. Further, in order to help managers, the Resource Based View must be complemented by the theory of Dynamic Capabilities to suit what we investigate.

3.2 Theory of Dynamic Capabilities

Before the emergence of Dynamic Capabilities, the focus on previous research on the topic mostly revolved around sustaining and safeguarding already existing competitive advantages. What Dynamic Capabilities contributes with is looking at how and why companies could build competitive advantages in environments in a rapidly changing environment (Teece et al., 1997, p. 509). Dynamic Capabilities has its relevance in a

“Schumpeterian world of innovation-based competition, price/performance rivalry, increasing returns, and the ´creative destruction´ of existing competences” (Teece et al., 1997, p. 509).

The competition in high-technology industries is fierce and have been shedding light on the need for an enlarged paradigm to understand how to build competitive advantages. Large companies in such industries often show signs on following the Resource Based View strategy by accumulating patents on key technological solutions (Teece et al. 1997, p. 515).

However, this is not enough to build a real sustainable competitive advantage. Teece argues that “Winners in the global marketplace have been firms that can demonstrate timely responsiveness and rapid and flexible product innovation, coupled with the management capability to effectively coordinate and redeploy internal and external competences”

(Teece et al., 1997, p. 515).

What the two key terms of Dynamic Capabilities - ‘dynamic’ and ‘capabilities’ - are referred to is 1) the capacity to reinvent competences to be in line with the changes of the business environment in which the companies exist in, which is of importance when time-to market, timing, the technological change is rapid and uncertain developments in business environment are crucial factors. And 2) the strategic management's ability to adapt and change the internal and external organizational skills, functional competencies and resources to be aligned to the changing business environment (Teece et al. 1997 p. 515).

One challenge of Dynamic Capabilities is the influence from previous choices. A company cannot make large changes from day to day, they are somewhat limited to the trajectory chosen to develop competence (Teece et al. 1997 p.515).

Dynamic Capabilities is relevant for this thesis study in the sense that it covers the gap the Resource Based View left when it comes to companies quickly reacting and responding to changing environments in order to stay competitive. As mentioned above the continuous winners in any certain industry are the ones that can respond with innovation to a changing business environment. We assume that a company that time and time again can stay innovative and ahead of the competitors will take market shares and ultimately sell more goods, hence increasing turnover growth. Dynamic Capabilities also suits the ESG-criteria of our study in regards to sustainable technological development and the fact that demand for sustainable solutions is a field with high competition and one that changes rapidly.

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17 3.2.1 Critique on Theory of Dynamic Capabilities

Arend & Bromiley (2009, p. 87) argues that Dynamic Capabilities lacks a coherent set of underlying assumptions or a coherent theory. The Dynamic Capability-theory must start off with something that resembles a theory or model otherwise it will be difficult for other researchers to build upon Dynamic Capabilities. This will result in, according to Arend &

Bromiley (2009, p. 87), that soon the field will leave Dynamic Capabilities behind in gain for other more elaborated theories of strategic organization.

Peiró- Signes et al. (2013, p. 110) conducted a study on US companies and discovered that the lowest quartile of firms in their industry in terms of ESG- performance had significantly better financial performance than those in the top quartile. However, the top quartile in terms of ESG-score had significantly higher revenue per employee and cash flow per share values, when adjusted for industry. What can be concluded by this study is that it seems to be more effective to be in the extremes of ESG-scores contrary to the industry standard (Peiró-Signes et al. 2013, p. 110).

This raises the question if it is worth it to be ahead of the curve and take on costly sustainable investments if the performance for the companies that are in the lowest quartile have better financial performance. However, by not being up to standard in sustainability poses risks of lagging behind if the new sustainable strategies becomes industry standard. Also, regulators may impose laws that potentially can severely damage the laggards business models.

3.3 Legitimacy Theory

Legitimacy Theory stems from a socially constructed understanding of what legitimate behavior of an organization, in this case a company, is. The idea is about how observers such as stakeholders and/or the general public perceive the company that creates reactions and mirrors the compatibility between the behaviors of the company and the shared belief- system of the observer. If the behavioral pattern matches what the observers support or can accept, the company can be considered to have legitimacy. A company can somewhat deviate from the behavioral pattern but cannot change the pattern completely (Suchman, 1995, p. 574). It is the social contracts between observers and companies that decides the legitimacy of said company. The definition of legitimacy we are going to use as our interpretation comes from Suchman’s work “Managing Legitimacy: Strategic and Institutional Approaches”:

“Legitimacy is a generalized perception or assumption that the actions of an entity are desirable, proper, or appropriate within some socially constructed system of norms, values, and beliefs” (Suchman, 1995, p. 574).

There are three distinct categories of legitimacy. 1) Pragmatic legitimacy that comes from the observers self-interest and which is based on their own view on utility calculations.

Because of that, companies can theoretically reward specific observer-groups and thus buy pragmatic legitimacy (Suchman, 1995, p. 584-585). 2) Moral legitimacy is seen as more pro-social and acting “the right way”, and the moral legitimacy builds upon normative approval (Schuman 1995, p.579). 3) Cognitive legitimacy builds on the essential and distinguishing attribute of a company, meaning that legitimacy comes from the availability of cultural models that give answers for the operations of the company. The predictableness of the company’s activities will increase with these three models. If not taken into account, activity will fall apart due to mistakes, oversights and distractions (Schuman 1995, p. 582).

The Impact of ESG-Score on Turnover Growth