Nina Elomaa and Riku Ruokolahti – ESG, Reputation, and Leadership: No One Wants to Do Business with Crooks

“Corporate responsibility has surely been a topic of discussion for as long as business itself has existed. The pursuit of one’s own interests without regard for moral and ethical rules or the expectations of others has always been viewed with suspicion, even if the actions themselves did not directly violate the law,” write Nina Elomaa and Riku Ruokolahti in the book Why Do We Need a Reputation?

When someone acts within the law but contrary to prevailing moral and ethical standards, it is not the authorities who enforce the rules, but the emotions within us as human beings. Word gets around, and trust erodes. People do not voluntarily do business with crooks, whereas they specifically seek to do business with reputable actors. This is true among people and, as research shows, also between companies.

UN Secretary-General Kofi Annan sends a letter

In 2004, then-UN Secretary-General Kofi Annan sent a letter to the CEOs of more than fifty major financial institutions. With the blessing of the World Bank, the International Finance Corporation (IFC), and the Swiss government, Annan invited the executives to participate in a joint initiative aimed at integrating sustainability considerations into the capital markets.

A year later, the project produced a report titled *Who Cares Wins*. The report argued that integrating environmental, social, and governance (ESG) perspectives into capital markets would be a wise move. This would lead to more sustainable business practices and better communities.

ESG is, therefore, a joint effort by visionaries and policymakers aimed at integrating sustainability considerations into corporate finance. Nearly two decades later, it appears that this is indeed happening—and, in some respects, has already happened.

But why has this taken so long?

Maximizing profits and shareholder value goes hand in hand with sustainable business practices

On September 13, 1970, Milton Friedman wrote an essay for The New York Times titled “A Friedman Doctrine: The Social Responsibility of Business Is to Increase Its Profits.”

In his essay, Friedman considered who bears responsibility for accountability. In Friedman’s view, a company is merely an artificial business entity that, as such, can bear only artificial responsibilities. Responsibility can only be attributed to people. And since management works for the shareholders, it is their responsibility to maximize the latter’s benefits—that is, the financial results of the business. Shareholders, as individuals, can then assume whatever responsibilities they deem appropriate.

During the boom years of the 1980s, the business elite became enthusiastic about the idea that the sole purpose of business operations, management, and governance was to safeguard shareholder value—and, more specifically, to maximize it. A new nuance in Friedman’s ideas was the shift in focus from business results to corporate market value.

Many prominent economic experts have since called this way of thinking one of the most egregious mistakes in the history of management science. Even Jack Welch, regarded as the father and superhero of the school of thought that swore by shareholder value maximization, stated the following in a 2009 interview with the Financial Times:

“The idea that a company should focus on creating shareholder value is the silliest idea in the world: shareholder value is the result of the combined efforts of management and employees. It is not a plan or a strategic focus. Your business is kept afloat by your employees, your customers, and your products.”

Business practices that are sustainable for companies’ stakeholders, nature, and the planet—as embodied by ESG principles—are, in a sense, the antithesis of market opportunism.

Despite all this, we still encounter a mindset that prioritizes shareholder value above all else. One obstacle to the growth of sustainable business is precisely the value system by which companies are managed. There is a very long way to go from treating the maximization of shareholder value as a sacred principle to operating in a manner that is environmentally sustainable and takes the company’s stakeholders into account.

The frantic rush to generate ever-increasing profits at an extremely rapid pace is often at odds with sustainable business practices. Another obstacle to sustainable business is its upfront costs. Sustainable and long-term solutions often require substantial investments.

On the other hand, many companies externalize their costs onto people, societies, nature, and our planet. A morally and ethically unstable company may not even succeed in transitioning to sustainable business practices if its competitiveness is based purely on shifting costs to a third party.

Shareholder value is driven by corporate responsibility

Fortunately, researchers are not sitting idly by while the world moves forward. Over time, evidence has begun to emerge that companies that voluntarily act responsibly perform better in the long run than their less responsible counterparts. One of the most compelling pieces of evidence for this is the article “The Impact of Corporate Sustainability on Organizational Processes and Performance” by Robert G. Eccles, Ioannis Ioannou, and George Serafeim, professors at Harvard University and the London School of Economics .

Eccles, Ioannou, and Serafeim identified 90 companies that, as early as the early 1990s, had adopted various environmental and social responsibility policies, launched initiatives, and made strategic decisions. They designated this group as highly responsible companies.

As a control group, the researchers identified a similarly sized group of companies that had not actually initiated any measures of the kind mentioned above. This control group of 90 companies with low sustainability performance corresponded quite closely to the group with high sustainability performance. The control companies were from the same industries, were of similar size, and had comparable performance, growth potential, and capital structure. On this basis, the companies’ development could be tracked in terms of business operations, sustainability, and the development of business processes; however, from an ESG (i.e., financial) perspective, nothing was as interesting as the development of financial performance and shareholder value.

The table below shows the evolution of the shareholder value of these two portfolios. The researchers calculated this development by investing $1 in each equally weighted portfolio in 1992 and tracking the performance of these investments over 18 years, through 2010.

The data clearly shows that, among the companies in the sample, those with high sustainability performance also outperformed their low-sustainability counterparts in terms of shareholder value. Critics, of course, point out that this observed fact may not be due to sustainability itself. After all, the companies in the sample might simply have been better managed from a more traditional business management perspective. For example, they had incorporated sustainability practices into their operations long before sustainability became mainstream. And they might even have a stronger brand and a better reputation… Touché! But let’s come back to this later.

Even the most cynical quick-profit capitalist can no longer deny the fact that corporate responsibility does no harm to companies in the long run. In all likelihood, the opposite is true.

And then came the crash

There is a lot of buzz surrounding the link between corporate responsibility and financial performance. The topic is a popular area of research, and new findings are emerging all the time.

NYU Stern professor Tensie Whelan and her colleagues undertook a monumental task: the researchers searched for and identified over 1,000 studies on the topic and combined them into a single, massive meta-analysis. All of the studies included were quite recent; they were published between 2015 and 2020. To be on the safe side, the researchers also combined earlier meta-analyses into a single meta-meta-analysis. The meta-meta-analysis was derived from 13 different meta-analyses, which in turn included over 1,200 individual studies.

The results of the massive meta-analysis and meta-meta-analysis on ESG and Financial Performance (Whelan et al. 2021) are largely consistent with previous findings. Good corporate governance from an ESG perspective is reflected in the long term in companies through better returns on capital, higher stock market valuations, and lower risk levels. Only a very few individual studies have found that strong sustainability management has had negative effects.

But how and why does responsible management generate economic value? Instead of answers to this question, the researchers found only helpful guesses in their data. Perhaps good ESG management also leads to a more innovative company and more efficient use of resources? Could the social sciences and sociology have something to say about this? And could this be related in some way to stakeholder theory?

Support from stakeholders is crucial to a company's competitiveness and shareholder value

Let’s return to the opening remarks of this article: the pursuit of one’s own interests without regard for moral and ethical rules or the expectations of others has always been viewed with disdain.

The existence and success Reputation&Trust are based purely on stakeholder theory, which views reputation as the perceptions of a company’s operations held by its stakeholders. These perceptions, in turn, arise from how people interpret the company’s decisions, actions, and omissions.

The tone of each stakeholder’s interpretation is decisively influenced by the company’s ability to provide things that are perceived as valuable: the kind of workplace employees want, a clear conscience and products or services that are worth the price for customers, positive impacts and tax revenue for society, as well as a return on invested capital and the joy of ownership for investors.

The voluntary support that stakeholders provide to a company is, in its own way, a key factor in the company’s competitiveness and, at the same time, its shareholder value. After all, people decide for themselves where they want to work, what products they buy, and which companies they invest their money in.

Stakeholder theory posits that different stakeholders have more common interests than conflicting ones, although conflicts do, of course, exist. It is the responsibility of corporate management to balance the common interests of key stakeholders in order to achieve a shared benefit. In this framework, a company’s reputation lies at the heart of competitiveness and leadership. As noted, a company’s reputation is stakeholders’ perception of the company’s ability to produce value, and is therefore a key metric for leadership.

At T-Media, we have been able to clearly demonstrate the link between reputation and purchasing, word-of-mouth recommendations, job applications, investment, and, ultimately, trust (The Handbook of Reputation Management, Ruokolahti 2020). Through this, we have demonstrated the link between reputation and corporate competitiveness and have also provided support for the validity of stakeholder theory. Based on this, we have also created metrics and analytical tools for reputation management.

How did ESG considerations come to be included in the Reputation&Trust model?

When we began developing Reputation&Trust at T-Media twelve years ago, ESG was not nearly as mainstream as it is today. The model’s development did not take ESG perspectives into account; instead, it was developed with a single goal in mind: to identify, isolate, and shape the generic perceptions people have of organizations and that are linked to stakeholders’ actions in relation to various organizations.

The methodology of our qualitative exploratory study was inductive. In practice, this means that we did not seek to test prevailing theories among the interviewees, but rather drew out perspectives and new insights from the qualitative data as they emerged.

Why is this kind of research jargon important in this context? It is important because ESG perspectives emerged from our data without us specifically looking for them—or even necessarily being familiar with the concept itself. Corporate responsibility issues were certainly already on the agenda at the beginning of the last millennium, but we weren’t specifically looking for them either.

So what happened?

(E) Environmental

Traditional perspectives on environmental responsibility were incorporated Reputation&Trust as a separate category. In this regard, we decided to measure the overall perception of whether an organization operates responsibly and takes the environment and society into account in its operations.

(S) Social

Reputation&Trust incorporated the perception of the organization as an employer. However, the content does not follow the traditional framework of employer image, which typically emphasizes career opportunities, job duties, salary, coworkers, or a prominent position. The workplace dimension of our model emphasizes the organization’s social responsibility. From this perspective, we measure stakeholders’ perceptions of whether the organization treats its employees fairly and equitably. Over time, the workplace dimension Reputation&Trust has evolved into a measure of social responsibility—which is, in fact, what it has always been.

(G) Governance

The governance dimension Reputation&Trust measures stakeholders’ perceptions of an organization’s openness and transparency. This assessment is also influenced by the interpretation of whether the organization is acting correctly from a moral and ethical standpoint. Thus, the content of the governance dimension thematically delves into the ESG world, but in the ESG world, governance also involves stakeholders and the organization’s ability to listen to them. And sure enough: over time, the very aspect that emerged as a key component Reputation&Trust—to be measured as a distinct perspective—was precisely…

(D) Dialogue

that is, interaction and the organization’s ability to listen to its stakeholders.

Naturally, those who manage corporate responsibility as part of their job turned their attention to the ESG aspects of Reputation&Trust at a very early stage, and pioneers in the field made the model an important part of their organizations’ sustainability metrics. What made Reputation&Trust particularly interesting to sustainability professionals was the fact that the research methodology distinguished the impact of sustainability-based perceptions on business operations, thereby making the business impacts of sustainability visible.

Highlighting and verifying the business impacts of sustainability, in turn, shed light on the economic rationale behind sustainability-related investments, in addition to ethical considerations.

This gave rise to the need and rationale for treating ESG considerations as a separate statistical category and set of metrics, alongside overall reputation. The ESG Perception Index and company-specific metrics were developed to address this need.

A rigorous longitudinal study produced a knowledge-based time machine

Reputation&Trust will celebrate its tenth anniversary in the fall of 2022. It is striking to note that the model is more relevant today than it was when it was first developed.

Timeliness manifests itself in two different ways. First, this is evident in the world of statistics. National surveys and meta-analyses clearly show that the impact of reputation on stakeholder favorability has grown significantly over the years. The importance of reputation has thus effectively grown. On the other hand, its relevance is evident in surrounding issues, phenomena, and leadership themes. The rapid rise of ESG to the core of finance-driven matters is certainly the most significant single factor among these.

The challenge with longitudinal studies is always comparability. Comparing one thing to another requires rigorous standardization and the ability to implement it strictly. On the other hand, many brilliantly designed longitudinal studies die due to a lack of funding with no end in sight. Creativity, the need for self-fulfillment, and new good ideas, as wonderful as they are, are the bane of longitudinal studies.

Reputation&Trust a welcome exception in that this rigorous research project has been conducted in a standardized manner (research framework, data collection, methodology, structure, content, and so on) ten times in a row. This is just a good start for a longitudinal study, but one that is extremely timely.

The disciplined implementation Reputation&Trust makes amazing things possible in the world of ESG. Perhaps the most mind-boggling of these is the knowledge-based time machine. A longitudinal study launched even before ESG became mainstream enables the measurement and comparison of ESG content, as well as the examination of historical data going all the way back to 2013.

This publication is the chapter “ESG, Reputation, and Leadership: No One Wants to Do Business with Crooks” from the book *Why Do We Need a Reputation?*, written by Nina Elomaa, Head of Sustainability at S Group, and Riku Ruokolahti, Head of Development at T-Media.

NINA ELOMAA serves as the Head of Sustainability at S Group; prior to that, she worked as the Head of Sustainability at the Fazer Group. In her current role as Head of Sustainability at the S Group, Nina Elomaa is responsible for the S Group’s sustainability program as well as the strategic development of sustainability at the group level, its integration into business operations, and leadership. Nina Elomaa has over 20 years of experience in sustainability work. She has previously worked in the energy sector and has experience in procurement and business management. Nina Elomaa is a member of the Board of Directors and the Supervisory Board of WWF Finland, as well as a member of the Board of Directors of the international amfori sustainability network.

RIKU RUOKOLAHTI is T-Media’s long-time Head of Development, author of the Reputation Management Handbook, lead developer of Reputation&Trust, and Chairman of T-Media’s Board of Directors. Riku is also a partner and board member at Third Rock, T-Media’s sister company that promotes responsible business practices.