Eco-Value, Sustainability, and Shareholder Value: Driving Environmental Performance to the Bottom Line

ENVIRONMENTAL QUALITY MANAGEMENT / Summer 2001 / 1

Eco-Value, Sustainability, and Shareholder Value:Driving Environmental Performance to the Bottom Line

Matthew J. Kiernan

Contrary to popular assumptions, superior eco-efficiency is associated with superior financialperformance throughout a range of industries. In fact, environmental leaders typically outper-form laggards by a substantial margin. © 2001 John Wiley & Sons, Inc.

Chief executive officers, chief financialofficers, and investors alike would all bewell advised to contemplate the implica-tions of the phenomenon we have else-where labeled the “Eco-IndustrialRevolution.”1 Take, for example, only oneof the manifestations of the revolution: theclimate change debate. In the remarkablyshort space of only two years, climatechange has morphed from an arcane, mar-ginal, and scientifically controversialissue to a broadly accepted “fact,” a majorpublic policy priority, the number oneissue for the global “crème de la crème” atthe World Economic Forum in Davos,Switzerland, and the driver of ambitious,multi-million dollar strategic mega-shiftsby leading global companies such asRoyal Dutch/Shell and BP Amoco.

In my view, the entire climate changedebate is only the tip of a much largerindustrial and socio-political paradigmshift that is making the “eco-value” or“sustainability” of companies far morecentral to their global competitiveness,profitability, and share price perform-ance than ever before. And we’ve onlyseen the beginning.

© 2001 John Wiley & Sons, Inc.

By and large, the financial communi-ty has given environmental and sustain-ability issues extremely short shrift; theyhave historically been nonfactors ininvestment decision making. Slowly butsurely, however, that is beginning tochange. Environmental considerationsare moving from being the sole preserveof the still statistically marginal “sociallyresponsible” investment movement intothe mainstream.

AN ATTITUDE SHIFTOne of the most critical drivers of

this new, stakeholder-led paradigm shiftis a deep-seated shift in public attitudesthat is surprisingly consistent around theworld. The respected survey researchfirm Environics International recentlycompleted a “Millennium Poll onCorporate Social Responsibility.” Thatunprecedented exercise included inter-views with roughly 25,000 citizens in 23countries on six continents.2 The studywas supported by, among others,PricewaterhouseCoopers and theConference Board. Among the study’smost portentous findings:

Matthew J. Kiernan2 / Summer 2001 / ENVIRONMENTAL QUALITY MANAGEMENT

• The average investor’s opinions ofcompanies now depend more heavi-ly on perceived “corporate citizen-ship” (56 percent) than on eitherbrand quality (40 percent) or evenbusiness fundamentals (34 percent).

• Fully 20 percent of the respondentshad actually rewarded or punishedcompanies financially within thepast year on the basis of their envi-ronmental and social performance. Afurther 20 percent actively consid-ered doing so.

• The “bar” is being raised continual-ly; what was considered adequateenvironmental and social perform-ance only a few years ago is nowunacceptable. What was once lead-ing-edge is now commonplace.

In short, it is a brand new ballgame,an unprecedented test not only of com-panies’ environmental managementquality but also of their strategic man-agement capability.

ENVIRONMENTAL AND FINANCIALPERFORMANCE: THE GROWING NEXUS

Much has been written about thepresence or absence of a robust, positiverelationship between environmental andfinancial performance, some of it in thisvery journal.3 The balance of availableevidence strongly suggests that such arelationship does indeed exist, and thereare compelling reasons to believe that itwill get a lot stronger before it gets weak-er. Most important of all, the major insti-tutional investors have begun to payclose attention. Where their major share-holders lead, major corporations mustinevitably follow.

Historically, mainstream institution-al investors have accepted unquestion-ingly the conventional industry “wis-dom” that the pursuit of environmentalexcellence in companies can only beachieved at the cost of lower financialreturns for investors. An important

corollary of this argument held that sinceenvironmental factors are, at best, irrele-vant to the risk/return equation, prudentfiduciaries are actually precluded fromconsidering them.

It turns out that both the convention-al wisdom and its corollary are, quitesimply, wrongheaded. The U.K. govern-ment’s recent pension reform legislationhas explicitly acknowledged that fact,and other countries such as Sweden,Switzerland, and Germany are consider-ing similar moves. The “prudent fiduci-ary” equation is now—quite rightly—being turned on its head: Since there isnow incontrovertible evidence thatsuperior environmental performance4

does in fact affect the risk level, prof-itability, and stock performance of pub-licly traded companies, fiduciaries arenow derelict in their duties if they do notconsider environmental factors.

Recent pension regulation reforms inthe United Kingdom implicitly acknowl-edge this new reality. And just wait untilthe $25 trillion-plus in worldwide pen-sion and mutual fund assets starts to rec-ognize the profit potential—not neces-sarily the moral righteousness—of “eco-investing.” Then watch out!

But where is the financial evidenceto support this new view? One importantsource of evidence is the long series ofhistorical investment analyses per-formed by highly credible third parties.5

Another is a more recent and focusedresearch program undertaken by ourown firm, Innovest Strategic ValueAdvisors.

The performance graph in Exhibit 1summarizes a live, real-time portfoliosimulation conducted by MorganStanley’s quantitative analysis group inNew York. An “eco-enhanced” S&P 500portfolio constructed with Innovest out-performed its benchmark by 190 basispoints. It is also worth noting that supe-rior eco-efficiency appears to provideadditional protection for investors on the

Fiduciaries are nowderelict in their

duties if they do notconsider environ-

mental factors.

Eco-Value, Sustainability, and Shareholder Value ENVIRONMENTAL QUALITY MANAGEMENT / Summer 2001 / 3

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downside. As the graph demonstrates,even when the overall market dipped,the eco-enhanced portfolio declined by alesser amount.

Similarly promising results wereachieved in a more recent analysis con-ducted in late 2000 by the independentquantitative analysis specialist firm QEDInternational. This study used an evenmore sophisticated “time-series” method-ology. As in the Morgan Stanley test, all ofthe other known investment factors thatcould have explained the outperformancewere normalized out. The potential finan-cial impact of differences in companies’market capitalization, price/earningsratios, industry sectors, and volatilitywere all eliminated through sophisticatedoptimization techniques.

As the chart in Exhibit 2 illustrates,depending on how much emphasis wasgiven to environmental performance fac-tors, the outperformance margin rangedfrom 180 to 440 basis points (1.8 to 4.4percent). The more heavily weighted the

environmental factors, the greater thefinancial outperformance. None of thisoutperformance can be explained by tra-ditional securities analysis.

Most skeptics, however—and not afew agnostics—prefer “harder” evi-dence: actual performance numbers fromreal funds with real money invested inthem. For those of a more skeptical bent,I can report that our firm is intimatelyinvolved in two of these. Alas, both havethe relatively short track record of only ayear or so, a nanosecond in “sustainabil-ity time.” Still, as Exhibits 3 and 4 indi-cate, the early results are at the very leastencouraging.

One, an eco-enhanced S&P 500index fund constructed with MellonCapital, has marginally (7 basis points,.07 percent) outperformed its bench-mark. The other, a global fund with agreater designed risk tolerance and runby ABN-AMRO, is outperforming itsbenchmark by 8.9 percent—a substantialmargin in the investment world.

Exhibit 2. Eco-Value ‘21: Time Series Evaluation Relative Performance Since 12/31/98 vs. S&P 500

Based on information provided by QED International


ECO-VALUE’S EFFECT ON FINANCIALPERFORMANCE

But where does this stock marketoutperformance come from? Whilethere are as yet no studies that conclu-sively prove a direct cause-and-effectrelationship between environmental

and financial performance, it is possi-ble to at least postulate a reasonablehypothesis:

Superior eco-value helps generatefinancial outperformance by con-tributing to at least five well-recog-

Exhibit 4. ABN-AMRO/Innovest Sustainable World Fund Performance (Since Inception)

Exhibit 3. Mellon Capital/Innovest Eco-Enhanced Index Fund (Since Inception)

Exhibit 5. Key Drivers of Competitive Advantage


nized drivers of competitive advan-tage, profitability, and superiorshare price performance. Thesedrivers include shareholder capital,customer capital, innovation capi-tal, cost/risk reduction, and humanresource capital.

Exhibit 5 illustrates the influence of eco-value on these key drivers.

As we have seen, these competitiveweapons tend to produce superior share-price performance, even in a broadlydiversified index such as the Standard &Poor’s 500.

But things really get interesting forinvestors when one “drills down” fromaggregated, marketwide data and focusesin on the financial outperformancepotential in individual, high-impact sec-tors. Let’s look at examples from fourindustry sectors: mining, integrated oiland gas, steel, and electric utilities.

Mining SectorIn the mining sector, the stock

returns of environmental leaders outper-formed those of laggards by 37 percent inthe three-year period from October 1997to October 2000 (see Exhibit 6).

What could account for an outperfor-mance gap of this magnitude? Considerjust a few anecdotal examples of the newinvestment dynamic at work:

• Leading companies such as Alcanand Barrick are now saving $10 mil-lion-plus annually in costs throughenergy efficiency measures.

• Environmental leadership can leadto expedited permitting and astronger negotiating position whencompeting for new mineral leases.

• Corporate social responsibility hasnow become a critical element ofany mine expansion or develop-ment, particularly in the developing

Source: Innovest Strategic Value Advisors


world. (The $6 billion lawsuitagainst Rio Tinto in Indonesia’s IrianJaya provides a recent and soberingillustration.)

• Tightening tailpipe and other emis-sions restrictions are increasingdemand for the platinum group met-als used in fuel cells and catalysts.

Integrated Oil and Gas SectorIn the integrated oil and gas sector,

the stock returns of environmental lead-ers outperformed those of laggards by 12percent over the period from December1997 to April 2000. See Exhibit 7.

To understand why, consider the fol-lowing factors:

• The price tag for failing to report ille-gal hazardous waste dumping in thestate of Alaska has reached $22 mil-lion for just one company (BPAmoco).

• Air quality standards are regularlyreviewed and tightened, often withsignificant financial consequencesfor refining and marketing compa-nies. The United StatesEnvironmental Protection Agency(EPA) has estimated the capital costsrequired to comply at a single refin-ery to be about $210 million, with anadditional $60 million to $100 mil-lion for refineries requiring marineterminal modifications.

Exhibit 6. Mining Sector



• Recent lawsuits filed against Texaco,Unocal, and RD/Shell under theAlien Tort Claims Act are the first tobe filed against individual corpora-tions. If successful, they will sub-stantially alter the risk/return equa-tion for oil and gas development inemerging markets.

• Methane emissions reductions cangenerate a direct bottom line contri-bution. Marathon Oil, for example,has generated over $15 million inannual savings this way.

• Companies such as Exxon and BPAmoco are seeing market leader-ship, first-mover advantages and

strong growth in the renewable ener-gy sector, and are making sizeablecommitments.

Steel SectorIn the steel sector, the stock returns

of environmental leaders outperformedthose of laggards by 26 percent over thethree-year period from August 1997 toAugust 2000. See Exhibit 8.

Why? Here are some possible con-tributing factors:

• Leading energy-efficient practition-ers such as Japan’s NKK are seeingannual cost savings in excess of

Exhibit 7. Integrated Oil and Gas Sector



$100 million through the employ-ment of new technologies and othermeasures.

• New steel applications in every-thing from auto bodies to buildingsare bringing top-line revenuegrowth to firms focused on R&D andvalue-added product developmentactivities.

• The net present value of meeting tar-get greenhouse gas emissions reduc-tions between 2000 and 2008 is esti-mated to have a potentially double-digit percentage impact on the totalmarket capitalization of the mostheavily exposed steel firms.

Electric Utilities SectorIn the electric utilities sector, the

stock returns of environmental leadersoutperformed those of laggards by 11percent over the three-year study periodof December 1996 to December 1999. SeeExhibit 9.

Here are some of the possible reasons:

• Complying with new or pendingrules to limit ozone, haze, and par-ticulate matter could cost the indus-try well over $100 billion and forcethe premature shutdown of oldercoal plants. Pending rulemakingsunder the Clean Water Act could

Exhibit 8. Steel Sector



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require installation of cooling towerson plants using once-through cool-ing, which could cost the industryover $50 billion.

• Potential financial exposures togreenhouse gas emissions restric-tions are immense. They range from38 cents per share to over $14 pershare among the 26 Standard &Poor’s 500 utility companies.

• Renewable energy and distributedgeneration technologies, such as fuelcells and microturbines, have thepotential to gain significant marketshare in a deregulated energy servic-es market.

THE WAY FORWARDAs has been demonstrated above,

compelling evidence now exists thatsuperior eco-efficiency and eco-value arealready helping drive financial outper-formance today. Of perhaps even greatersignificance, however, is the confluenceof a number of macro-level structuralforces that give every indication of creat-ing an even larger “eco-value premium”tomorrow and for many years to come:

• tightening global and domestic regu-latory pressures, such as the KyotoProtocol and European Union regu-lations

• the globalization and intensificationof industry competition

• changing consumer/investor demo-graphics, with many younger,“greener” consumers and investors

• growing institutional shareholderactivism

• growing CEO/CFO awareness of thecompetitive and financial benefits ofsuperior environmental performance

• global population/resource con-sumption pressures

• the increased transparency andvelocity of information

• pressure from nongovernmentorganizations

Each of these mega-trends is powerfulenough to expand the “eco-value premi-um” all by itself. Taken together, they forma virtually irresistible force that seems cer-tain to transform the global competitivelandscape for at least the next decade.

This should come as good newsindeed for EH&S professionals, whohave for years been laboring in an orga-nizational gulag, cut off from their com-panies’ business strategies and “compet-itive DNA.” Leading-edge companyCEOs and CFOs are belatedly recogniz-ing what the EH&S people have knownall along: Done well, strategic environ-mental management can help build com-petitive advantage and brand equity.Done poorly, it can vaporize shareholdervalue in a heartbeat.

Now that Wall Street—the primarysource of major companies’ financialoxygen—is awakening to the new com-petitive dynamic, can corporate execu-tives be far behind? They disregard thesenew trends at their peril.

NOTES1. See, for example:

Kiernan, M.J. (1992, May/June). The age of eco-strate-gy. International Executive. Kiernan, M.J. (1996). The 11 commandments of 21stcentury management. Upper Saddle River, NJ:Prentice Hall. Kiernan, M.J., & Levinson, J. (1997, Winter).Environment drives financial performance: The jury isin. Environmental Quality Management, 7(2), 1–8.

2. Environics International. (2000, September). The mil-lennium poll on corporate social responsibility. GlobalIssues Monitor. Toronto.

3. See, for example:Soyka, P.A., & Feldman, S.J. (1998, Winter). Capturingthe business value of EH&S excellence. CorporateEnvironmental Strategy, 5(2), 61–68.Feldman, S.J., Soyka, P.A., & Ameer, P. (1997, Winter).Does improving a firm’s environmental managementsystem and environmental performance result in ahigher stock price? Journal of Investing, 6(4), 87–97.Kiernan, M.J., & Levinson, J. (1997, Winter).Environment drives financial performance: The jury isin. Environmental Quality Management, 7(2), 1–8.

4. We define “environmental performance” here and inour company research very broadly. We use the termto include, inter alia, actual emissions performance,management architecture and commitment, and for-ward strategy.


5. See, for example:

Bank Sarasin. (1999). Sustainable investments: Ananalysis of returns in relation to environmental andsocial criteria. Basel.

Bank Sarasin. (1998). Environmental shareholdervalue. Basel.

World Business Council for Sustainable Development.(1997). Environmental performance and shareholdervalue. Geneva.

World Business Council for Sustainable Development.(1996). Financing change. Geneva.European Federation of Financial Analysts. (1996). Eco-efficiency and financial analysis: The financial ana-lyst’s view.ICF Kaiser. (1996). Does improving a firm’s environmen-tal management system and environmental perform-ance result in a higher stock price?Centre for the Study of Financial Innovation. (1994).Measuring environmental risk. London.

Matthew J. Kiernan, Ph.D., is executive managing director of Innovest Strategic Value Advisors, Inc., an invest-ment advisory firm specializing in environmental finance. Prior to founding Innovest, Dr. Kiernan served as direc-tor of the Business Council for Sustainable Development in Geneva, where he led the group’s initial capital mar-kets task force. Previously, he had served as a senior partner with KPMG Peat Marwick, one of the world’slargest business advisory and financial consultancies.

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Eco-Value, Sustainability, and Shareholder Value: Driving Environmental Performance to the Bottom Line