IS CORPORATE SUSTAINABILITY A VALUE-INCREASING STRATEGY FOR

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Blackwell Publishing LtdOxford, UK

CORGCorporate Governance: An International
Review0964-8410© 2007 The Authors; Journal
compilation © 2007 Blackwell Publishing Ltd
March 2007152345358ORIGINAL ARTICLESIS
CORPORATE SUSTAINABILITY A VALUE-INCREASING
STRATEGY FOR BUSINESS?COPRORATE GOVERNANCE

Is Corporate Sustainability a Value-

Increasing Strategy for Business?
Shih-Fang Lo* and Her-Jiun Sheu

A new movement reconciling corporate sustainability and investment is gaining world-wide

attention. Whether corporate sustainability has an impact on market value is examined using
large US non-financial firms from 1999 to 2002 in this paper. Taking Tobin’s q as the proxy for
firm value, a significantly positive relation between corporate sustainability and its market
value is found. We also find a strong interaction effect between corporate sustainability and
sales growth on firm value. Moreover, there is evidence to support that being sustainable
causes a firm to increase its value. This indicates that companies with remarkable sustainable
development strategies are more likely to be rewarded by investors with a higher valuation
in the financial markets.

Keywords: Corporate social responsibility, corporate governance, sustainability index, market

value, Tobin’s q, panel data

Introduction because they help to retain talented staff and

efore The Wealth of Nations, Adam Smith
B wrote The Theory of the Moral Sentiments
(1759), which states that a capitalist system
must be based on honesty and integrity,
otherwise it will be destroyed. Adam Smith
understood that self-interest should be moder-
ated by ethics so that purely selfish or exploit-
ative behaviour would be the exception and
not the rule (Dawson, 2004) in our society. The
corporation has to honour the moral mini-
mum or respect individual rights and justice
while making a profit (Bowie, 1995). Follow-
ing the business scandals and corporate fail-
ures which occurred in the past few years,
works to rebuild public trust in business and
in the financial markets have been discussed
extensively both in practice and academia.
Many current studies in corporate governance
have focused on those issues, including cor-
porate fraud, the abuse of managerial power
and business social irresponsibility, etc. In
response to the changing market, business is
being forced to take externalities into account
in management behaviour. Corporate social
responsibility and ethics are thus becoming
a vital part of staying competitive, partly
to satisfy customers’ expectations (Gardiner
et al., 2003). Different from the previous
research regarding corporate responsibility
and ethics, the authors of this article would
like to introduce a less touched upon topic
– “corporate sustainability” – a positive
multi-faceted concept covering areas of envi-
ronmental protection, social equity, com-
munity friendship and sustainable develop-
ment in corporate governance and to test its
impact on a firm’s market value.
“Corporate sustainability”, by definition, is
a business approach that creates long-term
shareholder value by embracing opportunities
and managing risk from economic, environ-
mental and social dimensions (Dow Jones
Sustainability Indexes). Aside from creating
profit, sustainable company leaders capture
other qualitative, non-financial criterion as
references for their performance, such as *Address for correspondence:
quality of management, corporate governance International Division, Chung-
structures, reputation, human capital manage- Hua Institution for Economic
Research, Taiwan, R.O.C.
ment, stakeholder relations, environmental Mailing Address: Rm 516, 75
protection and corporate social responsibility. Chang-Hsing St, Taipei 106,
Contrary to traditional business belief which Taiwan, R.O.C. Tel: +886-2-
2735-6006, ext. 516; Fax: +886-
aims to make a profit without taking into 2-2739-0610; E-mail: shihfang.
consideration the social and environmental lo@gmail.com

© 2007 The Authors

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consequences, a new style of investment is get-
ting more and more attention and is gaining
world-wide momentum: the so-called ethical
investment. As a new movement that recon-
ciles corporate responsibility (social and en-
vironmental responsibilities) and investment
is emerging, it is worth asking whether corpo-
rate sustainability is a value-increasing stra-
tegy for today’s companies.
Both academia and those practising corpo-
rate sustainability are starting to discuss the
benefits derived from a firm’s sustainability
performance. However, the influences have
only a few empirical foundations, especially
from the standpoint of an investor. In this
article, we examine whether or not corporate
sustainability has an impact on firm value
using a sample of large US non-financial firms
from 1999 to 2002. It is therefore a study inves-
tigating the effect of membership of the DJSGI
USA on firm value. Data and information on
this topic are typically well represented in the
US, and thus this paper tends to focus on the
US trends, even though similar cases can be
found in Europe and other regions. Tobin’s q
is taken as the proxy for firm value. It is found
that a positive relation exists between a firm’s
value and corporate sustainability. The sus-
tainable premium is statistically significant.
Those companies actively maintaining sus-
tainable development are more likely to be
rewarded by investors, because of having a
higher valuation in the financial market.
The paper herein extends prior studies and
contributes in the following ways. From the
theoretical perspective, it initiates by bringing
together the concepts of corporate sustain-
ability and financial performance into two
contrasting paradigms: the shareholders’ per-
spective and stakeholders’ perspective. From
the empirical perspective, we use panel data
to control for any unobservable firm hetero-
geneity to test our hypothesis. Hill and Snell
(1989) prefer using panel data to cross-
sectional analysis while using static data to
test dynamic relationships. We estimate both
the pooled and fixed-effects models. Possible
interaction between corporate sustainability
and other financial variables on a firm’s value
are explored. Lagged independent variables
are used to ensure that our results are not
affected by endogenous regressors.
Theoretical background
This section contains three aspects of pertinent
literature: the concepts and definitions of cor-
porate responsibility versus corporate sustain-
ability, the relationship between corporate
governance and ethical investing, and the
Volume 15 Number 2 March 2007
CORPORATE GOVERNANCE
linkage between corporate sustainability and
firm market value are reviewed herein to pro-
vide a theoretical background to this study.
Corporate responsibility versus corporate
sustainability
Recent corporate scandals have emphasised
the need for greater transparency and account-
ability. A more humane, ethical and trans-
parent way of doing business is therefore
broadly discussed. However, related concepts
such as corporate social responsibility, sustain-
able development, business ethics and their
sister concepts are still too ambiguous in aca-
demic debate or in corporate implementation
(Votaw and Sethi, 1973; De George, 1990;
Henderson, 2001). These concepts are often
used to fit various management purposes (e.g.
total quality management, marketing, commu-
nication, finance, human resources manage-
ment, etc.) and still lack standard definitions
(van Marrewijk, 2003). Take the term “corpo-
rate social responsibility” for example. A clas-
sical view from the shareholder approach is that
the social responsibility of a business is to
increase its profits and value for its owner
(Friedman, 1962; Quazi and O’Brien, 2000).
The stakeholder approach points out that busi-
ness is not only accountable to its shareholders,
but should also consider stakeholder interests
which may affect or may be affected by the
operations or objectives of a business (Free-
man, 1984; Evan and Freeman, 1988; O’Rourke,
2003). Corporate social responsibility can also
be viewed from an instrumentalist perspective
where corporate image and goals are of pri-
mary concern (MacAdam and Leonard, 2003).
Yet the word “sustainability” remains am-
biguous. In the past, while corporate re-
sponsibility refers to social aspects such as
human rights, sustainability is usually related
to the environment (Funk, 2003). In spite of the
traditional bias of corporate sustainability
towards environmental policies, there is suffi-
cient interest in integrating social and eco-
nomic aspects into corporate sustainability.
“Corporate sustainability” is generally de-
fined as a business approach that creates long-
term shareholder value by embracing oppor-
tunities and managing risk from three dimen-
sions: economic, environmental and social
dimensions (Dow Jones Sustainability In-
dexes). A sustainable company is one whose
characteristics and actions are designed to
lead to a “sustainable future state” (Funk,
2003).
In summary, corporate sustainability (CS)
and corporate social responsibility (CSR) are
referred to as voluntary business activities,
including social and environmental concerns,
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IS CORPORATE SUSTAINABILITY A VALUE-INCREASING STRATEGY FOR
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so as to interact with stakeholders. Some
would argue of the “vagueness” between CS
and CSR, but recently there are more and more
studies trying to clear the lines between these
two concepts. Wempe and Kaptein (2002) in-
dicate that CS is the ultimate goal, with CSR
as an intermediate stage where companies try
to balance the Triple Bottom Line (profit, peo-
ple and planet). Van Marrewijk (2003) recom-
mends a distinction between CS and CSR.
While CSR is “communication”-oriented re-
lating to people and organisations (e.g. stake-
holder dialogue, sustainability reporting, etc.),
CS is concerned with the agency principle (e.g.
value creation, environmental management,
human capital management, etc.). Linnanen
and Panapanaan (2002) depict the relationship
between corporate sustainability and cor-
porate responsibility by drawing a more
consistent picture. Three aspects of corporate
responsibilities (economic responsibility, so-
cial responsibility, environment responsibility)
are contained in the realm of corporate sus-
tainability that a business has to be concerned
with. It is therefore showing how corporate
social responsibility fits into the current
corporate sustainability/responsibility frame-
work.
Ethical investment and corporate
governance
“Ethical investment” began appearing in the
late twentieth century and is an investing
vehicle which reflects investors’ values and
concerns regarding the impact and conduct of
business activities (Williams, 1999; Gardiner et
al., 2003). It selects companies for investment
considering the social and environmental
performances as well as the financial per-
formance. The term “social responsibility
investment” (SRI) is often used interchange-
ably with the term “ethical investment” (Mal-
lin, 2002). Etzioni (1988) states that some
investors are guided by a sense of moral duty.
Therefore, investors who are not only inter-
ested in the maximisation of shareholders’
wealth but also the maximisation of stake-
holders’ welfare will seek out those companies
for an above average growth rather than a
temporary outsized performance. Following
Cassidy’s (2003) argument, it is believed that
a substitution of longer-term sustainability for
shorter-term volatility and risk is needed for
today’s businesses. Leading sustainable firms
are more likely to deliver predictable earnings
with less negative concerns. In other words,
corporate governance and the firm’s eco-
nomic, social and environmental performance
can be effectively linked with adequate disclo-
sure (Ethical Corporation, 2003).
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Why are ethics and integrity important
in corporate governance? “Corporate gover-
nance”, defined by Letza et al. (2004), is about
the understanding and institutional arrange-
ments for relationships among various eco-
nomic actors and corporate participants who
may have direct or indirect interest in a cor-
poration, such as shareholders, directors/
managers, employees, creditors, suppliers, cu-
stomers, local communities, government and
the general public. On the other hand, cor-
porate governance should not depart from
ownership rights, but such rights should not
be solely centred on shareholders; ownership
rights can also be claimed by other stake-
holders (Turnbull, 1994, 1997a, 1998; Letza
et al., 2004).
The Ethics Resource Center (2003) sees
ethics as a core concept in corporate gover-
nance and the struggle against corruption.
Companies perceived to be ethical can re-
cruit and retain the best workers and foster
positive, long-term relationships with ven-
dors, customers, investors and stockholders
(Potts and Matuszewski, 2004). Without
high standards of corporate governance, busi-
nesses may under-perform, while those com-
panies exercising strong governance on a
habitual system based on ethical values will
perform strongly (Cassidy, 2003). Therefore,
ethics in business is not only a moral issue, but
also instrumental in achieving better commu-
nity relations (Moir, 2001). Ethical investment
has now been increasingly perceived as a
mainstream element of good corporate gover-
nance, both from individual companies and of
institutional investors (Mallin, 2002), and
good corporate governance can have good ef-
fects on long-term corporate financial perfor-
mance (Allen, 2001).
There is rapidly increasing interest in the
area of sustainability and ethical investments
both in the US and UK financial markets. The
growth rate is up to 70 per cent per year
in Europe and North America. Ethically-
screened funds in the UK are in the range
between £50 billion to £100 billion, while
socially-screened funds are estimated to be
US$2 trillion (Knoepfel, 2001). Moreover,
global indexes, such as FTSE4Good Index
and Dow Jones Sustainability Group Indexes,
are designed to measure the performance of
companies that meet globally-recognised
corporate responsibility standards and to
facilitate investment in those companies.
The Dow Jones Sustainability Group In-
dexes (DJSGI) launched in 1999 are the first
global indexes to track the financial perfor-
mance of leading sustainability-driven com-
panies worldwide. In a yearly review, 10 per
cent of the leading sustainability companies
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in each of the ten economic sectors (con- Linking corporate sustainability to
sumer non-cyclical, consumer cyclical, en- firm value
ergy, healthcare, financial, telecommunication,
basic materials, technology, industrial and
utilities) are selected from Dow Jones Global
Index (DJGI) which includes 2000 global
companies. The DJSGI is a family of 20
different indexes, and five of these in-
dexes are geographical in character: the
world as a whole, Europe, North America,
the Asia-Pacific region, and the US. The com-
panies included are continuously monitored
throughout the year, and if necessary, ex-
cluded from the index. The identification of
sustainability companies for DJSGI is based
on the Corporate Sustainability Assessment
of Sustainable Asset Management (SAM) Re-
search. A defined set of criteria and weight-
ings is used to assess the opportunities and
risks in economic, environmental and social
developments for the eligible companies as
shown in Table 1. Those companies included
in the DJSGI benefit from the growing de-
mand for sustainability-related investments.
In addition, they gain the reputation of being
an industry leader in strategic areas covering
economic, environmental and social dimen-
sions.
CORPORATE GOVERNANCE
Will a firm become unprofitable by adopting
high ethical standards while its competitors
adopt lower ones? The analysis of Brickley et
al. (2002) points out that this is incorrect, since
potential customers discount their demand
prices where there is uncertainty about the
quality of the product. Furthermore, by cred-
itably promising to act ethically, a firm can
differentiate its products and increase their
demand. On the other hand, a firm that
acquires a reputation for unethical behaviour
will lose current as well as potential future
customers and the profits they would have
generated. Chami et al. (2002) argue that the
corporation should care about ethics, because
the firm’s ethical reputation is the valuable
intangible asset which will affect the market
price of its shares. The investors will aggregate
their judgements and transmit them to the
firm in the form of financial rewards or
punishments. In summary, a firm’s value
maximisation requires a deeper understanding
of ethical standards than the typical economics
discussion of short-run profit maximisation
might suggest (Brickley et al., 2002).

Table 1: DJSGI corporate sustainability assessment criteria

Dimension Criteria

Economic Codes of Conduct/Compliance/Corruption & Bribery

(33% weight) Corporate governance
Customer relationship management
Financial robustness
Investor relations
Risk & crisis management
Scorecards/measurement systems
Strategic planning
Industry specific criteria
Environment Environmental policy/management
(33% weight) Environmental performance
Environmental reporting
Industry specific criteria
Social Corporate citizenship/philanthropy
(33% weight) Stakeholders engagement
Labour practice indicators
Human capital development
Knowledge management/organisational learning
Social reporting
Talent attraction & retention
Standards for Suppliers
Industry specific criteria

Information in this table is from Dow Jones Sustainability Indexes website (http://www.sustainability-
indexes.com)

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IS CORPORATE SUSTAINABILITY A VALUE-INCREASING STRATEGY FOR
Edited by
The demands from stakeholder groups for
greater accountability of corporations on issues
such as labour standards, environmental pro-
tection and human rights, if successfully imple-
mented, are unlikely to negatively impact
financial performance and may deliver finan-
cial gains (McLaren, 2004). To reverse tradi-
tional views that environmental compliances
and social welfare expenditures are costly and
correlate negatively with returns, Reinhardt
(1999) suggests that there are opportunities for
competitive advantage and increased profits
by engaging in environment strategies. Many
empirical studies have uncovered the positive
relationship between corporate responsi-
bility and its financial benefit, primarily on a
firm’s environmental performance (Diltz, 1995;
Konar and Cohen, 1997, 2001; Khanna and
Damon, 1999; Blank and Carty, 2005).
There is no doubt that financial reports can
tell managers a great deal about past perfor-
mance, but they are unable to reveal fully a
company’s intangible assets or the risks and
opportunities it faces in the market. Those
intangibles related to environmental or social
responsibility are highly interacted with
customer satisfaction and other stakeholder
preferences, and improvement in these areas
can induce gains financially. Companies that
actively manage a wide range of sustainability
indicators are better able to create long-term
value for all stakeholders (Funk, 2003). How-
ever, while there are numerous studies discuss-
ing the importance of ethics or sustainability
to business performance, to date there is rela-
tively little empirical evidence of whether
or not a firm’s integrated responsible per-
formance, such as its sustainable strategies
covering economic, environmental and social
dimensions, increases its value. That is the main
subject which this study intends to discuss.
Estimation methodology
Data
This study examines whether or not corporate
sustainability has an impact on firm value
using a sample of US large non-financial firms
Table 2: Profile of sustainable firms
Numbers of firms in the DJSGI USA index
Numbers of firms in the sample
Per cent
This table presents the number and percentage of sustainable firms selected from DJSGI USA after
eliminating financial and small–medium-sized companies in this paper.
© 2007 The Authors
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from 1999 to 2002. With a ratio of one-fifth
each year, the US companies consist of the
largest part within the DJSGI component firms
worldwide. Given that using the entire popu-
lation in the DJSGI, which includes a set of
global firms, is prohibitively costly and that
selecting the counterpart firms (other non-
sustainable firms) lacks generally-accepted
principles, we therefore base our sample on
large US firms. All non-financial firms of S&P
500 companies from the Compustat database
are included. During the sample period, all
the firms (sustainable firms and other non-
sustainable firms) included are also listed in
the DJGI USA. Firms of small and medium
capital which are in the DJSGI USA but not in
the S&P 500 are excluded. Table 2 presents the
number and percentage of sustainable firms
selected from DJSGI USA. Our sample consists
of more than 60 per cent of the sustainable
firms from DJSGI USA after eliminating finan-
cial and small–medium-sized companies.
After removing observations with missing
data, we are left with an unbalanced panel set
of 1,273 data points for 349 firms during the
years 1999 to 2002. Panel A of Table 3 reports
the summary statistics of all firms. Panels B
and C in the same table present the statistics
of sustainable and other firms, respectively.
We observe that the mean q for sustainable
firms is 2.55 higher than the mean q of 1.66 for
others. This primary result is consistent with
our expectation that sustainable firms have a
larger value than others. Aside from the mean
q, most other control variables, such as mean
size, dividend, debt to equity ratio, ROA,
diversification and credit rating of sustainable
firms, are higher than that of other firms. The
mean value of q is higher than the median
value of q from panel A to panel C, which
suggests that the distribution of q is skewed.
To control for the skewness, we take a natural
logarithm of q as the dependent variable in our
following analysis so that the distribution of q
becomes more symmetric.
Empirical model
Panel data require special statistical methods,
because the set of observations on one
1999 2000 2001 2002 Total
46 52 75 61 234
30 33 45 40 148
65% 63% 60% 66% 63%
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350 CORPORATE GOVERNANCE

Table 3: Summary statistics

Variable Mean Std. dev. Median Skewness Kurtosis

Panel A: All firms

Tobin’s q 1.77 1.77 1.20 4.01 26.01
Size (log of total assets) 8.99 1.08 8.99 0.20 −0.41
Dividend dummy 0.78 0.42 1.00 −1.34 −0.23
Debt to equity ratio 0.87 1.81 0.67 3.39 255.70
ROA 0.05 0.09 0.05 −2.94 23.37
Sales growth 0.12 0.42 0.06 7.39 91.17
Investment growth 0.09 0.12 0.05 4.87 35.57
Diversification dummy 0.78 0.42 1.00 −1.34 −0.20
Credit rating 4.46 0.94 4.00 −0.08 0.80
Panel B: Sustainable firms
Tobin’s q 2.55 2.71 1.64 3.65 19.84
Size (log of total assets) 9.47 0.95 9.56 −0.60 0.11
Dividend dummy 0.79 0.41 1.00 −1.44 0.08
Debt to equity ratio 0.90 1.37 0.67 9.18 97.20
ROA 0.06 0.11 0.06 −4.48 37.25
Sales growth 0.08 0.24 0.05 1.57 6.53
Investment growth 0.07 0.05 0.06 1.94 4.73
Diversification dummy 0.82 0.38 1.00 −1.72 0.98
Credit rating 4.95 0.95 5.00 0.16 0.27
Panel C: Other firms
Tobin’s q 1.66 1.58 1.16 3.53 19.35
Size (log of total assets) 8.92 1.08 8.89 0.32 −0.28
Dividend dummy 0.78 0.42 1.00 −1.32 −0.26
Debt to equity ratio 0.86 1.86 0.68 9.44 255.62
ROA 0.05 0.08 0.05 −2.47 18.96
Sales growth 0.13 0.44 0.06 7.20 86.91
Investment growth 0.09 0.13 0.05 4.69 32.55
Diversification dummy 0.77 0.42 1.00 −1.30 −0.31
Credit rating 4.40 0.92 4.00 −0.10 0.86

This table presents summary statistics for our sample of all non-financial firms listed in S&P 500 index
(panel A) and for the sub-sample for sustainable firms listed in DJSGI USA index (panel B) and the rest of
other firms (panel C) from 1999 to 2002. Firm size is the logarithm of total assets. Dividend dummy equals
1 if the firm paid a dividend in the current year. Debt to equity ratio is taken as total liabilities over total
equity. Return on assets (ROA) is defined as the ratio of net income (loss) to total assets. One-year sales
change (percentage) is used to measure a firm’s sales growth. Investment growth is measured by the ratio
of capital expenditure to sales. Diversification dummy equals 1 if the firm operates in more than one
segment. Credit rating is established by a seven-scaled variable to specify the general credit rating of the
firm. Follow Chung and Pruitt’s (1994) approximating formulation of Tobin’s q, the approximate q is defined
as the sum of market value, preferred stocks, and debt over total assets. Market value is the product of a
firm’s share price and the number of common stock shares outstanding; preferred stock is the liquidating
value of the firm’s outstanding preferred stock; debt is the value of the firm’s short-term liabilities net of
its short-term assets, plus the book value of its long-term debt.

subject tend to be inter-correlated. To con- incorporate problems relating to the estima-

trol for firm-specific heterogeneity (such as
corporate culture or managerial quality)
which is not possible to measure but has a
significant impact on firm value, a longi-
tudinal model is employed. To account for
unobserved heterogeneity in our data, we
tion of both fixed effects and random
effects.
Since unbalanced panel data is allowed in
this model, the number of periods for each
firm does not have to be the same. In this
study we have panel data for t years for i

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Journal compilation © Blackwell Publishing Ltd. 2007
IS CORPORATE SUSTAINABILITY A VALUE-INCREASING STRATEGY FOR BUSINESS?
firms. The model can be estimated using a
pool object written as:
qit = a i + b 1¢Sit + β ¢Cit + eit ,
where αi is a scalar constant representing
the effects of omitted variables that are
specific to the ith firm and constant over
time (Hsiao, 1986). Firm value is given by
qit, Sit is the sustainability dummy that
equals 1 if a firm is sustainable and 0 other-
wise, Cit shows the various control variables
that are included by the previous literature
(i.e. firm size, ability to access financial mar-
kets, leverage, profitability, sales growth, in-
vestment growth, industrial diversification,
credit quality and industry effects), b 1′ and
b ′ are the panel regression coefficients, and
εit is the error term which is assumed to be
an independent and identical distributed
random variable with mean zero and con-
stant variance s e2. As the variance of the
composite error term αi + εit is unknown, a
feasible generalised least square method is
used. If the firm-specific effects are corre-
lated with the explanatory variables, then a
fixed-effects model treating αi as a fixed con-
stant is appropriate; if αi is uncorrelated
with explanatory variables, then a random
effects model is appropriate. Both models
are used to test the stated hypothesis re-
garding corporate sustainability and firm
value. The Hausman test is used to select
the appropriate specification between these
two models.
The possible effects of reverse causality
from firm value to sustainable dummy can
be avoided since the dependent value of q
is computed from the information at the
end of the year and the independent vari-
able of sustainable dummy takes a value
prior to the end of the year. Once a com-
pany is selected as a member of the DJSGI
family, it is monitored continuously with re-
gard to newly arising critical issues (Dow
Jones Sustainability Index), and any addi-
tion or deletion of components is regularly
announced every September. It can there-
fore be ensured that our “cause” (being
sustainable or not) precedes the “conse-
quence” (firm value). Furthermore, in order
to minimise the potential simultaneity bias
caused by contemporaneous cross-sectional
analysis, we lagged all our independent
variables by one period. This approach of
lagging the endogenous variables (i.e. firm
size, ability to access financial markets,
leverage, profitability, sales growth, invest-
ment growth, industrial diversification,
credit quality) as explanatory variables is
commonly used in longitudinal studies
(Greene, 2003).
© 2007 The Authors
Journal compilation © Blackwell Publishing Ltd. 2007
351
Variables
Dependent variables
(1)
Our dependent variables are specified as
firms’ value from the financial perspective in
order to investigate the relationship between
corporate sustainability and the values it
creates. The financial market usually assesses
a firm’s value on the basis of its future profit-
ability. Under the assumption of a perfect cap-
ital market, the price of the security is the best
available and unbiased estimate of the firm’s
present value (Fama, 1970). In this study the
measurement of firm performance and valua-
tion is based on Tobin’s q, which considers
price information. Tobin’s q, defined as the
ratio of the market value of a firm to the
replacement cost of its assets evaluated at
the end of the fiscal year of each firm, has been
widely employed in the field of corporate
finance. There are still many authors such as
Lang et al. (1996) who use it to proxy for the
future investment opportunity set, like the
growth prospects facing the firm. A benefit of
using Tobin’s q is that it makes comparisons
across firms relatively easier than comparisons
based on stock returns or accounting measures
where a risk adjustment or normalisation is
required (Lang and Stulz, 1994).
Due to limited information and complex
computation for the real q data, we follow
Chung and Pruitt’s (1994) approximating for-
mulation of Tobin’s q. The approximate q is
defined as the sum of market value, preferred
stocks and debt over total assets. Here, market
value is the product of a firm’s share price and
the number of common stock shares outstand-
ing; preferred stock is the liquidating value of
the firm’s outstanding preferred stock; debt is
the value of the firm’s short-term liabilities net
of its short-term assets, plus the book value of
its long-term debt. All the information men-
tioned is done so at the end of the year and is
attainable from a firm’s basic financial reports.
Sustainability dummy variable
We define the proxy for corporate sustaina-
bility as a sustainability dummy which equals
1 if the firm is listed in the DJSGI USA in the
current year or zero otherwise. Setting up a
dummy variable for sustainable/other firms
may lose information content since corporate
sustainability is a kind of corporate evolution
containing multiple levels (van Marrewijk and
Werre, 2003). Unfortunately, no data are avail-
able for the sustainable score that each firm
has gained in DJSGI. Following Allayannis
and Weston (2001) (they set dummy variables
for a hedger and non-hedger to investigate the
relationship of using foreign currency deriva-
Volume 15 Number 2 March 2007
352
tives and firm market value), setting a dummy
variable to identify the sustainable firms and
others is deemed suitable to cope with our
research issues and to attenuate the research
limitation we meet.
Control variables
To infer that sustainability increases the value
of firms, it is necessary to exclude the effect of
all other variables that could affect a firm’s
value. In the following section we list the con-
trol variables included in the regression anal-
ysis and describe the theoretical reasons for
adopting them.
(1) Size: Most previous literature has found
firm size to be negatively related to firm
value (Mørck et al., 1988; McConnell and
Servaes, 1990; Smith and Watts, 1992). We
use the logarithm of total assets as the
proxy for firm size.
(2) Access to financial market: If firms give up
projects from lacking necessary financing,
their q value may remain high, because
they only undertake positive NPV (net
present value) projects (Allayannis and
Weston, 2001). Accordingly, we use a
dividend dummy as a proxy for the firm’s
ability to access the market. This equals
one if the firm paid a dividend in the
current year. Firms are less likely to be
capital constrained if they have paid a
dividend, and thus this may induce a
lower q (Lang and Stulz, 1994). Therefore,
the dividend dummy is expected to be
negatively related to q.
(3) Leverage: Much of the theoretical and
empirical literature has shown that a firm’s
capital structure has an impact on its value
(Allayannis and Weston, 2001; Palia, 2001).
To control the capital structure effect, we
use the debt to equity ratio by dividing
total liabilities with total equity.
(4) Profitability: If a firm is more profitable,
then it is more likely to trade with a pre-
mium than a less profitable one might and
thus increase its q. To control for profita-
bility, we use return on assets (ROA),
which is defined as the ratio of net income
(loss) to total assets.
(5) Sales growth: Growth in sales is generally
found to be positively correlated with a
firm’s value (Schmalensee, 1989; Hirsch,
1991). One-year sales change (percentage)
is used to measure a firm’s sales growth.
(6) Investment growth: Firm value also de-
pends on future investment opportunities
(Myers, 1977; Smith and Watts, 1992). R&D
expenditure is one of the variables that has
also been used mostly as a proxy for in-
Volume 15 Number 2 March 2007
CORPORATE GOVERNANCE
vestment opportunity (Mørck et al., 1988;
McConnell and Servaes, 1990). Compustat
does not report R&D expenses for all firms
in all years, as more than half of R&D ob-
servations have missing values in our sam-
ple. Following Yermack (1996) and Servaes
(1996), we use the ratio of capital expen-
diture to sales as proxy for investment
growth.
(7) Industrial diversification: There is ambigu-
ous evidence as to whether industrial
diversification leads to higher firm value.
While several studies in the theoretical
literature suggest that industrial diversifi-
cation increases value (Williamson, 1970;
Lewellen, 1971), there is still substantial
empirical evidence showing that indus-
trial diversification is negatively related to
firm value (Lang and Stulz, 1994; Berger
and Ofek, 1995; Servaes, 1996). To control
the effect of industrial diversification, we
follow Allayannis and Weston (2001) by
using a dummy variable which equals one
if the firm operates in more than one
segment. In our sample, about 65 per cent
of the firms are diversified across indus-
tries.
(8) Credit quality: Credit quality, reflected in
the credit rating of a firm’s debt, is likely
to be associated with the firm’s value
(Allayannis and Weston, 2001). We control
credit quality by establishing a seven-
scaled variable to specify the general credit
rating of the firm: 7 for AAA firms, 6 for
AA+ to AA−, 5 for A+ to A−, 4 for BBB+ to
BBB−, 3 for BB+ to BB−, 2 for B+ to B−, 1
for CCC+ and below.
(9) Industry effect: Firms are classified by the
ten economic sectors in DJSGI. We control
for industry effects by using these
economic sectors dummies: consumer
non-cyclical, consumer cyclical, energy,
healthcare, industries, information tech-
nology, materials, telecommunication and
utilities (financials are excluded).
Empirical results
Our key finding is that sustainable firms are
rewarded with higher valuations in the mar-
ket place for large publicly-traded US firms.
We firstly test the main hypothesis by using
univariate tests, followed by a multivariate
setting by controlling firm size, access to finan-
cial market, leverage, ROA, sales growth,
investment growth, industrial diversification,
credit quality and industrial effects. We also
test the possibility whether corporate sustain-
ability interacts with other control variables on
the firm value. To minimise the endogeneity
© 2007 The Authors
Journal compilation © Blackwell Publishing Ltd. 2007
IS CORPORATE SUSTAINABILITY A VALUE-INCREASING STRATEGY FOR BUSINESS?
problem in some specifications, we lag all our
independent variables and find no significant
change in our result.
Univariate tests
In this subsection we test our main hypothesis
that sustainable firms are rewarded by inves-
tors with higher valuations by comparing q
values for sustainable firms and others. As the
mean value of q is higher than the median
value of q (see Table 3) which suggests that the
distribution of q is skewed, we test our
hypothesis using both means and medians.
Table 4, panel A, presents the mean qs for
the sample firms: the mean qs for sustainable
firms is 2.5544, compared with a mean q of
1.6626 for others, which results in a sustain-
able premium of 0.8918. The premium is sta-
tistically significant at the 1 per cent level. In
panel B we test our hypothesis by using the
median qs. The median q for sustainable firms
is 1.6397, compared with 1.1556 for others,
suggesting a statistically significant difference
of 0.4841. The results using both mean and
median qs are consistent with our hypothesis
that sustainable firms have a larger value than
others.
Multivariate tests
To further explore the relationship between
corporate sustainability and its value, we
need to control variables (firm size, access
to financial market, leverage, ROA, sales
growth, investment growth, industrial diver-
sification, credit quality and industrial effects)
that could affect q. We take a natural loga-
rithm of Tobin’s q as the dependent variable.
Table 5’s regression (1) presents the results of
Table 4: Comparison of q: sustainable firms vs other firms
Sustainable
firms
Panel A: Difference in means
Mean 2.5544
Std Dev 2.7121
Panel B: Difference in medians
Median 1.6397
Numbers of observations
N 148
This table presents a univariate comparison of Tobin’s q between sustainable firms and other firms. The
firms marked as “sustainable firms” are those listed in DJSGI USA index (panel B in Table 3) and the rest
are marked as “other firms” (panel C in Table 3). P-value for testing the medians is constructed using a
rank-sum (Wilcoxon) test.
© 2007 The Authors
Journal compilation © Blackwell Publishing Ltd. 2007
353
a pooled OLS regression. The main variable
we use to test our hypothesis is the sustain-
able dummy that equals 1 if a firm is sustain-
able and 0 otherwise. The reported t-scores in
the parentheses are based on White’s het-
eroskedasticity robust standard errors, which
are consistent under homoskedasticity and
under heteroskedasticity of any form. It can
be found that the sustainability dummy has a
positive impact on Tobin’s q and is statisti-
cally significant.
Most control variables are statistically sig-
nificant and signs of the coefficients are gener-
ally as predicted – consistent to the empirical
results of the previous literature; for example,
the study of Lang and Stulz (1994) and Allay-
annis and Weston (2001). We find that size is
negatively related to Tobin’s q; firms with
access to financial markets (proxied by a divi-
dend dummy) have lower qs; more profitable
firms (measured by ROA) have higher qs; and,
similarly, firms with higher sales growth have
higher qs. More diversified firms are less valu-
able than single-industry ones, which is con-
sistent with the diversification literature.
Finally, the credit quality is significantly posi-
tive related to q value and is also consistent
with the prior literature. Economic sector
dummies are also included, but suppressed in
the table.
To control for a firm’s unobserved character-
istics that may affect firm value, we estimate
fixed effects as regressions (2) shows. Similar
to regression (1), we find a positive and signif-
icant relationship between sustainability and
a firm’s value. The signs and significance of
the coefficients of our control variable are
similar to those in the pooled regression. We
also implement a robust check by using a
panel data technique with fixed and random
effects. The Hausman test strongly rejects the
Other Difference t-statistics p-value
firms
1.6626 0.8918 3.91 0.0001
1.5802
1.1556 0.4841 <0.0001
1,125
Volume 15 Number 2 March 2007
354 CORPORATE GOVERNANCE

Table 5: Sustainable effect on firm value (contemporaneous)

Pooled (1) Fixed effects (2) Pooled (3) Fixed effects (4)

Intercept 0.0543 −0.0725 0.0476 −0.0629

(0.36) (−0.29) (0.32) (−0.26)
Sustainability dummy 0.2485 0.2712 0.1889 0.1082
(4.40)*** (2.81)*** (3.65)*** (1.05)
Size −0.1053 −0.0755 −0.1068 −0.0771
(−6.48)*** (−2.58)*** (−6.55)*** (−2.69)***
Dividend dummy −0.0978 −0.1301 −0.0874 −0.1005
(−1.83)* (−1.54) (−1.67)* (−1.21)
Debt to equity ratio −0.0064 −0.0404 −0.0054 −0.0364
(−0.54) (−1.52) (−0.46) (−1.40)
ROA 3.0664 4.4753 3.0327 4.7225
(6.91)*** (10.25)*** (6.91)*** (10.92)***
Sales growth 0.1578 0.3793 0.1294 0.2680
(3.62)*** (3.24)*** (3.43)*** (2.27)**
Investment growth 0.8235 0.8695 0.8510 0.9229
(5.11)*** (2.81)*** (5.24)*** (3.07)***
Diversification dummy −0.1194 −0.1347 −0.1185 −0.1198
(−2.79)*** (−1.92)* (−2.81)*** (−1.74)*
Credit rating 0.2101 0.1769 0.2121 0.1659
(8.65)*** (4.67)*** (8.93)*** (4.46)***
Sustainability dummy*Sales − − 0.7527 2.2353
growth (2.49)** (3.90)***
Economic sectors Yes Yes Yes Yes
Adjust R2 0.4852 0.4657 0.4987 0.4581
Number of observations 1,273 1,273 1,273 1,273
Number of firms 349 349

This table presents the results for pooled and fixed-effects regressions of corporate sustainability on firm
value. The dependent variable is the natural logarithm of Tobin’s q. Size is the logarithm of total assets.
Dividend dummy equals 1 if the firm paid a dividend in the current year. Debt to equity ratio is taken as
total liabilities over total equity. Return on assets (ROA) is defined as the ratio of net income (loss) to total
assets. One-year sales change (percentage) is used to measure a firm’s sales growth. Investment growth is
measured by the ratio of capital expenditure to sales. Diversification dummy equals 1 if the firm operates
in more than one segment. Credit rating is established by a seven-scaled variable to specify the general
credit rating of the firm. For pooled regressions ((1) and (3)), the reported t scores in parentheses are based
on robust standard error. Hausman test favours fixed effects over random effects but is suppressed. ***, **
and * denote significance at the 1%, 5% and 10% levels, respectively. “YES” denotes that the economic
sectors’ effects are estimated but not reported.

null hypothesis, which supports the fixed
effects model over the random effects model.
It is possible that corporate sustainability
and any other control variable may interact in
their influence on the firm value. To explore
this possibility, we add an intersection term
between the sustainability dummy and con-
trol variable one by one into our analysis. The
result (not reported) shows that these inter-
section terms are not significant, except the
intersection between sustainability dummy
and sales growth. According to the estimation
results on the right half of Table 5, the inter-
section term (sustainability dummy*sales
growth) is positive and statistically significant
at the 5 per cent level with pooled regression
(3) and 1 per cent level with fixed effects (4),
respectively. It illustrates that when a firm’s
sales growth is relatively high, corporate sus-
tainability is positively related to firm value.
In contrast, when a firm’s sales growth is
relatively low, the magnitude of the positive
relationship is reduced. The higher the sales
growth, the stronger the relationship will be
between corporate sustainability and firm
value. The possible managerial implication for
this result is that some investors may hesitate
about a firm’s sustainable strategies which, in
their beliefs, will increase a firm’s production
and operation costs and thus reduce sales.

Volume 15 Number 2 March 2007 © 2007 The Authors

Journal compilation © Blackwell Publishing Ltd. 2007
IS CORPORATE SUSTAINABILITY A VALUE-INCREASING STRATEGY FOR
Edited by BUSINESS?
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For Evaluation Only.
Therefore, good news on sales growth for a Table 6: Sustainable effect on firm value (1-year
sustainable firm will inspire investors to give lagged)
higher valuation.
In order to attenuate the potential simul- Pooled (1) Fixed
taneity bias caused by contemporaneous effects (2)
cross-sectional analysis from other control
variables, we lag all our independent variables
by one period. Table 6 shows an alternative Intercept 0.2114 0.1814
model, which we take a one-year lagged nat- (1.20) (0.71)
ural logarithm of Tobin’s q as the dependent Sustainability 0.2337 0.3214
variable. We find a similarly positive relation- dummy (3.98)*** (3.24)***
ship between corporate sustainability and Size −0.1248 −0.1194
market value. The signs and significance of the (−6.62)*** (−4.04)***
control variable coefficients are quite similar. Dividend dummy −0.0531 −0.0489
The Hausman test also suggests that the fixed- (−0.94) (−0.59)
effects regression is a more appropriate model Debt to equity ratio −0.0187 −0.0497
specification. Intersection terms between sus- (−1.07) (−1.87)*
tainability dummy and any other control vari-
ROA 3.7295 4.4512
able are not significant here.
(9.22)*** (9.52)***
Sales growth 0.0965 0.2227
(2.62)*** (2.52)**
Conclusions
Investment growth 0.7026 0.7862
There is an ethical side and a profit side to any (4.19)*** (2.74)***
business, and the two factors have to be Diversification −0.0887 −0.0979
balanced. Following a series of well-publicised dummy (−1.81)** (−1.40)
business scandals, social and environmental Credit rating 0.1781 0.1647
performances as well as verification and (6.89)*** (4.46)***
accountability should be recognised as being Economic sectors Yes Yes
equally important. The growth of ethical in-
Adjust R2 0.4756 0.4654
vesting has reflected the keen interest from
Number of 924 924
investors and other stakeholders in the sus-
tainability of businesses. This paper explores observations
corporate sustainability and its market value Number of firms 337
using data of large US firms that belong to the
S&P 500 from 1999 to 2002. It is found that This table presents the results for pooled and fixed-
firms are rewarded in the market for taking effects regressions of corporate sustainability on
economic as well as environmental and social firm value. The dependent variable is the natural
logarithm of Tobin’s q taking 1-year lagged. Size is
concerns into their developing strategies. The
the logarithm of total assets. Dividend dummy
dataset is of a panel data in design, which equals 1 if the firm paid a dividend in the current
helps us control for the endogeneity problem year. Debt to equity ratio is taken as total liabilities
and firm-specific fixed effects. over total equity. Return on assets (ROA) is defined
Taking Tobin’s q as the proxy for firm mar- as the ratio of net income (loss) to total assets. One-
ket value, it is found that corporate sustain- year sales change (percentage) is used to measure
ability is strongly associated with market a firm’s sales growth. Investment growth is
value. This result is robust from the use of measured by the ratio of capital expenditure to
numerous control variables (size, ability to sales. Diversification dummy equals 1 if the firm
access financial markets, leverage, profita- operates in more than one segment. Credit rating is
established by a seven-scaled variable to specify the
bility, sales growth, investment growth, indus-
general credit rating of the firm. For pooled
trial diversification, credit quality, industry regressions (1), the reported t scores in parentheses
effects and time effects) to the alternative sta- are based on robust standard error. Hausman test
tistical models handling the potential biased favours fixed effects over random effects but is
and inefficient estimation. Considering other suppressed. ***, ** and * denote significance at the
possible intersection terms into the analysis, 1%, 5% and 10% levels, respectively. “YES” denotes
all of them are not significant, except the inter- that the economic sectors’ effects are estimated but
section between sustainability dummy and not reported.
sales growth. The relation between corporate
sustainability and firm value is positively rein- and we have found no significant change in
forced by the growth of sales. In addition, to our result which supports that corporate sus-
attenuate the potential endogeneity problem, tainability increases market value. The efforts
we have lagged all our independent variables made by those firms taking sustainability into

© 2007 The Authors Volume 15 Number 2 March 2007

Journal compilation © Blackwell Publishing Ltd. 2007
356
their developing strategies seem to be valued
positively by investors and appear to be in the
right direction.
Corporate sustainability is an ultimate goal
that our work on corporate governance
would like to attain. While most studies in
the previous literature discuss the concepts
and benefits of corporate sustainability, this
paper examines the relatively neglected asso-
ciation between corporate sustainability and
market value that it creates. It is therefore
hoped that future issues on corporate gov-
ernance and accountability can be inspired
by the evidence we have provided herein.
Whereas the main purpose of this article is
linking corporate sustainability to firm value,
in order to construct a full comprehension of
the sustainable effect on market value, one
might extend this topic by incorporating
other corporate governance variables (e.g.
managerial ownership, size of the board of
directors, the proportion of outsiders on the
board, CEO compensations, etc.) into the
model. We leave such issues for future
research.
While the concept of corporate sustain-
ability has been strongly promoted by aca-
demia as well as industrialists for decades,
very little is known about the fundamental
questions, such as what motivation do
investors have to value corporate sustain-
ability. To answer those questions, someone
may find clues from the wisdom of Adam
Smith: “How selfish soever man may be
supposed, there are evidently some prin-
ciples in his nature, which interest him in
the fortune of others, and render their hap-
piness necessary to him, though he derives
nothing from it, except the pleasure of see-
ing it” (The Theory of Moral Sentiments,
Part I, Section I, Chapter I). The result of
this study is really an attempt to infer that
aside from short-term profit and growth,
investors are learning to think more long
term: they are becoming more aware of a
firm’s sustainable development in today’s
capitalist society.
Acknowledgements
We would like to thank Mr Alexander
Barkawi, the Managing Director of SAM
Indexes, for providing data. We would also
like to thank Dr Yeutien Chou from the
Institute of Economics, Academia Sinica, and
two anonymous referees for their helpful
comments. Partial financial support from the
National Science Council, Taiwan R.O.C. is
acknowledged.
Volume 15 Number 2 March 2007
CORPORATE GOVERNANCE
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Shih-Fang Lo is an assistant research fellow in
the International Division, Chung-Hua Insti-
Volume 15 Number 2 March 2007
358
tution for Economic Research. She received
her PhD degree in business and management
from National Chiao-Tung University, Taiwan
in 2005. Her research interests include Corpo-
rate Social Responsibility, Performance Evalu-
ation and Investment.
Her-Jiun Sheu is a professor in the Depart-
ment of Management Science and the Gradu-
Volume 15 Number 2 March 2007
CORPORATE GOVERNANCE
ate Institute of Finance, National Chiao-Tung
University, Taiwan. He served as Dean of the
College of Management at National Chi-Nan
University, Taiwan from 2001 to 2003. His
research interests include Derivatives, Cor-
porate Finance, Performance Evaluation and
Sustainable Development.
© 2007 The Authors
Journal compilation © Blackwell Publishing Ltd. 2007