How can financial tools help companies to innovate responsibly and create value for stakeholders?

• This text has been published initially in the EDHEC Vox Mag #14, “Pioneering Sustainable Finance” (Dec. 2023)

Sustainability in today’s business world

A sustainable business seeks to generate value not only for its shareholders, but also for its stakeholders – employees, consumers, suppliers, the environment, local communities, etc. But, how does it do this? Milton Friedman famously defined business social responsibility in 1970 only as increasing profits to generate dividends for shareholders.

To generate these profits over the long term, a company also has to be responsible, for instance, by treating its employees well, or it won’t last long in the competitive landscape. Recently, however, we have seen a shift in thinking – a sustainable company is now seen as one that first focuses on generating value to stakeholders, and as a result, profits follow. This means that businesses need to understand where their core expertise and competitive advantage lies, and how to use them to drive innovation and long-term increases in the value of their key stakeholders.

The role of finance in making businesses more sustainable

Sustainable finance is difficult to understand. The value of sustainability is intangible and often takes years before it materializes into measurable outcomes. The most important issue is to set the right conditions for companies to create social and environmental value. Finance is rich in tools that can help companies innovate and create stakeholder value, if applied correctly. For example, incentivising managers to create social value by linking executive compensation to long-term value creation while restricting compensation for reaching short-term targets.

Three keys for making the transition

First, managers need to understand that there doesn’t have to be a tradeoff between social and environmental value and profitability. Plenty of companies are both profitable and able to generate value for their stakeholders. Luckily, we already see a shift in thinking in that direction.

Second, it is important that companies adopt an intrinsic rather than monetary motivation for undertaking actions that can improve the welfare of their stakeholders.

Third, companies need guidance as to what actions to prioritise to become more sustainable. They also need to better understand their purpose in this world – who their products or services are for, and why the company can generate more value for its stakeholders than other businesses.

How does EDHEC fit into this transition?

The role of research and education is essential for increasing sustainability in the business world, for example, helping better understand how to drive innovation, how to spend cash most efficiently on social causes or how different stakeholder groups should be prioritised.
On the investment front, is it better for socially minded investors to stay away from polluting companies or to invest more in the company and actively try to change its course of action?

EDHEC is well-equipped to focus on innovations in research and teaching in these areas, which increases the knowledge that we can pass on to our students. We thus are helping to prepare the next generation of business leaders to make an impact by using finance not only to generate profits, but also to incentivize companies to create social value.

Photo by Annie Spratt on Unsplash