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Toeing the line

Conformity with environmental, social and governance (ESG) practices can carry negative reputation ‘spillovers’ when peers are publicly criticised, says paper at Cambridge Judge recognised for two Academy of Management awards.

Portrait of a couple of investors looking concerned.

Companies seek the “safety of conformity” in an environment of public and regulatory scrutiny that is new and not fully understood, namely environmental, social and governance (ESG) practices: benchmarked “being like others” gives them confidence and assures investors that the companies are doing things appropriately.

Investors and companies openly state this, and the data in a study from Cambridge Judge Business School confirm that conforming to industry norms can thus boost a firm’s financial performance.

However, the paper also identifies a significant unanticipated risk that goes with this – the risk of “negative reputational spillovers”. When industry peers’ ESG practices are publicly criticised, then companies that conform to industry norms are also penalised, even when they have nothing to do with the criticised practices. Conformity can become a trap in such a situation of extensive public criticism, while being different makes a company less comparable and protects it from the negative spillovers.

This strategic trade-off is pointed out by the Cambridge Judge study, which was the winner of the ONE (Organizations and the Natural Environment) Best Student Paper Award and a finalist for the Carolyn Dexter Award at the 2021 Academy of Management annual meeting.

The Carolyn Dexter Award is given to the paper that “best meets the objective of internationalising the Academy of Management”. The winner and finalists were announced in the first week of August during the Academy’s annual meeting, held virtually this year.

The paper – entitled “How the pursuit of sustainability poses trade-offs between legitimacy and reputational spillovers” was co-authored by Nareuporn Piyasinchai, a PhD candidate at Cambridge Judge; Dr Matthew Grimes, Reader in Innovation & Organisation at Cambridge Judge; and Professor Christoph Loch, Dean of Cambridge Judge.

The paper is based on a dataset of 2,313 companies across 62 industries and 70 countries from 2013 to 2018.

The research concludes that conformity with ESG standards does benefit a firm’s financial performance on average. But in the event that peers are publicly criticised, the negative spillover effects “can outweigh any legitimacy-related gains associated with conformity.”

The paper finds, alternatively, that firms in industries with highly diverse sustainability practices can enjoy positive spillover effects when their industries’ peers are severely criticised.

“Firms may try to mitigate sustainability-related risks by conforming, but the safety of conforming in turn introduces higher risks due to negative reputational spillovers,” the study concludes. “Our findings thus offer evidence that firm conformity with respect to sustainability practices implies a theoretically and practically important trade-off between gains associated with enhanced legitimacy and the risks of reputational spillovers.”