Investors value ethics over returns: IIM-A paper

A working paper by the Indian Institute of Management, Ahmedabad (IIM-A) on investor perception towards ethical nature of a company's management, has found that investors do care about the ethical image of a company. Given the perception, the paper is of the view that it is important to maintain ethical standards even with regards to the activities that may not impact the company directly.

Authored by Saravana Jaikumar, Viswanath Pingali, and Vineet Virmani of IIM-A, the paper has been titled as 'Are Investors Ethics Agnostic?'.

As part of its research, the has used event study methodology to assess the impact of two unethical events - legal but potentially profitable act, and illegal act but does not impact the financial performance of the firm.

"In the first event (ICL's acquisition of CSK in IPL), in spite of the possibility of positive gains, we find that the stock market returns for ICL were statistically negative. In the second case, when the unethical act was not related to the financial performance of the company, we again find that the stock market returns were negative and significant."

"As to our second event - match fixing scandal in 2013 - people related to the management of ICL were implicated. However, match fixing per se has no direct relation to the performance of ICL. The prime accused in the match fixing scandal, Mr. Meyappan, was only related to the management of ICL, and does not hold any official position within either CSK or ICL. Yet, we find that the investors? reaction to be rather adverse," the paper observed.

Resultantly, the paper finds that when the action leads to a positive outcome for the company, the investors' reaction is statistically insignificant. However, when another action did not lead to any potential positive outcome, the abnormal returns associated with the company's stock are negative and significant.

According to the paper, investors form opinions about a company and its financial health based on several actions undertaken by the management of the company, even if some such actions have no tangible impact on the company's day-to-day performance. Further, some such actions can also lead to shareholders forming perceptions regarding the ethical behaviour of the management, thereby influencing their actions. The paper looked to ask the question of whether or not the investors care about the ethical perception of the management per se. "More specifically, we ask the following question: If investors punish a company for unethical perception, can it be interpreted that the investors value the ethical practices?," it states.

"Definitely, the unethical behaviour with respect to match fixing, might have cast doubts in the investors' mind regarding the veracity of the statements Mr. Srinivasan makes, including about the financial health of the company. Therefore, the trust the investors of ICL would place on the ICL's management team (led by Mr. Srinivasan) could diminish leading to a loss in the share price. This leads us to conclude that the investors do care about the ethical persona of the management," the paper further states.