Why considering business ethics makes good investing sense

Daniel Rourke Head of ESG Integration, Private Bank

Strong management of business ethics can be a source of shareholder value

These days, smart investors don’t only analyze financial statements, they also look at a broad range of intangible assets—like goodwill, human capital and intellectual property—when making investment decisions.

Take, for example, business ethics. Business ethics is an intangible asset that is difficult to measure. From an investor’s perspective, strong ethical norms can signal a competitive advantage by creating durable relationships with customers, suppliers and employees.

On the flipside, headlines too often tell of companies diminished - even destroyed - by failures to stop harassment, safeguard information, disclose material risks or prevent fraud. Lawsuits and regulators have been punishing. Reputations have nosedived.

Investors who are practiced at assessing the value of intangible assets, like business ethics, are in a stronger position than others to find shareholder value.

So what, exactly, is important for you as an investor to know—and how do you find it out?

What do we really mean by “business ethics”?

Broadly speaking, the ethical conduct of a business means that the company avoids committing fraud, prevents corruption and does not engage in bribery, facilitation payments or other lapses such as conflicts of interest, misrepresentation, bias or negligence.

From an investor’s perspective, companies can preserve shareholder value and may even turn their ethical practices into a competitive advantage by incorporating them as a core part of their value proposition to customers. For example, some tech companies lead with their privacy protection standards, cultivating trust with consumers in an era where large-scale data breaches can be detrimental to business.

That said, well-managed business ethics can differ by sector, industry and geography.

For example, it can be critical for investors to take a closer look at business ethics when considering a stake in companies that rely on sensitive or high-value natural resources or operate complex global supply chains. More specifically:

Health care delivery and distribution—Healthcare companies wrestle with safeguarding consumers’ sensitive information, financial and medical. Because they operate in a highly regulated environment and are targets of cyber threats, security measures and privacy policies are essential to prevent costly data breaches. A company which competently trains employees on data handling and invests in cybersecurity technology can avoid the significant expenses associated with data breaches – most commonly directed at recapturing users. IBM reports that across industries, healthcare companies have experienced the most expensive data breaches each of the last 13 years – with breach costs having jumped 53.3% since 2020. Employee training and incident response planning and testing were found to be effective cost mitigators, as companies with either of these measures in place saved about $232,000 per breach¹.
Engineering and construction services—A key ethical risk in this industry involves conflicts of interest between brokers, agents and appraisers in bidding on projects and supplies. Unethical bidding practices can damage reputations and lead to investigations by authorities, large fines, costly settlements and—in some cases—bans from future projects, resulting in lost revenue. Adding to the business challenge, laws and norms related to bidding and sourcing for engineering and construction projects vary by jurisdictions. Companies in this industry with global operations must manage compliance with multiple countries’ laws and govern multinational supply chains.
Metals and mining—Leading companies in this industry must pay attention to their anti-corruption, anti-bribery and payments-transparency efforts, as their relations with governmental authorities are vital for accessing mining reserves². Companies with significant reserves or operations in corruption-prone countries could face heightened risks to regulatory violations and higher ongoing compliance costs.

Other examples of industries where business ethics can play a particularly material role in a risk-return profile include—financial services, oil & gas, telecommunications and transportation.

While business ethics can drive corporate risk and opportunity, it can be difficult for investors to assess the current state of ethical norms at a specific company, or size the potential impact. One place to start is examining regular corporate disclosures³ and comparing them to peers and market standards. This information is sometimes also addressed in environmental, social and governance (ESG) reports.

Some sophisticated investors are using disclosed information on business ethics policies and practices as a starting point for deeper engagement with companies that appear to lag industry peers, encouraging more transparency and intentionality to safeguard their investments.

Regardless of approach, it’s clear that business ethics has been on the mind of investors for some time. Truvalue Labs (now part of FactSet) is a data analytics platform that uses machine learning techniques to assess and rank companies based on news flow and sentiment linked to ESG factors. In a recent study, they found that business ethics was one of the three most commonly discussed ESG factors (along with greenhouse gas emissions and labor practices) over 12 years⁴ of news about Russell 3000 companies, which represents about 97% of the U.S. public equity market.^5,⁶

Exploring your investment options

A lot of research might be required to find the information you need about companies’ business ethics. You can do the digging yourself or select a fund or manager with a research team dedicated to unearthing such information and—this is critical—determining what is material.

If you are looking at a fund that proports to do the research for you, the key question to ask is: “Does this strategy truly have the people, philosophy, process and performance in place to deliver competitive returns in line with its investment objectives?”

For a thorough analysis of your ESG investing options and how they might fit into your portfolio and support your financial goals, reach out to your J.P. Morgan team.

¹IBM. Cost of a Data Breach Report 2023. July 2023, https://www.ibm.com/reports/data-breach https://www.ibm.com/downloads/cas/3R8N1DZJ.

²The Sustainability and Accounting Standards Board (SASB) Standards guide the disclosure of financially material sustainability information by companies to their investors. Available for 77 industries, the Standards identify the subset of environmental, social, and governance issues most relevant to financial performance in each industry. See SASB Materiality Finder.

³e.g. a company publishes their policies for internationally recognized labor conventions, and/or outlines their oversight of material ESG risks in their Form 10-K.

⁴2009-2020

⁵The AI program processed the volume of written information through a framework of ESG metrics, linking phrases to associated ESG metrics based on their definitions and key issues.

⁶Kuh, Thomas and Shepley, Andre and Bala, Greg and Flowers, Michael, Dynamic Materiality: Measuring What Matters (January 17, 2020). Available at SSRN: https://ssrn.com/abstract=3521035 or http://dx.doi.org/10.2139/ssrn.3521035