Investment decisions: The trade-off between economic and environmental objectives

Abstract

While there are broader socio-political, psychological, and structural factors that influence investment decisions (see Harris et al., 2016), in line with the critical approach, this study provides an empirical insight into the notion that financialization, specifically the tendency to prioritise economic over environmental objectives, has a strong bearing on how managers view investment trade-off decisions in relation to sustainability issues. The study empirically investigates this notion by examining the investment trade–off preferences of Australian managers in relation to three decision attributes – economic outcomes (i.e. financial returns), environmental impact (i.e. carbon emissions) and stakeholder pressure to consider environmental issues. We use the discrete choice experimental method to quantify the trade-offs between the above mentioned three attributes. In addition, we also investigate the potential effect of three contingency factors on individual's preferences. Specifically, at the organisational level, we explore the effects of financial and environmental rewards and at the individual level, we explore the effect of environmental consciousness. In line with the financialization hypotheses our results indicate that managers prioritise financial returns over carbon emissions and stakeholder pressures with the preference for financial returns found to be positively associated with rewards for financial performance. However, in line with the pragmatic approach and despite the overall dominance of financial returns, there is evidence that manager's focus on financial returns can be influenced, with the preference for financial returns negatively associated with rewards for environmental performance and environmental consciousness. In addition, while stakeholder pressure was not found to be associated with any of the three contingency factors and, manager's emphasis on carbon emissions was not associated with financial rewards, manager's emphasis on carbon emissions was found to be positively associated with both rewards for environmental performance and environmental consciousness. Therefore, our findings suggest that corporate management have an important role to play, both in respect to the design of performance rewards systems and the recruitment of environmentally conscious managers, in order to promote the sustainability agenda.

Introduction

There is a large body of literature in the accounting and management disciplines that has examined issues concerning organisational (particularly corporate) responses to the sustainability challenges facing the world at present. These studies are varied and have examined issues pertaining to organisational change (Arjaliès & Mundy, 2013; Narayanan & Adams, 2017), sustainability reporting (Cho, Roberts, & Patten, 2010; Clarkson, Li, Richardson, & Vasvari, 2011), the adoption of environmental initiatives (Anton, Deltas, & Khanna, 2004; Darnall & Edwards, 2006; Darnall, Henriques, & Sadorsky, 2010; Melnyk, Sroufe, & Calantone, 2003; Potoski & Prakash, 2005) and the impact of such initiatives on environmental performance (Daddi, Magistrelli, Frey, & Iraldo, 2011; Darnall, Gallagher, Andrews, & Amaral, 2000; Darnall, Henriques, & Sadorsky, 2008; Khanna & Anton, 2002; King, Lenox, & Terlaak, 2005; Phan, Baird, & Su, 2018). This line of research adopts a pragmatic approach, and emphasises the role of academics and others in engaging with corporations to bring about improvements that may lead to more sustainable outcomes for all stakeholders (Adams & McNicholas, 2007; Adams & Whelan, 2009; Larrinaga-Gonzalez, Carrasco-Fenech, Caro-Gonzalez, Correa-Ruýz, & Paez-Sandubete, 2001).

There is also a broader literature that takes a more critical approach to sustainability reporting and engagement (Gray, Adams, & Owen, 2018). The critical accounting authors argue that managers will only pursue social and environmental sustainability initiatives if they have a positive impact on financial performance and refute the majority of the literature which employs the ‘win-win’ paradigm in which it is argued that “economic, environmental and social sustainability aspects can be achieved simultaneously” (Hahn, Figge, Pinkse, & Preuss, 2010, p. 217). However, in line with Hahn et al. (2010) and Margolis and Walsh (2003) we question this assumption, arguing that trade-offs, representing “compromise situations when a sacrifice is made in one area to obtain benefits in another” (Byggeth & Hochschorner, 2006, p. 1420), are the “rule rather than the exception” (Hahn et al., 2010, p. 217).

Hence, in the context of sustainability issues, we argue that managers will often be forced to make trade-offs. Shepherd, Patzelt, and Baron (2013, p. 1253) maintain that there are “four primary drivers of business decisions regarding sustaining the natural environment: values, economic opportunities, stakeholder pressures, and legislation”. Our study uses the conjoint analysis methodology to uncover the investment trade-off preferences of Australian managers in considering two of these drivers: economic opportunities, assessed in respect to the expected financial returns, and stakeholder pressures, specifically the pressure exerted by stakeholders to consider environmental issues. In addition, a third factor, environmental impact, assessed in respect to the expected level of carbon emissions, is considered. Accordingly, the first objective of the study is to provide an insight into and quantify managers’ preferences for trading-off economic outcomes, environmental impact, and stakeholder pressure to consider environmental issues when making investment decisions.

The examination of managers' investment decision trade-off preferences is considered pertinent for many reasons. First, the literature on trade-offs in the corporate sustainability field is sparse (Hahn et al., 2010) and tends to be qualitative. Hence, our analysis will serve to provide an empirical insight into the relative weights placed on economic outcomes, environmental impact, and stakeholder pressures in choosing between investment projects. Second, the study addresses calls in the literature to “evaluate trade-off situations in corporate sustainability, in order to identify strategies that yield substantial contributions to sustainable development” (Hahn et al., 2010, p. 226). Previous studies have looked at several aspects of managerial decision-making in relation to investment decisions (see for example (Bebbington, Brown, & Frame, 2007), and suggested models that can be utilised for a comprehensive approach which includes sophisticated social and environmental considerations. Work has also been undertaken to explore the possibilities around theorisation of managerial decision making in this area (Harris, Northcott, Elmassri, & Huikku, 2016). These studies are valuable and contribute to multiple facets of sustainable investment decision-making. This study builds on and contributes to this broader area by shedding light on the extent to which managers are prepared to trade-off economic factors for environmental ones and vice versa. The study also addresses calls for research that examines individual managers’ behaviour within the appropriate contextual setting. For example (Harris et al., 2016, p. 1189), state:

“Future studies could adopt a more ontic-level investigation to shed light on the relationship between accounting and strategy, and consequently focus on processes and practices at an individual level. This could enhance our understanding of how in-situ agents understand the contextual field in relation to their own values, duties and obligations and how they come to act in one way rather than another. Such ontic-level analysis using SST may contribute to a better meso-level understanding of SIDM by enabling cross-case comparison”.

Furthermore, in line with the principles of financialization, which maintains that the emphasis on economic returns drives corporate and employee decision making, we provide an empirical insight into the propensity of managers to focus on economic (financial) returns, as opposed to non-financial attributes (carbon emissions and stakeholder pressure to consider environmental issues) when making investment decisions.

In addition, we provide an insight into the tension in the literature between those that take the critical view of corporate engagement in sustainability issues, maintaining that organisations will only pursue social and environmental initiatives that have a positive economic impact, and those that take a more pragmatic stance and focus on the role of the corporation in promoting sustainable outcomes.

Hence, while we anticipate that, in line with the widely reported business case model, managers will prioritise economic outcomes (financial returns) in making trade-off decisions, the second objective of the study is to focus on human agency, considering whether individual's preferences for specific decision attributes, when making investment decisions, can be influenced by specific contingency factors. In particular, we contribute to the literature by examining the influence of two organisational-level factors (the link of rewards to financial performance and the link of rewards to environmental performance) and one individual-level based contingency factor (environmental consciousness). The examination of these associations will contribute to the literature focusing on the factors that influence managers' investment decisions (Kida, Moreno, & Smith, 2001; Sawers, 2005), thereby facilitating the development of strategies to influence managers' decisions.

The focus on the management compensation scheme, specifically the extent to which rewards are linked to financial and environmental performance, is pertinent given the strong evidence in the literature concerning the influence of affective reactions on managers investment decision making (Kida et al., 2001) and of rewards on employee behaviour and actions (Langfield-Smith, Smith, Andon, Thorne, & Hilton, 2018; Pheonix, 2006). This relationship is grounded in agency theory which purports the importance of management compensation systems in aligning the interests of principals and agents (i.e. managers).

The focus on environmental consciousness, operationalised in relation to Shepherd, Kuskova, and Parzelt (2009) ‘respect for nature’ construct (see Section 3), is an important contribution to the literature. While previous studies have examined the link between environmental commitment and the undertaking of specific environmental activities (Gadenne, Kennedy, & McKeiver, 2009; Jiang & Bansal, 2003; Madsen & Ulhøi, 2001; Menguc & Ozanne, 2005), and/or the take-up of environmental management initiatives within organisations (Su, Tung, & Baird, 2017), there is little empirical evidence on the impact of individuals' environmental consciousness on investment trade-off decisions. Accordingly, this analysis addresses calls in the literature to consider the influence of sustainability values, specifically environmental consciousness, on sustainable development (Mabogunje, 2004; Shepherd et al., 2009). Such analysis is also pertinent given ‘values’ represent one of Shepherd, Patzelt, and Baron (2013, p. 1253) four “drivers of business decisions regarding the natural environment” and hence the findings will provide practitioners with an insight into how individual values influence investment decision/s. Our research also contributes in a broad sense to the area of strategic investment decision-making, in the sense that we look beyond financial measures, into non-financial decision attributes and see a role for human agency in decision-making (Alkaraan & Northcott, 2006; Elmassri, Harris, & Carter, 2016; Grant & Nilsson, 2019; Harris et al., 2016).

The study uses the discrete choice experiment/conjoint analysis methodology to provide an insight into the investment decision preferences of managers. Managers are presented with a series of investment decisions with various levels of projected economic outcomes, environmental impact, and stakeholder pressure, and asked to choose between two projects in each instance. Conjoint analysis was used to gain an insight into the following two research questions:

The findings indicate that managers are more likely to focus on economic outcomes (financial returns) when making investment decisions and their preferences are significantly influenced by the hypothesised contingency factors. Specifically, the extent to which rewards are linked to financial (environmental) performance exhibited a positive relationship with the extent to which managers emphasise economic returns (environmental impact) when making investment decisions. Furthermore, environmental consciousness exhibited a positive (negative) relationship with the extent to which managers emphasised environmental impact (economic outcomes) when making investment decisions.

The remainder of the paper is organised as follows. The next section examines the extant literature on trade-offs in managerial decision making, emphasising the sustainability/corporate responsibility area. Hypotheses regarding the focus of managers in making trade-offs and the likely impact of each of the contingency factors on these trade-off decisions are then developed. Section 3 describes the methodology and Section 4 presents the results of the empirical work. Section 5 concludes the paper, explicates the implications of our findings and suggests avenues for future research.