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Thursday, June 14, 2012
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The hidden pitfalls of performance ranking: can recognizing good performance lead to to worse?

By Guest Author, Aaron Reuben, Yale School of Forestry & Environmental Studies '12

Humans love to rank. We rank universities and sports teams, investment portfolios and spelling-bee contestants.

Partly we do so to simplify the world in a meaningful way. Rankings, particularly those created by a body of experts, can synthesize complex and opaque information into an accessible and potentially useful ordered presentation: this company has greater potential to earn profits, this school to produce knowledgeable students. We can look at a ranking and know, or think we can know, the better bets from the worse.

But we also rank to recognize good performance and to chastise bad behavior. Think of restaurant health code ratings. Here the goal, besides helping unwitting citizens avoid gastroenteritis, is to improve the performance of the ranked entities. Those at the bottom of a particular ranking can be convinced to shape up or close up, as is the case with health code violators, and those at the top may be blessed with accolades and fungible benefits, as is the lot for the rare restaurant to top out the Michelin restaurant ratings with three stars.  In both cases ranked individuals, we assume, are incentivized to perform well:  the former to improve their station in society, the latter to avoid losing their high status.

In the arena of corporate environmental performance, a term that describes the effort a firm has taken to limit their company’s impacts on the environment, this former trend seems to be especially true.  

In a recent study presented in the Strategic Management Journal, Aaron Chatterji, of Duke University’s Fuqua School of Business, and Michael Toffel, of the Harvard School of Business, examined the environmental stewardship behavior of nearly 600 firms across 5 years in relation to an initial environmental performance ranking.[1] The authors reported that firms that ranked poorly on measures of environmental performance one year were more likely than unranked or well-ranked firms to improve their environmental performance in subsequent years. Like restaurants with low health code ratings, the worst polluters were “shamed” into improving, in this case by lowering their annual total toxic chemical emissions.

This is good news, which supports the theory of rankings as social motivators.

But could the opposite phenomenon also occur? Could a positive ranking somehow incentivize a decrease in firm performance?  That is precisely the finding of a forthcoming study from Ben Lewis of Cornell University’s Johnson Graduate School of Management, who presented his research at the fourth annual conference of the Alliance for Research on Corporate Sustainability (ARCS) at Yale University this past May.

Considering Chatterji and Toffel’s findings that poor rankings led to improved firm performance, Lewis wondered where good rankings could lead. Did well-ranked firms maintain their strong performance over time? Or do they, once christened as good stewards, allow their socially beneficial behaviors to slide?

The answer was somewhat surprising, though perhaps it shouldn’t be. After examining the charitable-giving behavior of more than 400 firms over 5 years, Lewis found that firms that were ranked well on measures of corporate social responsibility were more likely than their low-ranked or unranked peers to perform worse in the future.[2]

Meaning that, at least for socially responsible firms, recognizing good behavior in the present can lead to worse behavior in the future.

Why is this true?

There may be many explanations for this trend but Lewis suggests that part of the answer may lie in the social science of “moral licensing.”

“A substantial body of work suggests that past moral behavior can make individuals more likely to commit potentially immoral actions without worrying about or appearing immoral,” he writes in a working paper on the study.

It is possible, then, that corporations recognized for good social behavior in the past can rationalize poorer behavior in the present. At the very least they are “less likely to reinterpret reductions in future performance as a sign of weakness or cause of concern,” writes Lewis.

Does this mean that we should stop recognizing good performers?  Does this call into question the practicality of rankings in general? The answer, I think, depends on why we rank. Rankings still provide numerous benefits outside of incentivizing good behavior: information is made publicly available and accessible, poor performers are still incentivized to improve, and it becomes possible to identify trends across individuals or within a sector.

But, “from a policy perspective,” Lewis writes, “these results suggest that positive ratings can lead to consequences that are the opposite of those intended by the raters.” And this means that, for the purposes of incentivizing behavior improvements, those who rate may be better off focusing more on chastising poor performers and less on celebrating winners. 

 



[1]
The researchers used environmental ratings from KLD Research & Analytics, Inc. (KLD), which ranks S&P 500 Index and Domini Social 400 Index firms on a variety of  “corporate social performance” metrics, of which environmental performance is a large component.

[2] This study also relied on KDL firm performance ratings.

Aaron Reuben is a research assistant at the Yale Center for Environmental Law & Policy, where he studies the policy impacts of environmental health indicators. He holds a Masters of Environmental Management from the Yale School of Forestry & Environmental Studies and is a former Editor-in-Chief of the Yale environmental journal, SAGE Magazine.

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