SOCIALLY RESPONSIBLE INVESTMENTS: WHAT REALLY MATTERS?
Silvana Signori University of Bergamo (Italy)
Working Paper Submission for EBEN RESEARCH CONFERENCE 2007 FINANCE AND SOCIETY IN ETHICAL PERSPECTIVE BERGAMO (ITALY), 21-23 June 2007
Abstract In recent years initiatives through which investors combine ethical or social principles with more traditional investment selection criteria (return, risk, liquidity, etc.) have become increasingly common, even in "young" markets like Italy’s. One aspect, especially recently, that researchers, scholars and academics are monitoring is the financial performance of such choices. In reality, what motivates ethical investors is not (or not only) the expectation of a return similar to more traditional investments but also the ability to use their own money to fulfil ethical requirements. The evaluation of an ethical investment should therefore go beyond efficiency (financial performance) and include considerations such as effectiveness, that is to say, the investment’s ability to fulfil an investor’s ethical expectations. Some recent events (in particular the Gates Foundation investment policy case) suggest a third dimension: the relation to investors’ values, which can signify an organisation’s relation to its mission. This essay, after a short description of what is meant by ethical investors and the behaviours that characterize them, will focus on the balance that is possible between efficiency, effectiveness and mission-related investment.
Working Paper: Not for distribution. Please do not quote without permission of the authors. Comments are very welcome.
Introduction On January 7 and 8, 2007 the Los Angeles Times published two articles that have stimulated a lively discussion on ethics-based investing. Just the headlines give an idea of the uproar these articles have created: “Dark cloud over good works of Gates Foundation” and “Money clashes with mission. The Gates Foundation invests heavily in sub-prime lenders and other businesses that undercut its good works”. As written in this report “the Gates Foundation (1) has poured $218 million into polio and measles immunization and research worldwide, including in the Niger Delta. At the same time that the foundation is funding inoculations to protect health, The Times found, it has invested $423 million in ENI, Royal Dutch Shell, Exxon Mobil Corp., Chevron Corp. and Total of France — the companies responsible for most of the flares blanketing the delta with pollution beyond anything permitted in the United States or Europe” (LAT, January 7, 2007). The same article emphasizes that “like most philanthropies, the Gates Foundation gives away at least 5% of its worth every year […] and invests the other 95% of its worth. This endowment is managed by Bill Gates Investments, which handles Gates' personal fortune. Monica Harrington, a senior policy officer at the foundation, said the investment managers had one goal: returns "that will allow for the continued funding of foundation programs and grant-making." Bill and Melinda Gates require the managers to keep a highly diversified portfolio, but make no specific directives […].At the Gates Foundation, blind-eye investing has been enforced by a firewall it has erected between its grant-making side and its investing side. The goals of the former are not allowed to interfere with the investments of the latter”. “The Times found that the Gates Foundation has holdings in many companies that have failed tests of social responsibility because of environmental sustainability lapses, employment discrimination, disregard for worker rights, or unethical practices” and, specifically, that the Gates Foundation endowment had major holdings in: Companies ranked among the worst U.S. and Canadian polluters, including ConocoPhillips, Dow Chemical Co. and Tyco International Ltd., as well as many of the world's other major polluters, including companies owning oil refineries; one that owns a paper mill, which a study shows sicken children while the foundation tries to save their parents from AIDS; and pharmaceutical companies that price drugs beyond the reach of AIDS patients the foundation is trying to treat” (LAT, January 7, 2007). A few days after these articles appeared, the Gates Foundation chief executive, Patty Stonesifer, in a letter to the Los Angeles Times said that “The stories you told of people who are suffering touched us all, but it is naive to suggest that an individual stockholder can stop that suffering. Changes in our investment practices would have little or no impact on these issues” (LAT January 14, 2007. On the Foundation website now it is possible to find the Investment Philosophy where it is stated, among other declarations, that “[t]he most important thing a foundation does is choose a limited set of issues and develop expertise in them. Bill and Melinda have identified areas in which they think our grant-making can help solve complex, entrenched problems that affect billions of people—like the AIDS and malaria epidemics, extreme poverty, and the poor state of American high schools […]. Bill and Melinda have prioritized our program work over ranking companies and issues because it allows us to have the greatest impact on the most people. They also believe there would be much room for error and confusion in such judgments, and that divesting from these companies would not have an effect commensurate with the resources we would divert to this activity. The foundation’s not owning a tiny percentage of a company or selling it to another investor would often go unnoticed, and Bill and Melinda would not be comfortable delegating this kind of judgment. 1
“AT the end of 2005, the Gates Foundation endowment stood at $35 billion, making it the largest in the world. Then in June 2006, Warren E. Buffett, the world's second-richest man after Bill Gates, pledged to add about $31 billion in installments from his personal fortune. Not counting tens of billions of dollars more that Gates himself has promised, the total is higher than the gross domestic products of 70% of the world's nations” (LAT, January 7, 2007).
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Shareholder activism is one factor that can influence corporate behaviour. The foundation is a passive investor because we want to stay focused on our core issues. But as responsible shareholders, the investment managers do vote proxies consistent with principles of good management and good governance, and have voted against management’s recommendations when they have disagreed with them” (Our Investment Philosophy, www.gatesfoundations.org). This story raises a number of questions, in particular about ethical investing. The one we want to focus on is the relationship between various organisations’ mission statements, efficiency and effectiveness of ethically-based investment choices.
Socially responsible investment: a brief description In accordance with Cowton definition “ethical investment can be described, in broad terms, as a set of approaches which include social or ethical goals or constraints in addition to more conventional financial criteria in decisions over whether to acquire, hold or dispose of a particular asset […]”(Cowton, 2004, p. 249). There are various names to indicate investments made with “social” or “ethical” or environmental criteria: ethical investments, ethical finance, socially responsible investments or finance (thus the acronym SRI), sustainable investments, alternative investments, environmentally sustainable investments, “ecological” investments, etc. Despite the fact that some authors have highlighted narrow differences in terminology, (see for example, Cowton, 1999; Sparkes and Cowton, 2004; Kurtz, 2005; Viganò, 2001; Burke, 2002) in this paper the terms “ethical investments” or “socially responsible investments (SRI)” will be used interchangeably, with their distinguishing characteristics, leaving all judgements regarding their effective ethical nature and the comparison with more traditional investments out of consideration. Ethical investors usually adopt three different ways to introduce their values into investment choices, often combined together: •
the screening
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the engagement (mainly through the shareholder activism)
•
the community investing
Together with the more traditional negative screening, often called “sin stock” to evoke their origin strictly linked with religious rules or duties – such as alcohol, tobacco and gambling, new principles more closely linked to corporate social responsibility (CSR) practices have been developed2. In particular, besides the identification of some particular activities or industries considered especially worthy of financial support as “socially helpful” (for example, biological agricultural, or alternative energy management practices with low environmental impact, etc.), more and more complete and complex methods of analysis on 2
The most frequent social screens (negative) used by the ethical investors are: arms and military contracting, tobacco, pornography, nuclear energy, gambling, human rights and ILO fundamental conventions violations, child labour, GMO, alcohol, products dangerous to health/environment, excessive environmental impact and natural resources consumption, oppressive regimes, animal testing, furs, factory farming. It is important to emphasize that the above sectors are, in general all legal (some exception could derive from, for example, particular religions, like the production and consumption of alcohol in Islamic countries). The judgements to exclude them are not linked to non-conformity to a law, but to a pre-established ethical or moral order. Indeed, these sectors are not unequivocally “good” or “bad” , but such judgement depends on the usage of these products or sectors, the contexts in which the companies are operating, etc.
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the different aspects of the whole company and its management have been progressively asserted, in order to regard the corporate social responsibility as a holistic way of being a company (Some Italian authors on this idea in Rusconi e Dorigatti (eds), 2004, in particular: Caselli, 2004; Chirieleison, 2004; Coda, 2004; and Matacena, 2004). In the USA and the UK, in particular, but in recent years also in other countries in which SRI is becoming more and more important, the screening process is often supported by practices of engagement, through which investors involve companies in socio-environmental questions. If the social screening aim is to punish or reward some practices, then social selection is finalized to modify a specific behaviour in accordance with socially responsible principles. This action can be carried out in various ways: there may be a simple communication (to the company or to the public in general), an attempt at dialogue with the company or, in a more incisive manner, the filing of shareholder resolutions. This practice is often called shareholder activism. The reason encouraging investors to move towards such investments, therefore, is mainly linked to the possibility of using the voting right attached to ordinary shares to assert social, ethical or environmental objectives and to interact with companies whose social or environmental performances do not meet investors’ expectations. Besides the different aspects of socio-environmental policies, shareholders seem to be very active on questions linked to corporate governance (for example the Investor Responsibility Research Center – IRRC data published in Social Investment Forum (2003) e (2006) and the Interfaith Center on Corporate Responsibility website -www.iccr.org). Community investing is the third modality by which ethical investors can operate. This practice indicates the form of “financing that generates resources and opportunities for economically disadvantaged people in urban or rural communities […] under-served by traditional financial institutions”(Social Investment Forum, 2001, p. 20)3. This practice could be considered ethical in its capability of reaching sectors, people, countries or geographical areas underserved by the more traditional financial instruments, and the consequent enlargement (and in some cases the completion) of financial markets (Viganò, 2001). Experiences in this sector are rather numerous and varied (Viganò, 2001; Signori and Viganò, 1996), even if they are all generally characterized not only by the possible support of access to credit services for activities or people who otherwise would be excluded or penalized, but also by the particular attention to the socio-economic impact the investment has or can have on the whole community, thus extending the benefits beyond the financed project. In this category we can again consider most of the leading Italian and international experiences of investment in the so-called “third sector” (or non-profit sector), as well as micro-credit and micro-finance projects in underdeveloped countries or in other contexts of socio-economic marginality.
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The name “community investing” è mainly used in anglosaxon countries, in other countries, financial actions meant to support economic development are indicated and defined in such terms as “credit policy” or “cause related investments”. Regalli, Soana e Tagliavini (2005) prefer to use “cause-based investing”, besides Cowton (2002, p. 397) prefers the term “affinity”, because “in various fields it stands for relationship by choice, a mutual attraction or resemblance”. Similarly, in the francophone countries, the term “proximité” is used.
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Efficiency and effectiveness of SRI choices One of the aspects that, mainly in recent years, has most interested academicians and scholars has been the economic and financial sustainability of SRI. Hundreds of research studies, often empirical, have been dedicated to the analysis of the existence and the direction of the correlation between financial performance and corporate social responsibility in general, and ethical investment in particular (an in-depth list of these studies can be found in Signori, 2006. On the same subject see also Pava and Krausz, 1996; Rusconi, 1997; Kurtz, 2000; Tasch and Dunn, 2001; Viganò, 2001; Burke, 2002; and the website www.sristudies.org edited by Kurtz). Despite the attention dedicated to this field, the results are still inconsistent. This could be due to a series of different causes, among which at least the following must be mentioned. As regards the correlation between performance and corporate social responsibility (CSR) (in particular Rusconi, 1997; Wood and Jones, 1995): 1. the lack of an unambiguous, shared and precise definition of an ethical or socially responsible company; 2. even in the presence of shared definitions, there may be different ways to put abstractly-defined concepts into practice; 3. the difficulty of qualifying, quantifying and measuring ethical or social performances in a correct manner; 4. information availability and reliability about social performances; 5. the possibility that ethical choices might be purely apparent and not effective; 6. the lack of methodological rigour in some studies; 7. the risk of spurious correlations4. To which, with specific reference to SRI, must be added: 8. the variety of instruments used in making ethical investment choices; 9. the different “ethical contents” of these instruments5; 10. the different policies (i.e., screening, engagement, shareholder activism, community investing or a combination of two or more of these); 11. the fact that the variables that can influence the performance of one commodity or one investment might actually be more than two, and often with different strength and direction. One of the most often-recurring accusations charged by the opponents of SRI is based on the suspicion that the exclusion of particular investments held by “critical” companies or sectors could in some way compromise portfolio diversification, with a consequent higher risk or a lower return (diversification effect, also called Markowitz View)6. As shown below, the practices actually used by ethical investors give additional simple exclusions, aiming to investigate the numerous aspects of corporate strategies and business administration. This analysis, together with engagement and the following leading processes towards more socially responsible practices, seems to enlarge the possibility of better and deeper knowledge of the company, and thus in fact stemming the investment risk (information effect or Moskowitz View). 4
That is the risk that the two factors are correlated, but this correlation does not reflect any causal connections. It exists on financial markets SRI instruments with different “ethical contents”. In the field of ethical funds, for example, they are usually indicated as “ethical” both funds with just one negative screen (like tobacco, for example) and funds with sophisticated socio-environmental selection processes. This situation, as it should be clear, also affects financial performance. 6 One of the first authors to raise this doubt was Rudd (1981). 5
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Some authors, for example Kurtz (2000), support the idea that the empirical evidence shows neither a continuous underperformance nor a consistent over-performance of SRI in comparison to more traditional investments, probably because neither of these two effects consistently dominate the other. Thus, either the “financial markets are efficient enough that SRI portfolios incur a diversification cost, but inefficient enough for this cost to be offset by an SRI anomaly” or “SRI portfolios have the same performance as unscreened portfolios because screening introduces no unspecified diversification costs and there are no commercial information effects”. This raises the hypothesis that the effects of SRI selection processes on investment performance can vary, with different (mainly opposite) directions than those aimed at. For this reason it is difficult to draw generalizations from the results of the analysis7 and to suggest how to amplify and integrate the analysis with different perspectives to best understand how the financial markets move. As indicated in recent studies, it is important to isolate at least the effects not linked to an investment’s “sociality”, and to create multi-factor models of analysis; that is, models that consider more elements interacting among themselves (for example, the consideration expressed and quoted by Burke, 2002, p. 22 and this model’s application in Bauer, Koedijk and Otten, 2002; Schroeder, 2004; Scholtens, 2005)8. However, there is still, in this writer’s opinion, a perplexity due to the diversified offer of ethical or socially responsible products. These effects, as shown above, will be different in intensity (and in some cases also direction) from product to product, so we can very probably affirm that, at least in the long run, SRI performances are not so different from those of more traditional portfolios. As a matter of fact, the ethical investor is moved not only by personal profit motives, but also by ethical or moral ones. Despite the fact that most studies have concentrated mainly on the financial impact (on risk or return) of SRI choices, some academicians have already accentuated the need to enlarge the evaluation to other than strictly economic considerations. Malkiel and Quandt, since 1971, have interpreted socially responsible investing as an application of the old issues of externalities. They suggest that “portfolio managers should take into account the social, political and moral effects of a company’s activities when making investment decisions. This is so because of a growing community awareness of the effect of corporate activity upon society, and a corresponding increase in demands by community pressure groups for corporate compliance with certain social standards. The formerly objective task of fund managers to maximise financial return, subject only to risk, has yielded to a third dimension: the social, ethical and moral concerns of the community”9. In a similar way, Tipper and Leung (2001, pp. 45-46), have interpreted the Rudd (1981, p. 55) expression “the financial cost can be weighed directly against the perceived social 7
Just to mention a few, besides the information and the diversification effects described above, we can have: sectorial or geographic diversification effects; markets or investments sector effects; positive selection effects; segmentation effects; small cap growth effects, information cost effects; risk adjustment effects; anticipation effects; short or long time perspective effects; learning effects; fund dimension effects; fund manager capabilities effects, etc. (more analysis in Signori, 2006; Havermann and Webster , 1999; Sparkes, 1995 and 2002; Calcaterra and Perrini, 2002). 8 In 1991, Coffey and Fryxell reached an analogous conclusion as regards the concept of social responsibility. On examining the relationships between institutional investors and corporate social performances they have noted the existence of a correlation of different sign in relation to different elements of CSR analysed. The authors showed that the corporate social performance is “a set of distinct and only loosely integrated constructs (Carroll,1979)” and not a “monolithic dimension” (Coffey and Fryxell, 1991, p. 443; Rusconi, 1997, p. 141). 9 Tipper and Leung (2001) pag. 45. In fact, the concepts introduced by Malkiel and Quandt have a contents lager than the more traditional economic definition of externality (as stated, for example, by Pigou or Coase).
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benefit”. The authors, in fact, emphasize that the possible “financial cost” “is a private cost borne by the investor, whereas the “social benefit” is a public benefit, external to the investor”. Also Bruyn (1987), some years later, proposed the social investment theory under the persuasion that it was not possible to consider investment choices based only on financial considerations. Tagliavini (1996) and Cowton (in Sparkes, 2002, p. 22), as well, say that the ethical investor cares not only about the size of his/her prospective financial return and/or risk but s/he wants to know how this return is produced, where the company is located, what kind of goods or services it offers, how business is conducted, etc. In a larger sense, ethical investment “is broadly defined as the integration of personal values, social considerations and economic factors into the investment decision. Financial return remains an important outcome but it is not the sole criterion driving investments. Ethical concerns are also included” (Michelson, Wailes and Van der Laan e Frost, 2004, p. 1). The list of different interpretations could get longer, but already this brief consideration can open some reflections: the ethical investment effectiveness (or efficacy) analysis cannot leave ethics out of consideration10; these considerations may be based on deontological or religious aspects that influence the investor’s values sphere (private or institutional), or they could be linked to the consequences of investment choices; these consequences can be interpreted in terms of social value (or benefit) – using the externalities approach – or as a change in corporate behaviour (or practice), that often, even if not always, induces benefit for both individual investors and the community. As a consequence, the evaluation of an SRI regarding relative “goodness” or profit must be based on at least three different criteria: - the possibility of obtaining the desired risk-return combination (financial performance); - the probability of satisfying the investor’s ethical preferences (ethical assessment); - the capability of inducing positive change (social impact). The last two aspects are linked to effectiveness as the investment capable of reaching the desired ethical and moral goals, while the first evokes the concept of financial efficiency.
Ethics and financial return: is it possible to mediate? To understand how the ethical investor behaves it is important to analyse how financial and ethical interests can be reconciled and how much weight to assign to the different elements of various preference systems.
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Also the concept of efficiency is not free from ethical considerations. A shared definition describes efficiency as the capability to reach the maximum result (or return) with minimum costs. “But what do we include in the numerator and in the denominator? The answer depends on what we want to measure, because the concept of efficiency is not unambiguous, not even in economics” (Argandoña, 1995b, p. 11).
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The following points will aid this understanding (TO BE IMPLEMENTED): • an analysis of different investor behaviours and different investment strategies; • some considerations about investment choices, ethical implication and return renunciation (see Melè (1999) p. 326, Melé and Fernàndez (1998); Bowie (2001), and in particular on ethical investors (Lewis e Mackenzie (2000b), Rosen, Sandler and Shani (1991), Mackenzie and Lewis (1999), IREF-SAI (1999), Lewis and Mackenzie (2000), Oliverio (2000), Burke (2002), Bollen and Cohen (2004), Cowton (2004), Boatrigh (1999), Sparkes (1998) and (2001), Klonoski (1986), ); • some models (Basso e Funari (2002) e (2003); Beal, Goyen e Phillips (2005); Viganò (2001); •
the matrix (return ethics)
The Gates Foundation case suggests that we should consider another variable element. There may be situations in which it is not possible to choose; that is, for particular investors (mainly institutional investors) there might be ethical, moral, legal, fiduciary or any other restrictions, that do not allow mediation.
Coherence with your mission: socially responsible investment a choice, an opportunity or a duty? The concept of the ethical investor includes rather ample connotations in its definition: investor categories might include a single investor, a family, a corporation, a not-for-profit organization, a financial company, an investment fund or a pension fund with specific “ethical” or traditional orientations, etc. Various kinds of organizations can be defined as ethical investors. For some of these subjects, ethical investment seems, rather than a choice, to be a legal, fiduciary or mission-related duty. With regard to organizations that collect money without the obligation to give it back but with precise destination (usage) commitments, for example, the very delicate question could be raised about the usage, even if temporary, of collected money. Is it permissable for a foundation dedicated to the battle against lung cancer, for example, to invest the money collected to cure this disease without caring about its destination? And if it could be used to invest in the tobacco industry or in a company producing harmful substances or with poor attention to its worker health conditions? Is avoiding such activities or supporting initiatives coherent with its own mission is always suitable, even when there may be risk of compromising part of the investment’s financial return to future use? How much weight should be given to efficiency and to the coherence with its own mission in making investment choices (McKeown, 1997; Solomon and Coe, 1997)? What kind of ethical investments it is possible or suitable to choose? (see Figure 1 above).
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Figure 1 – Efficency, effectiveness and mission relationship in investment choices
Efficiency
Effectiveness
INVESTMENT CHOICE
Mission
Making the mission evident, particularly for not-for-profit organizations, could also be effectively pursued through investment policies which have become known as “missionrelated investing”. In reality, despite the big and evident potentiality, the phenomenon is still limited even in markets like the USA, which sustain a consolidated SRI tradition (Tash and Dunn, 2001). As regards Italy, a spur in this direction could also arrive from the recent modifications in the ex-banking foundations law. Some provisions, especially regarding the property and the not-for-profit nature of the foundation with a specific link to the territory, seem to open the possibility that this structure is beginning to assume the role of ethical investor. For some subjects ethical prescriptions might be stronger than any other considerations (for example, for ecclesiastical or other kinds of religious organizations); in other cases, indeed, SRI might be interpreted as an opportunity mainly linked to economic or financial opportunities rather than to ethical or moral choices11. This is very currently the case of pension funds in Italy. One of the most controversial points regarding pension funds is the fear that including selection criteria other than the traditional (financial) ones, could break the fiduciary duty between pension funds and those participating (for the above-mentioned diversification effect and the consequent higher risk or lower return). Actually some authors (Among all: Sethi, 2005; Smith, 2004; Kinder, 2004) are pointing out that the fiduciary duty could also be respected through a “responsible” usage of the right linked to share ownership12. As long as there is suspicion of negative effects return, the adoption of negative screening by these subjects is advised. Shareholder activism, however, is particularly interesting because of the potential pressure, and the consequent corporate behaviour changes, such investors can induce. In particular, holders of pension funds and other long-term shareholders are interested in long-term performance and they thus also drive corporate behaviours in this direction. This possibility improves management prudence and induces the demand that the companies they invest in respect this practice even in such delicate 11
Future investigations should be dedicated to the analysis of the motivations which induce a company or an organization to be an ethical investor and of the correlated implications. 12 “The SEC [U.S. Securities and Exchange Commission] has now categorized proxy voting as a fiduciary duty. Hence, a trustee must exercise the same degree of care as s/he does in managing money” (Kinder, 2004, p. 6).
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questions as ethical code application, climate change13, working conditions, the socioenvironmental impact of their actions, corporate governance, etc. (Smith, 2004; Sethi, 2005)14. One further consideration is that the social responsibility evaluation allows the discovery of opportunities not immediately evident in a more traditional analysis (Forum per la Finanza Sostenibile, 2004, p. 29). This is true, in particular, with reference to the long term point of view usual for pension plans. The adoption of positive screening seems not to be precluded, at least on questions linked to CSR. In fact, companies that pay attention to causing the minimum environmental damage, aware of their stakeholder responsibility and of the consequences of their actions, seem to “minimize future financial risks emanating from imprudent or unsafe business practices” (Sethi, 2005, p. 101). This is undoubtedly coherent with safety and integrity: principles that must drive all pension fund management processes (and those of every financial business). Not even community investing seems to be excluded if it can grant market returns (preferably fixed in advance).
Conclusions These brief considerations are intended to draw attention to the complexity of the analysis and to the importance of breaking free from the bias of basing investment choices exclusively on financial return. In this paper we suggest enlarging analysis to a set of three targets: efficiency (expected financial return of investments), effectiveness (the investment suitability in satisfying the investor’s ethical preferences or to induce the changes the investor expects to obtain), and mission consistency with respect to all of his or her economic, social and moral values. This view is open to new empirical verification on how these three dimensions could be combined in such a way as to fully respect the ethics of ethical investors.
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Silvana Signori PhD in Business Administration and Strategies (University of Milan – Bicocca), dissertation discussion about “Ethical Investors”. She is assistant professor at the University of Bergamo – Department of Business Administration. Her main areas of research are ethical investments, business ethics and corporate social responsibility, non-profit organization accounting and accountability. She is a founding member of the Italian chapter of EBEN and at the moment she is also its executive secretary.
University of Bergamo Department of Business Administration Via dei Caniana, 2 – 24127 Bergamo (Italy) e-mail:
[email protected]
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