SOCIALLY RESPONSIBLE INVESTING

Corporate Social Responsibility Assignment

16 Nov 2012

Rahul Pathak
Student reference number: F5540595Q

I am only one, but still I am one. I cannot do everything, but still can do something; and because I cannot do everything, I will not refuse to do something that I can do. In these words of Helen Keller resonate a surge seen in recent years of corporate actions on societal concerns being placed on an equal and important footing, next to the age-old maxim of creation of shareholder wealth. Much of this acceleration in interest can be attributed to the investors themselves, who as future shareholders seek companies as possible investment candidates that not only meet certain financial performance baselines, but also show a commitment to corporate integrity. Social change through shareholder activism has induced companys world-over to minimize corporate externalities and strive to reduce or eliminate practices that are perceived to be harmful to the society, economy and environment at large. Examples of these are, avoiding businesses whose activities do not take into consideration the enhancement to the quality of life1; investing in those that expand the total pool of economic and social value2; and the ones that look at their value chain to see where they may have inflicted a burden on natural resources3. The integration of social or ethical criteria into the investment decision-making process is what is commonly known today as Socially Responsible Investing (SRI). The origin of SRI dates as far back as the 1920s when church organizations began to divest in sin stocks of companies that produced alcohol, tobacco and engaged in gambling activities. The SRI methodology gained momentum in the 1970s and has since seen the establishment of SRI specific mutual funds and investment groups. With more traction, exposure and positive change brought about by shareholder activism, SRI continues to grow in the volume of effort, if not yet, in the measure of financial success. The social responsibility of Business is to increase its Profits. Not all profit is equal. Profits involving a social purpose represent a higher form of capitalism, one that creates a positive cycle of company and community prosperity. The dichotomy presented in these words of Milton Friedman and Michael Porter respectively, reflect the prevalent conflict in spite of an increasing number of companies embarking on societal needs next to the conventional economic value. In the mix, remain businesses that still view corporate responsibility programs as necessary to enhance its reputation towards the public and institutional investors. In treating it as an expense, so do many shareholders, who feel short-changed in what they see as an irresponsible use of their money. The proof perhaps isnt in assessing whether SRI is within the fiduciarys duty to the corporation and hence compliant with laws of corporate governance. But, whether SRI can actually increase the long-term value of a corporation in spite of greater short-term costs,

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practice of child labor fair trade movement in purchasing 3 lowering carbon emissions, expanding re-cycling and re-use

Rahul Pathak
Student reference number: F5540595Q

under the assumption that, generation of long-term value is a commitment towards all stakeholders4 and not shareholders alone. In a general sense, socially responsible investors want their investments to be compatible with their personal values. Since values and ethics are personal, what constitutes an ethical investment depends on the individual investor's views. Typically, socially responsible investors are younger and better educated, and identify environmental and labor relations as fundamental determinants of responsible corporate behavior. Yet, studies have shown that though this next gen values socially responsible behavior in companies they invest in, they are not willing to sacrifice financial returns to achieve it. In addition to individuals, many institutional investors are heavily involved with SRI. Pension funds for example are taking an increasingly active role, using economically targeted investing as a method to achieve a market rate of return, in addition to achieving a social or economic benefit to the public at large. Regulated financial institutions like community development banks are another example of institutional investors that are active in SRI, fostering long-term economic development via loans to people and corporations working and doing business in low to moderate income communities. We have to choose between a global market driven only by calculations of short-term profit, and one which has a human face. Between a world which condemns a quarter of the human race to starvation, and one which offers everyone a chance of prosperity. Between a selfish free-for-all and a future in which the strong and successful accept their responsibilities. This excerpt from then UN Secretary General, Kofi Annans speech at the World Economic Forum at Davos in 1999, provides food for thought for investors and corporations alike, in incorporating environmental, social and ethical issues into a fiduciary role. But, for SRI to make major in-roads and gain widespread acceptance, it is important to be able to measure its success. Success in SRI can take on many different meanings, but fundamentally it involves the impact and the results of investor activism, the effect on society and unequivocally, the measure of financial performance. 1. Results of Investor Activism When activism is the investment objective, its goals are usually not directly related to the financial return of the investment. Rather, activists are generally more concerned with using their rights as voting shareholders to effect some change. However, since most corporations operate on a one-share, one-vote system, individual shareholders generally have little influence on corporate resolution voting. Institutional investors on the other hand though, have enormous financial clout and can take an increasingly active role in shaping the corporate policies of their holdings5. 2. Societal Effects While investor activism can exert direct or indirect pressure on a corporation to make changes that are in the best interest of society, the measure of societal impact remains to be
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employees, suppliers, customers, and the community as a whole By the mid 90s, social resolutions were beginning to receive 10-25% of votes, while corporate governance resolutions were gaining 20-50%

Rahul Pathak
Student reference number: F5540595Q

difficult to assess. One way could be to gauge a company on its products, equity or debt instruments that are generally being boycotted or avoided by a conscientious public and responsible investors alike, highlighting an area within the company that is in need of change. A contrarian approach could be to assess a company on the demand for its products and investment securities, based on what it says they are doing in order to enhance the quality of life, reduce environmental impact, and expand the pool of economic and social value. 3. Financial Performance Although financial performance as a SRI criterion for success is easier to quantify, yet it is difficult to evaluate, since quantitative performance statistics can be calculated for any portfolio, regardless of the degree of SRI ambition6. Moreover, financial performance metrics tend to be generated by groups or individuals that have a vested interest in either depicting a positive or negative image of SRI's financial success. As a consequence, analytics that address the financial performance of socially screened portfolios churn-out inconsistent results. For example, the effects of divestment of South African holdings during the apartheid era indicated that the costs associated with divestment were significant, while the avoidance of such securities did not necessarily improve an investor's financial situation. Another research showed companies with good environmental records, policies of charitable giving, and an absence of nuclear and defense work achieved higher-than normal returns, whilst companies that exhibited good performance on family issues earned lower-than normal returns. One of the pioneering concepts to effectively analyze a companys merit as a socially responsible investment, especially in relation to its peers, is the Calvert RatingsTM. Calvert7 created a comprehensive rating system that takes into account a companys actions, corporate social responsibility initiatives, and related performance. Measured across six key areas, the ratings are on a scale of 1 to 5, ranging from performance is substantially below Calvert standards to superior performance. Eligibility as an investment in one of Calverts funds is limited to those companies that achieve a rating of 3 or higher, on each of the six key areas listed below8. Environment: In addition to assessing a companys compliance with federal, state, and local environmental regulations, performance and policies are measured in four specific areas the environmental impact a company has during its manufacturing process, the impact of the companys product use as well as its disposal, the transparency and nature of the companys environmental management policies, and the sustainability of the companys development practices. Workplace: Workplace practices, programs and policies are assessed across three areas labor relations, worker safety, and workplace diversity. Business Practices: Corporate governance is examined to determine the rating by reviewing the following areas board practices, board independence and diversity,

Without a meaningful benchmark to compare the statistics, the facts and figures associated with the portfolio are not of much use 7 Founded in 1976, Calvert is an SRI focused asset management firm offering equity, fixed income and mutual fund products all screened for performance and for corporate integrity 8 source: www.calvert.com

Rahul Pathak
Student reference number: F5540595Q

compensation of executives and directors, quality and independence of auditors, corporate charters and bylaws, and the degree of shareholder communication. Product Safety and Impact: Companies that produce safe products and services in accordance with federal consumer product safety guidelines are rated significantly higher, while generally speaking, those manufacturing tobacco products; having a direct involvement in gambling operations; are significantly involved in the manufacture of alcoholic beverages; design, sale and distribution of weapons, are avoided. Human Rights: Record of compliance with human rights statutes, both domestically and internationally is measured, including the degree to which it supports governments with poor human rights records. Also considered, in relation to human rights, are a companys policies and practices, whether a company exceeds or simply meets the minimum standards required by a host country, the extent to which a company actively addresses human rights abuses, and the level of disclosure and reporting a company offers regarding its human rights record. Community Relations: Corporate philanthropy, employee volunteerism and other means of support to non-profit organizations by a company, specifically in relation to such initiatives impact on communities, are assessed. In spite of the Calvert RatingsTM being clear, concise and easy to use, it has its limitations. The ratings allow the incorporation of outliers. For instance, Cisco could be considered as aiding the Chinese government by censoring internet access to the Chinese public. Yet, Cisco could still be rated high on Human Rights. Similarly, it is questionable whether equal weightage across the six key areas is fair, given that perhaps failure in one category impacts society more than excellence in another. Corporate Governance is the structure that is intended to make sure that the right questions get asked, and that checks & balances are in place to make sure that the answers reflect what is best for the creation of long-term sustainable value. The difficulty to measure success in SRI even with available tools brings to question, whether socially responsible investing is successful. An SRI-focused company could be best served in basing its corporate governance structure on the above definition by Robert Monks & Nell Minow. In this way, it could move away from trying to calculate success with SRI, instead focusing on the relative merits of socially responsible actions it has undertaken. For an individual or institutional investor, SRI may be considered a success so long as the objectives they seek in trying to bring change to a corporation or society are met. Businesses and society have long been pitted against each other, in part because economists have legitimized the idea that to provide societal benefits, companies must temper their economic success. Each is assumed to be an obstacle in pursuing the goals of the other. Social improvement actions for example, would inevitably impose a constraint on the corporation and raise costs, thereby reduce profits. Corporate responsibility programs as such, have largely emerged more as a reaction to external pressures than of accepting social progress at the core of a companys success. A narrow conception of capitalism prevents businesses from harnessing its full potential to meet societys broader challenges. In moving beyond trade-offs and connecting societal and economic progress, corporations
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Rahul Pathak
Student reference number: F5540595Q

need to recognize that while social harms are inherent in their business models9, solutions lie within their business scope10 itself. Recognizing that societal needs and not just economic needs define markets, and acknowledging that businesses acting as businesses, not as charitable donors, are the most powerful force in addressing the pressing issues we face, is what defines the concept of shared value. Companies themselves create shared value opportunities as opposed to surrendering to social responsibility due government imposed taxes and regulations, or confusing philanthropic largesse as its way of doing good to the society. By reconceiving products and markets11, redefining productivity in the value chain12 and by enabling local cluster development13, businesses can reconnect company success with social progress. Transformation neednt come at a cost, nor at the expense of one over the other, or being forced rather than believed in. If more businesses were to embrace the concept of shared value, the fiduciary role of the corporation in maximizing shareholder wealth would involve value creation not only in financial terms but also in the well-being of the community, the environment, the company and all its stakeholders. In my opinion, shared value has the power to remove doubt and steer arguments away from why SRI, to what benefit, and how much. With shared value, business, people and society all partake in wealth creation in the broadest sense. In a shared value world, SRI becomes a norm than a mandate, is not put through analytic screening or success metrics, and where activist investors co-exist with engaged corporations towards fulfilling a greater cause. I liken this to our project involving the Community Foundation of Singapore (CFS) who as an activist investor tries to match engaged and interested corporations towards fulfillment of a greater cause, like assisting charities. While not all societal problems can be solved through shared value solutions, CFS would greatly benefit on time, effort and resource allocation, while screening donor organizations on SRI criteria. Besides, it would allow CFS access to a larger pool of sponsors and, even shorten the decision making process, as more and more firms start looking through the lens of shared value. On the flip side, a socially responsible corporation is perhaps of a lesser consideration to the charities themselves, who are often dried of funds and would find any willing financier benevolent to their cause. In assisting CFS build the capacities of charities seeking corporate funding, SRI applicability of prospective donors could be a factor worth investing time on with the charities, during the apprenticeship period.

Wasted energy, raw material and costly accidents By use of new technologies, productivity enhancement and management approach 11 Fast-food chains like McDonalds are refocusing on the fundamental need for better nutrition rather than concentrate on taste and quantity to drive consumption 12 Cutting 100m miles from its truck routes, Wal-Mart lowered carbon emissions and saved $200m in costs 13 Nestl helped set-up agricultural, technical, financial and logistical firms and capabilities in each coffee cluster/region, which in turn made its procurement practices more effective
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Rahul Pathak
Student reference number: F5540595Q

Reference: HBR THE BIG IDEA Creating Shared Value How to reinvent capitalismand unleash a wave of innovation and growth by Michael E. Porter and Mark R. Kramer