On August 23, the Wall Street Journal published an editorial by Dr. Aneel Karnani that questioned the value of corporate social responsibility (CSR). His argument was directed against “pleas” and “appeals” for executives to “act voluntarily in the public interest and against shareholder interests.” He called CSR “irrelevant or ineffective,” an “illusion, potentially a dangerous one.” A reader unfamiliar with the term might surmise that CSR is actually a dangerous chemical, like DDT.

The socially responsible investing (SRI) community, as expected, took issue with Dr. Karnani’s column. Social Investment Forum (SIF) CEO Lisa Woll wrote to the Journal, countering the polemic with real-world evidence about the positive impact of corporate sustainability efforts. (With permission from SIF, Ms. Woll’s letter is printed in full at the bottom of this article.)

Besides its empirical shortcomings, Dr. Karnani’s case also betrays a methodological flaw that is both common, and instructive: While we can tell what he takes issue with, it’s never quite clear who he’s talking about. Here is the plainest statement of his thesis about corporate social responsibility:

Trend stories are a staple of the news media, and two articles this past weekend explored the prospects for socially responsible investing (SRI). What’s interesting is that one story (in the Boston Globe) found that SRI’s trend line points up, while a piece in the Financial Times asked why its growth has stalled. This divergence comes because the Globe considered the US market, where SRI mutual funds have kept growing even as mainstream equity funds shed billions. The FT looked at a lagging market for SRI: Germany.

The FT reporters found “rather typical” explanations for Germans’ lack of interest in environmental, social and governance (ESG) integration. But it should be noted that the ESG community has taken concrete steps towards answering skeptics in Germany, and around the world. These steps include ongoing academic research into the performance impact of ESG integration, and an initiative to develop standardized metrics for comparative evaluation of company performance. MSCI’s ESG team has supported both of these efforts.

Last week, the Harvard Business Review blog presented some Harvard faculty responses to the newly signed Dodd-Frank financial reform bill. The Business School Professors’ sentiments range from the “cautious optimism” of Robert Steven Kaplan to Robert C. Pozen’s assertion that the act “misses the main cause of the crisis,” which was Fannie Mae/Freddie Mac, in his opinion. And while David A. Moss believes that the bill takes important steps to rein in “too big to fail” banks, Clayton S. Rose says that “little has been done” to defuse the systemic risks of such institutions.

None of the Professors focus on what Joseph Fuller, co-founder of Monitor Group, has called “The Terminator” of modern financial markets: computer-based modeling and trading programs. In a 2009 piece in The American Scholar, Mr. Fuller argues that the work of “quants” worsened the financial crisis. He also describes regulatory steps that could help dampen the volatility produced by automated trading programs.

Neither the Dodd-Frank Act nor Harvard’s Professors assign high importance to quant-driven volatility, but Mr. Fuller’s argument suggests that they should. Automated models drive hair-trigger, lockstep responses to market signals. “The Terminator” has also discouraged the sort of qualitative historical analysis that many investors, including those who consider environmental, social and governance (ESG) factors, believe is the key to long-term value creation.

What does “analytics” mean? When we first began using the word in 2000-2001, we got this question often. It struck me as I read Walter Kiechel’s excellent Harvard Business Review blog post on the state of “strategy” in business thinking that I don’t remember when I last got the question. But as we’re now part of a much larger ESG Analytics team, it is a question well worth answering nonetheless.

Frequent enough tourist destination cities, like Boston, and you’ll get to know shell games. Players will try to guess which of three shells covers a pea or a stone. Try to take a picture, and you suddenly learn it’s a team con. It’s not just the operator’s flashing hands that tease the mark’s wits.

Reading the four opinions written by the majority in the January 21 US Supreme Court decision in Citizens United v. Federal Election Commission¹ brought to mind this team sport. Comment has focused mainly on the majority opinion – and the Court’s decision – written by Justice Kennedy. Three concurring opinions – one each by Chief Justice Roberts, Justice Scalia and Justice Thomas – have attracted less attention than they should.

Most comments on the January 21 US Supreme Court decision in Citizens United v. Federal Election Commission (1) have focused on the effects of direct contributions by corporations to candidates. Are such contributions invitations to corruption, or exercises of protected speech by persons associated in corporations?

But for those concerned about corporate governance or corporate accountability in any of its forms, Citizens United has a context and implications that go well beyond elections and freedom of speech. These challenge fundamentally the notion of corporate social responsibility (CSR) and socially responsible investing (SRI).

In this post and some that will follow, I want to explore how Citizens United affects what proponents of CSR and SRI have advocated.

In the aftermath of the global financial crisis, many investors have grown concerned about standards of corporate governance. In fall of 2009, the European Commission released a study of corporate governance monitoring and enforcement practices in its member states. The study was undertaken by RiskMetrics Group in collaboration with BusinessEurope, ecoDA and their affiliates, and Landwell & Associates and their affiliates.

In most EU states, national governance codes set rules with which corporations must comply, or else explain why they have not complied. The RiskMetrics study found support for "comply-or-explain" regimes, but also found "some deficiencies," including "unsatisfactory level and quantity of information on deviations by companies and a low level of shareholder monitoring."

The final version of the Walker Report on corporate governance of UK banks and financial institutions was published on Nov. 26. The Prime Minister requested the report, which was issued by the Treasury. Sir David Walker chaired the report team. He is a prominent City banker who has had stints at Lloyd's and Morgan Stanley.

The Report includes, among its recommendations (no. 17, p. 17), one that would require fund managers to adopt the Code on the Responsibilities of Institutional Investors announced by the Institutional Shareholders Committee (ISC) on Nov. 16. The Code, which Walker suggests be renamed the "Stewardship Code," would require, among other things, that managers commit to engagement or explain why they didn't.

The renaming of the Code seems important. Its original name is undescriptive and passive. "Stewardship" implies action, taking charge of assets entrusted to the manager. It is a word of rich significance to mission- and faith-based investors. The oldest UK SRI mutual fund is the Friends Provident Stewardship Fund.

The Walker Report in total has come in for a good deal of criticism from people the Guardian refers to as "campaigners." Nonetheless, in governance and engagement Walker seems a step forward. How large a step will be up to Parliament.

Below are links to the Walker Report, the ISC Code press release, and some background on Walker and the controversy surrounding his work.

A Review of Corporate Governance in UK Banks and Other Financial Industry Entities [PDF]

Press Release from Institutional Shareholders Committee on the Code on the Responsibilities of Institutional Investors [PDF]

Fund managers in UK must sign up to stewardship principles or say why not: Walker report final Responsible Investor

Sir David Walker: 'I'm a man of the people, not a City grandee' Guardian

Campaigners blast Walker report on banks Guardian

Like many of us at RiskMetrics and the former KLD, I belong to LinkedIn groups that address socially responsible investing (SRI). This week, an "SRI Professionals" discussion brought up one of the seminal questions in SRI: What does it cost, compared to investing that disregards corporate environmental, social and governance (ESG) practices?

With permission from Advocacy Investing's Marc Lane, leader of the SRIP group, here is Richard Nash of Investors Group in Vancouver, BC:

"There is not much information available that shows the comparative returns of the FTSE4Good indices against their "non-SRI" index counterparts - i.e. an analysis to gauge the perceived cost of being SRI."

The question of comparative returns is part of why KLD, among other ESG research firms, came into being. Our first index, which is now called the FTSE KLD 400, was created as an ESG-screened counterpart to the S&P 500. Many other FTSE KLD Indexes are similarly based on "non-SRI" benchmarks.

Click here to compare the performance of FTSE KLD Indexes to their benchmarks.

In the right-hand column of the Index home page, click on the name of any Index, and then click "Performance." You'll see a table and a graph indicating the relative performance of each Index and its benchmark.

Other References

Robert Kropp of SocialFunds.com recently wrote about a new Mercer study of ESG's impact on performance:

Studies Find Positive Link Between ESG Integration and Investment Performance

Also see these KLD Blog articles on this topic:

"Are Ethical Investments Good?" New Research on Impact of FTSE KLD 400

The Wages of Social Responsibility: 2008 Moskowitz Prize-Winning Research Paper Studies Long-term SRI Performance

Social Investment Forum Answers Top Ten Questions about SRI/Sustainable Investing

Investment & Pensions Europe's Nina Röhrbein has presented some highlights from last week's TBLI conference in Amsterdam. She quotes RiskMetrics Group's Ran Fuchs, who asked why, historically, environmental, social and governance (ESG) research has primarily focused on equities, rather than fixed-income assets.

Mr. Fuchs' question is about investment horizon, as ESG investment is long-term investment. In considering extra-financial metrics of corporate value, ESG investors act on their skepticism about short-term indicators, like share prices or quarterly returns. As ESG research can uncover longer-term risks and opportunities, Mr. Fuchs believes, its practitioners should apply its lessons to assets with longer time horizons.

"Debt is Vital to the Survival of a Company"

His comments, from the IPE report:

"Fixed income investments last for 10 to 15 years or even longer, so any type of long-term ESG investments should be going straight to debt." … "The short-term performance of such investments should easily convince investors that there is value in this. But the impact on the industry can also be much stronger through fixed income because, while the price of the equities is relevant, the cost of debt and financing is absolutely vital to the survival of the company."

In citing a desire for "impact on the industry," Mr. Fuchs affirms that engagement – or "lobbying the corporation" – remains a priority for the ESG sector. As bondholders, he suggests, investors could help reorient corporate thinking in a more sustainable direction.

Moving Minds with Markets

"Sustainability" is a buzzword that can obscure as much as it explains. A company that sustains a healthy balance sheet may use resources – natural and human – in an unsustainable way.

The ambiguity of "sustainability" hints at why the ESG sector – of which KLD was an early member, and to which RiskMetrics has made a strong commitment – describes its work as "integration."

Within the financial services community, we seek to integrate extra-financial factors into mainstream analysis. For the economy as a whole, we work towards the integration of environmental, social and governance concerns into mainstream corporate management.

From this perspective, financial instruments are only means to an end. We argue that business can only create as much value as the community and environment can sustain. This perspective demands a philosophical shift – a change in managers, not just markets.

Thinking 'Round the Bend

This change has already begun. Tom Konrad at Seeking Alpha recently posted a revealing exchange with Ray Anderson, head of carpet maker Interface:

"Q: In your experience, how does the financial community view corporate sustainability? Does anyone outside of the Socially Responsible Investment community care? Have you encountered much skepticism? Ray Anderson: In the early days of our journey, we definitely experienced skepticism from the financial community. In fact, our former CFO Dan Hendrix (who is now the Interface CEO) was asked on more than one occasion if I had "gone 'round the bend." I explained that as a leader, that was my job, because 'round the bend is where our future lies. … Q: How does sustainability help returns for investors and over what time horizon? Ray Anderson: As with any new thinking there's a time lag between early adoption and mainstream acceptance, and that naturally influences the return horizon for investment in new products, processes and technologies. I believe there are new fortunes to be made as we define this, the next industrial revolution. I also believe that part of what needs to change is our focus on short time horizons, i.e., the focus on the next quarter, for both companies and for their investors. Sustainability by its very nature requires a long view on the future as we consider the impact of our decisions today on future generations."