A good, tough question from a conference I attended Friday. Since we have an established infrastructure to track corporate financial performance (the accounting profession) and investment characteristics (Wall Street), why not let them handle corporate social responsibility reporting? After all, the accountants and Street analysts probably know the company better than anyone else.
It's a thought-provoking question. Why do we need all this CSR infrastructure? But if you think about it, I don't think CSR reporting can be handled by accountants and analysts. Let's take them in turn.
Instead of GAAP, we could have GASP (Generally Accepted Social Procedures). Just as accounting firms have broadened their brief to include Sarbanes-Oxley, they could also pick up the social reporting requirements as well. Here are my objections:
- The accounting profession is itself in crisis, with one of the big firms (Andersen) now virtually extinct following its role in the Enron scandal and the others all involved in major scandals or frauds in recent years. An incomplete list of these would include Worldcom (Andersen again), Rite-Aid (KPMG), Adelphia (Deloitte and Touche), and AOL/Time-Warner (Ernst & Young). PriceWaterhouse Coopers has avoided the worst problems, but was the auditor when Bristol-Myers overstated revenues by $2.5 billion over a three-year period due to "inappropriate accounting" for inventories, an unwelcome event I experienced firsthand as a buyside analyst.
- I'm not sure that GAAP is a good example for anyone. Who, exactly, uses it? Not Wall Street analysts, who prefer operating earnings. Not most buy-siders - we use proprietary models that are more likely to incorporate Wall Street estimates, cash flows, and other indicators. Not academics - most I have met believe cash flows or metrics such as Stern Stewart's EVA are better indicators. Alfred Rappaport of Northwestern has famously said that "earnings are an opinion, but cash is a fact."
- The GAAP process, despite many denials, is highly politicized. One need look no further than the accounting profession's decades of refusal to count stock options as an expense. As Warren Buffett repeatedly pointed out in the 1980s and 1990s, they are a cost to shareholders. The argument that they have no value is absurd (if they're free, give me some).
So maybe the accountants are busy with other things. What about Wall Street? Surely they have the broad-based business knowledge and systems to facilitate social responsibility reporting?
By Wall Street I mean the 'sell side' of the investment business, the brokerage firms and investment banks. These organizations are incredible repositories of knowledge about specific businesses and industries. Want to know more about the EVP in charge of a company's largest division? The one person who can probably give you that color, and more besides, is a sell-side analyst. There have been superb individual reports from sell-siders on CSR issues. When I worked for KLD in the early 1990s the single best source of environmental information on Dupont was an extraordinarily thorough sell-side report. And I would single out Amar Gill's piece on corporate governance in developing countries as one of the best CSR reports I have seen from any source.
But I think reports like Gill's will be the exception rather than the rule, for three reasons:
- Hostile culture: Wall Street is almost religiously single-minded about money. Wall Streeters go there to make money and when they want to do something else they leave. It is the dominant aspect of the culture. For most, CSR is a way to lose focus and fall behind in the race. Wait a minute, you might argue, some of these things have real impact on the bottom line. True, and you might be surprised at how carefully Wall Street analysts have evaluated social issues likely to impact earnings in the near term. But they're not doing it out of social conscience.
- Investment banking: One of Wall Street's most lucrative businesses is investment banking. And investment bankers hate it when people say bad things about firms they're trying to do deals with. In 1997 Martin Fridson, then the chief high-yield strategist at Merrill, cited "screaming fits by investment bankers" as a key obstacle to getting good quality of earnings information. Advocates of corporate social responsibility can expect the same treatment.
- Time horizons. Social issues like asbestos, tobacco, and the environment are not one- or two-year challenges. They may take 20 years or more to unfold. Yet Wall Street is built for short-term thinking. On the brokerage side, the most valuable client is the one who trades a lot, and that client has, by definition, the shortest time horizon. This short-termism reflects the broader client base - according to Benartzi and Thaler, the average institutional investor's time horizon is about a year.
Given where its incentives are, I seriously doubt if Wall Street will ever play more than a peripheral role in corporate social responsibility.