SRI Notes

Feedback on 'Who is Good?'

Jeff MacDonagh of Domini offers these comments on my 'Who is Good?' post...

Hi Lloyd,

Two points might help explain (or spread!) the confusion.

1) SRI evaluations are primarily derived from a backward-looking description, whereas most people's ideas of "socially responsible companies" are forward-looking prescriptions. I hear people say, "a responsible utility gets electricity from wind, a responsible grocery sells organic, etc."

The opposite is the case for non-SRI! Financial evaluations are primarily about future projections, whereas most non-professionals definition of a "hot stock" is based off of its 12 month chart.

I'm not 100% sure what this means, except that popular conceptions of SRI sets it apart from traditional stock analysis.

2) SRI evaluations don't lend themselves to single variable continuous quantification. Unlike PE ratio or other financial factors, it is very difficult to produce a continuum of SRI scores. Intuitively, this would seem to make it more difficult to link SRI scores to stock valuation.

- Jeff

The CalPERS Effect Re-Re-Re-Visited

There have been many studies of the impact of CalPERS' corporate governance program on stock prices.  Studies from CalPERS staff and consultants have argued that the program added significant value (see discussion here).  But other studies have found a less powerful effect (example here), and still others question whether there is a 'CalPERS Effect' at all (example here).

Now Brad Barber at Cal Davis has done what appears to be a careful and comprehensive study of stocks named on the CalPERS Focus List, 1992-2004.  He finds a small-looking 25 basis point positive benefit.  Small, until you realize those 25 basis points translates into wealth creation of $3.1 bn.

Levitt on Social Responsibility

Steven Levitt, author of Freakonomics, spoke earlier this spring at Boston College's International Corporate Citizenship conference.  A brief account of his remarks is here.

I point this out because Levitt is exactly the kind of person we need to get more involved in the global exchange of views on corporate social responsibility (CSR) and socially responsible investing (SRI). 

I have come to believe that CSR and SRI have too many normative critics, and not enough positive ones.  That is, there is a good supply of people to criticize social investors for holding the values they hold, or for the way they act on those values  (examples here and here).  But there are not enough who bring quantitative sophistication and fresh perspectives to the study of these problems. 

Good positive critics can be scary - they question your assumptions about how things work, they make you look at uncomfortable facts, they present analysis that doesn't fit your world view.  But that kind of engagement can also be transformative - it may be the only way CSR and SRI can move meaningfully forward from their current practices. 

Levitt has what it takes to be a valuable positive critic - he is curious about how things work, he is not afraid to tackle difficult or controversial subject matter, and he is brilliant at question-framing. 

Hats off to BC for inviting him.

Who is Good?

Since I have other writing obligations and it will be a few months before I can write this up properly, I want to make a note about definitional problems and a study I did earlier this year.

I've been bothered for some time by the definitional issues around corporate social responsibility and socially responsible investing.  I don't agree with Hawken that the term SRI is "so broad it is meaningless", but it is a very general concept.

This matters for quantitative work, because many studies of CSR and SRI have the following logic:
    1)  Be socially responsible
    2)  ???                                    <---explanation of this joke is here
    3)  Profit!   

If we can't define the  variable in Step 1 clearly, the work is worthless.  No amount of ingenuity in Steps 2 and 3 can save it.

So how do we define corporate social responsibility?  The definition game is a hard one, and there are many strategies.  Depending on your pain threshold you could consult Webster's, Wittgenstein, or Ramsey.  I only seriously considered two strategies, however.

First, you can create a description of the concept, like a dictionary definition.  This fellow in the UK offers his own definition, as well as definitions from other sources.  I ultimately decided not to pursue this strategy. My main problem with the descriptive approach is that many readers will feel no wiser after reading the definition than they did before.  Ok, it's about "social responsiveness," "the continuing commitment of businesses to behave ethically," "capacity building for sustainable livelihoods," and  "giving back to society."  What does that really mean?

So this spring I took a different tack.  Instead of trying to say what social responsibility is, I tried to identify companies that were viewed as superior social performers.  If I can't describe it, I thought, I can at least find some companies that exemplify the concept.  Then, when someone asks "what is social responsibility?" I can point to those companies.

Many researchers have done this by using the membership of social indexes.  That's ok, but I think  it can be improved on.  I believe the majority of the companies in those indexes are there because of an absence of disqualifying characteristics, as opposed to the presence of notably positive ones.

So my objective was to compile a list of truly exceptional companies.  I am a big believer in Armstrong's eclectic research approach, so I decided to make two lists using two different methodologies:

• The Poll:  I sent an e-mail to the membership of SIRAN asking them to name a few companies they thought had notably strong social responsibility records.  I received many responses, and after sorting through them I had the names of exactly 20 publicly-traded U.S. companies.  (I excluded non-U.S. companies because my financial database is only complete for the U.S. firms.  Also, three of these were coffee companies...not quite sure what to make of that.)
• The Quantitative Ranking:  I consulted the social investment research firm KLD, and asked them to share from their database the top 20 raw social scores of companies in the Russell 1000 (these scores are used in the construction of the KLD Select Social Index).

Then I cross-referenced the lists.  Eight companies appear on both.  They are:

• Dell
• Gap
• General Mills
• Hewlett-Packard
• Intel
• Southwest Airlines
• Starbucks
• Timberland

Finally, I applied an infallible test to determine if these companies were, in fact, socially responsible:  I asked Steven Lydenberg.  He said: "yes".

So I think this is a pretty good list.  Whatever CSR is, you can show by both hard data and expert opinion that these companies have a lot of it. 

A few superficial observations:

1. All of the companies are consumer-facing, and all have strong brand names.
2. Four of the companies are in consumer sectors, three in high-tech, one in transportation.  The energy, materials, healthcare, finance, capital goods, telecommunications, and utilities sectors are not represented.
3. For virtually all of these companies, historical growth rates, reinvestment rates, and market expectations for future growth (P/E and P/B ratios) are above market averages.  This accords with the theoretical work done by Angel and Rivoli (1997).
4. These are big companies.  This again agrees with the work of of Angel and Rivoli.
5. Of this group, I believe only Southwest has a unionized workforce.

So that's a start, anyway.  If you believe social responsibility pays, it should pay best at these firms, arguably the most socially resposible publicly traded companies in America.

Upcoming Conference in Europe

The 5th Annual European Summit on Corporate Governance and Responsible Investment will be held in Stockholm, May 31 - June 1 (info here).

(Thanks to Jeroen Derwall for the heads-up.)

Daniel Fermon and the CEO

I've expressed skepticism in the past that the sell side could add much to the social investment world, but there is a lot going on now, some of it very interesting.

Daniel Fermon, Senior Europe Strategist at Société Générale, is doing work that incorporates  traditional financial research, social/governance research (from Société Générale's SRI researchers, Sarbjit Nahal and Valéry Lucas-Leclin), and his own innovative views on the role of the CEO in investment returns.  There is a brief but interesting interview with him here.

In coming years I believe markets will gradually grow more efficient with respect to traditional investment variables such as valuation and momentum, making it tougher for traditional investment strategies to add value.  As that happens, researchers will have to dig deeper into predictors of sustainable value creation, such as management quality and governance.  Fermon's work shows how this type of analysis can be done.