SRI Notes

Turning the Page on the STAT Review

KLD has, after 16 1/2 years, decided to end publication of its Statistical Review of the Domini 400 Social Index.  A sensible move - the data's mostly available on the web now, and there are many social indexes at KLD and elsewhere for academics to work on.  Still, this was an important publication for a long time.

KLD's CEO, Peter Kinder, has written a brief note on this.  Congratulations to the folks at KLD who had the spirit and intellectual honesty to publish it for such a long time period, 'come what may'.  I think they can be proud of the results.

Update on Universal Owners

Thestreet.com's mutual fund columnist, Brett Arends, has an interesting (and strident) take today on the Home Depot controversy. 

"...[T]he people who should be right at the center of the scandal aren't the executives who are taking the loot or even the directors who gave it to them. It's the managers of some of America's biggest mutual funds, including Vanguard and Fidelity. Instead, so far, they're getting a pass."

That's the first time I've seen that said in the business media, although this criticism has been circulating in academia for some time.  In their excellent book, The Rise of Fiduciary Capitalism, Hawley and Williams warn of a society in which owners are separated from the companies they own by chains of agents (fund managers, directors, etc.), who ultimately do not do a good job of representing their interests.  That's what Arends sees going on at Home Depot:

"Bob Nardelli didn't really do anything wrong. He just asked for, and received, a massive amount of money. Wouldn't you?

"The problem lies with those on the other side of the trade -- the people hiring the executives. The people who are involved in the negotiations, namely the directors, aren't particularly motivated. They don't get paid very much, at least by heavy-hitter standards. And it isn't their money that's involved. No wonder they just outsource the calculations to "consultants" whose biggest interest is in keeping the executive class happy.

"Meanwhile, the people who are motivated to get the best price, namely the shareholders, aren't really involved. Which is why attention should turn to those who are supposed to represent them. Mutual fund managers have a fiduciary responsibility to their investors. "

It's an interesting article.  Did you know Fidelity voted against half of the stock option compensation plans that came up for a vote last year?  I sure didn't.

Hawley and Williams' site has much more on the universal owner concept.

File Under: Stakholder Relations

With corporate balance sheets flush and housing affordability low in many developed countries, it was only a matter of time before someone started building homes for their workforce.  The UK retailer Tesco is subsidizing an affordable housing development intended to benefit its staff.  Expect to see more of this if both housing and labor markets remain tight.

Housing affordability is becoming a major constraint for businesses in California, where only about 24% of people have enough income to buy the median-priced home, down from 49% at the start of 2003.  Data from the California Association of Realtors is here - these numbers used to look even worse, but they appear to have changed the method of calculation and have moved to quarterly, rather than monthly reporting. 

Some Weekend Reading

Thanks to MIT's remarkable OpenCourseware project, complete lecture notes for the school's course on behavioral economics and finance are here. 

More on Owners, Managers, and Socially Responsible Investors

The Financial Times got a great quote Wednesday (link via MSNBC) from executive headhunter John Challenger:  "The pressure is not going to relent on CEOs in 2007.  The days of the imperial chief executive are over."

One reason is the growing influence of private equity.  Reporter Francesco Guerrera got another great quote from Steve Ellis of Bain & Co.:  "One of the messages for 2007 is:  whether you like it or not, your company is for sale."

It seems that society's view of the CEO is becoming increasingly bi-polar.  We assume CEOs are extraordinarily gifted, as evidenced by their robust pay packages.  But we are simultaneously become less tolerant of underperformance, as evidenced by the Ellis quote and Mr. Nardelli's recent exit from Home Depot.  One could wonder if this fire and ice approach will deliver the best results.  It brings to mind something Warren Buffett wrote in another context in his 1990 Letter to Shareholders:

"Huge debt, we were told, would cause operating managers to focus their efforts as never before, much as a dagger mounted on the steering wheel of a car could be expected to make its driver proceed with intensified care. We'll acknowledge that such an attention-getter would produce a very alert driver. But another certain consequence would be a deadly - and unnecessary - accident if the car hit even the tiniest pothole or sliver of ice."

Like excessive debt, the current policy toward CEOs raises the stakes without doing much to improve prospective performance.  If one of our biggest problems is short-termism (past commentaries here), putting the CEO in a position where the only options are immediate positive results or termination seems to me ill-advised. 

But what is the alternative?  In his excellent update of Benjamin Graham's The Intelligent Investor, Jason Zweig observes that in early editions of the book Graham wrote extensively about management quality.  But he reduced the section over time, ultimately limiting it to a few paragraphs on dividend policy.

Perhaps no other part of The Intelligent Investor was more drastically changed by Graham than this...  Why did Graham cut away more than three quarters of his original argument?  After decades of exhortation, he evidently had given up hope that investors would ever take any interest in monitoring the behavior of corporate managers.

...Graham wants you to realize something basic but incredibly profound:  When you buy a stock, you become an owner of the company.  Its managers, all the way up to CEO work for you.  Its board of directors must answer to you.  Its cash belongs to you.  Its businesses are your property.  If you don't like how your company is managed, you have a right to demand that the managers be fired, the directors be changed, or the property sold.  "Stockholders," declares Graham, "should wake up."

So perhaps they are.  For those who believe, as Graham did (and as Robert Monks does today) that shareholders should rule the company, there is plenty to rebel against (see, for example, my September post on stakeholder theory).

But investor attention is, um...intermittent.  Scandals make headlines, but it's hard to show that governance improves.  Graef Crystal observes that even after the scandals and reform of the first half of this decade, there's still not much rhyme or reason to how top executives are paid.  That won't change until shareholders give the matter sustained rational attention. 

But how likely is that?  Home Depot co-founder Bernie Marcus doesn't seem to think it's about to happen.  In the AP story he is quoted as saying:  "It’s like the old story, if the stock goes up 10 points, who’s going to care?" 

By the way, there is an interesting new paper on CEO tenure and firm performance here.  I particularly like their distinction between 'owner' and 'manager' CEOs. 

Governance: Show Me the Money

The dialogue about the performance of socially responsible investments is full of mixed messages and mixed motivations.  Recent developments and data on corporate governance are likely to bring on a fresh wave of intellectual dissonance.

Corporate governance has been kind of a stepchild for social investors.  Although attention has been paid, and the most egregious violators are usually excluded from SRI portfolios, I would argue it has not been a central criterion for inclusion or exclusion - activist social investors have been more interested in things like South Africa, climate change, and Darfur, while less-activist ones have often delegated corporate governance due diligence to their money managers.  Still, everyone says governance is important.

It doesn't help that we don't have a good consensus definition of corporate governance.  ISS, Morningstar, and others provide rating services, but there are major differences in both definitions and ratings of individual companies.  CalPERS has its own take, which is different again - it has managed to both add value and annoy Warren Buffett, another mixed message for returns-focused investors.

But governance has special significance because it's one of the social or quasi-social variables where there's been academic support for the idea of a performance benefit.  It makes sense conceptually, and there's data.  The best data so far cam from Gompers et al, which showed that companies with corporate governance they didn't like underperformed materially in the 1990s.  For the most part, the Gompers governance metrics focused on takeover defenses - the more anti-takeover defenses, the lower your rating.  This raised the question of what we were measuring because large acquirors (the firms most likely to have strong anti-takeover defenses) underperformed materially in the 1990s.  But in the 2000s acquirors have done well, as takeover premiums became smaller and investors rejected big deals resembling the ugly stories of the 90s.

And simultaneously, a study by Empirical Research Partners ('Does Corporate Governance Matter?')finds that companies with high scores on the 'Gompers index' of corporate governance have significantly underperformed low-rated companies since 2000.  Empirical is a strong sell-side quant shop, and I have no reason to doubt their results.  Author Michael Goldstein (formerly a strategist for Sanford Bernstein) writes:

"There was, over the entire 15-year period, some payoff to good governance in holding periods beyond a year, but it wasn't impressive...  We also considered whether the governance score could help us distinguish winners from losers among the best- and worst-ranked stocks in our core model and its earnings quality module.  We found thre was an advantage conveyed by paying attention to governance when avoiding losers but only in the 1990s and not thereafter."

This is unpleasant news for governance advocates who have ridden the Gompers data a long way.  Goldstein goes on to argue that governance shouldn't matter much for stock prices since it's easily observable and tends to change slowly.  I disagree there - I don't know that we've perfected the art of measuring it, but one of the few points on which Ben Graham and Amy Domini would both agree that investing with a management you can't trust is a fool's game.

A Strong Study on Corporate Philanthrophy

I was happy to see Barron's this week recognize (link here, sub required) a strong study of corporate charitable giving from NYU that won an Honorable Mention in this year's Moskowitz Prize competition. 

This is one of those topics that raises all sorts of interesting questions, but where there has been virtually no empirical work (the only other decent study I'm aware of is Navarro's 1988 paper).  One of the most important aspects of this paper is the work they did trying to sort out causality.  Of course rich companies give money to charity - but do they derive a business benefit from doing so?  Consistent with Orlitzky, they find the answer is 'yes'. 

Does that flow through to stock prices?  Don't know.  More work is needed!  But this team is to be commended for exploring this neglected but important area.

A full copy of the NYU study is available here.  My sristudies.org abstract of it is here.