SRI Notes

Book Recommendation

I've just finished Dan Ariely's Predictably Irrational, and recommend it to anyone who wants to learn more about behavioral economics.  Ariely is a leader in challenging conventional economic wisdom, and provides empirical evidence of many situations where conventional economic analysis doesn't work well.

I was going to write in this post about the similarities and dissimilarities between this book and Freakonomics, which we've discussed here in the past.  But, procrastination pays once again - Ariely yesterday wrote a note on this himself (read it here). 

The books are similar in many ways, but taken together they frame a multi-disciplinary debate about how far economic analysis takes us.  Behavioral economists are challenging some fundamental assumptions economists like to make about human behavior.  It seems to me they are winning some and losing some, depending on the situation being analyzed - reading both of these books will give you a good sense of whose model might be better in a given situation.

A nice summary of the rise of behavioral finance can be found at Robert Shiller's website.

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.

A Good Chart

Several colleagues have sent me a link to this chart from McKinsey.  My first reaction, before I even read it, was:  that's a heck of a chart. 

But the message they are sending here is a useful one.  Most social investors have had the experience of meeting an idealistic management team, only to find that the company didn't live up to the ideals.  So I certainly agree with this: "a company should identify emerging trends and develop coherent organization-wide responses—an approach that requires it to integrate social issues into all dimensions of the business, not just the making of strategy."

It also reminds me of a point the late Robert Townsend used to make - some jobs are too important to be left to staff, particularly those relating to strategic direction or external communication.  Townsend had no love for consultants, but I think he'd approve of how McKinsey puts the CEO at the center of the chart.  It's certainly consistent with what I've seen over the years.  Corporate social records tend to be pretty stable.  You typically see rapid change only when a new CEO comes in and makes social responsibility a priority.

A commemorative edition of Townsend's entertaining and instructive Up the Organization is coming in May (details here).  Time magazine's original (1970) review of the book is here.

Economic Determinism vs. Biological Determinism

I've argued before that the underlying intellectual tension in social investing is the rejection by social investors of the idea that people are, or should be, primarily motivated by economic factors (as discussed in last year's Christmas post and Jim Hoopes' reply).

Frans de Waal has written a new book, Primates and Philosophers:  How Morality Evolved.  It is based on a series of lectures he gave at Princeton, and Princeton University Press lets you read chapter 1 free, here.  In a nutshell, de Waal believes morality is a result of human evolution, and is to some degree hard-wired in us. 

This challenges economic determinism with a kind of biological determinism.  On one level I'm happy to see it - economic analysis of human behavior can be frustratingly superficial, so it is nice to see someone push back and argue persuasively that something else - anything else - matters.

But careful what you wish for - if you accept de Waal's account, a host of new questions arise.  If human ethics and morality evolved, what does that say about the philosophy of ethics, which is supposed to be derived from reason - or religion?  I suspect Mr. de Waal will find his share of detractors.

Well, no one said it was going to be simple.  Primates and Philosophers offers good new reasons to pay attention to questions of ethics and morality.  Extra credit for getting a blurb from the estimable Robert Sapolsky:

"Frans de Waal has achieved that state of grace for a scientist--doing research that is both rigorous and wildly creative, and in the process has redefined how we think about the most interesting realms of behavior among nonhuman primates--cooperation, reconciliation, a sense of fairness, and even the rudiments of morality...This is superb and greatly challenging thinking."

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.

Counterpoint

I'm adding this to my reading list, if only because of the brilliantly immodest title:

"Stocking Up on Sin:  How to Crush the Market with Vice-Based Investing"

Positive blurbs from Joan Rivers, the founder of Worth magazine, a managing director at Tweedy Browne, and even The Motley Fool.

I should note that author Caroline Waxler is a journalist, not a professional investor.  She is therefore not bound by, for example, NASD's rule 2210, which prohibits exaggerated statements or claims.  So she is bound primarily by her conscience, which...nevermind.

Available at fine stores everywhere, and Amazon, too.

Deirdre and the Economists

I had a chance over the past two weeks to spend some time reading Deirdre McCloskey's How to Be Human* : *Though an Economist, a collection of her essays from the 1990s, many of which were first published in the Eastern Economics Review.  I recommend the book.  It is readable and informative, but, for reasons that will become apparent, also poses significant challenges to the reader.

The first thing to know about McCloskey is that she writes well, well enough to have authored an influential writing text for economists.  If you believe clear writing reflects clear thinking, McCloskey  is one of the clearest thinkers alive.  But, she says, this is not typical in her profession:

The main cause of bad writing in economics is that economists don't read good writing.  If economists would read Jane Austen or George Orwell, or even Adam Smith or JM Keynes or Thomas Schelling, in bulk, daily, habitually, they would improve. (p 131)

The second point to make about Deirdre is that, until 1995, she was Donald McCloskey, a prominent economist at the University of Iowa (following stints at Harvard and the University of Chicago).  The Economist, in its excellent 2004 article on her recent work, never mentions this - an impressive indication of how different that magazine is from its more sensational competitors.  But McCloskey herself thinks it is important, and chapter one of How to Be Human* describes some elements of what must have been an extraordinarily stressful period in her life.

No, I am not gay.  I am cross-gendered, and at age 53, having been a good soldier for over four decades, I am doing something about it... I'm going to become a tall and ugly but indubitably female economist.  I go full time in November 1995...  Why would anyone do such a thing?  The "why" question has the usual answer we give in economics:  stop asking it, since you might as well ask people why they like chococate ice cream.  (p 3)

McCloskey is, unsurprisingly, very alert to gender issues in economics, as this commentary on Lester Thurow's The Zero Sum Society suggests:

Thurow's football trope is not innocent.  Instead of trade as a sport in which everyone benefits, like aerobic dancing, the metaphor invites us to think of it as yardage extracted from one's trading partners.  The path is short - a path taken by England and Germany 1890-1914 - from sporting metaphor to the guns of August.  Stories matter.  (p 122)

I understand The Economist's reluctance to even mention McCloskey's gender status - it is the sort of thing that will lead many people to dismiss her arguments out of hand.  That is a major loss, because McCloskey is one of the most important critics of economics as it is practiced today.

Simply put, McCloskey thinks most modern economics has been done wrong and will have to be re-done.  She believes that economists' obsession with statistical significance (as opposed to real economic significance, or "oomph"), abstract analysis ("blackboard economics"), and social engineering have severely undermined the field's practical significance.

The late Richard Feynman, a Nobel laureate in physics, introduced a few simple theorems in matrix algebra into his first year class at California Institute of Technology with considerable embarrassment:  "What is mathematics doing in a physics lecture?... Mathematicians are mainly interested in how various mathematical facts are demonstrated...  They are not so interested in the result of what they prove."  Feynman's rhetorical question startles an economist.  In advanced economics it would be:  "What besides mathematics should be in an economics lecture? (p 216)

Her 1997 book The Vices of Economists; The Virtues of the Bourgeoisie gives a careful and detailed exposition of this argument, but How to Be Human* includes an excellent summary, entitled "Ask What the Boys in the Sandbox Will Have".  Unlike others who have been in her intellectual position, she takes little delight in what she believes are the misfortunes of economists.

The sadness is that economists, mainly men, are confident that their mechanical methods are correct and produce correct results.  The men stride about offering advice to governments and criticisms of each others' work as though they were doing real science...  They are of goodwill and have good minds.  They do not deserve to end up with a science lacking scientific findings.  No one with an ounce of human pity would be happy that such a good group of men are so wrong.

The scene is like an aunt watching her three-year-old nephew and his friends playing in a sandbox...  Yes, David, you are building a great fort in the sand.  My, how wonderful.  Yes, Gerard my dearest, yes. (pp 234-235)

Social investors, who protest that the assumptions of economic models are simplistic and incomplete, may take McCloskey to be an ally.  In this fight she certainly is.  But nothing I have read of hers suggests a left/liberal world view.  She is a self-described libertarian, and deeply suspicious of government programs that meddle in the economy.  But when she says "we have learned that one cannot solve great social questions standing at blackboard," many of us will say Amen.

Swensen and SRI

One man everyone involved in SRI should pay attention to is David Swensen of Yale University. His performance has been exceptional - over the past 2o years the Yale Endowment's returns have been the best of any educational institution. His books, Pioneering Portfolio Management and Unconventional Success, are excellent.

This has been accomplished despite at least some social constraints. Yale has an Advisory Committee on Investor Responsibility, and during the South Africa boycott the endowment divested its holdings in companies doing business in South Africa.

Marc Gunther, a journalist at Fortune magazine and the author of the excellent Faith and Fortune, is also a Yale alum and has written this profile of Swensen for the Yale alumnae magazine. It includes commentary both on Yale's social investment policies, as well as those of other schools (notably Williams, which now has a 'Social Choice Fund' available).

Swensen is not the only investor to achieve superb results despite social constraints. Sir John Templeton, widely regarded as one of the finest investors who ever lived, avoided alcohol, tobacco, and gambling stocks for religious reasons throughout his career.

Recognition for Pietra

Moskowitz Prize judge Pietra Rivoli's new book, The Travels of a T-Shirt in the Global Economy, was one of six shortlisted for this year's FT/Goldman Sachs Business Book of the Year Award. Today's Financial Times includes an excerpt from the book and some quotes from Pietra (link here, but subscribers only...).

Some other links:

• Last spring NPR did a series of reports based on the book, including a cool map.
• Here is a transcript of a presentation Pietra gave to an audience at the IMF.
• You can read an excerpt from the book here.

If you have a financial background, I'd also strongly recommend the paper Pietra did with Georgetown colleague James Angel in 1997.  There is a brief but good plain-English article on the study on page 5 of this issue of Georgetown Business magazine.

Beware The Superstar CEO

Jim Collins has detailed the dangers of superstar CEO in his excellent management book Good to Great.

Now a new study by Ulrike Malmendier of Stanford and Geoffrey Tate of Wharton provides a ton of color and interesting detail around this phenomenon.  They find that superstar CEOs tend to have subpar performance (more than would be expected from mere mean-reversion), and that the worst situations are those where governance is weak.  These guys are serious - their regressions include a variable for whether the CEO was writing a book at the time!

Someone should cross-reference this with the social/sustainability ratings.  I've beaten this to death already, but I'll bet that superstar CEOs underperform on social as well as financial metrics.