Mba1034 cg law ethics week 6 sri esg 2013


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Socially Responsible Investment, Environmental Social & Governance factors, Enron

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Mba1034 cg law ethics week 6 sri esg 2013

  1. 1. ASPECTS OF CONTROL :CORPORATE SOCIALRESPONSIBILITY PRACTICESStephen Ong, BSc(Hons) Econs (LSE),MBA International Business(Bradford)Visiting Fellow, Birmingham City UniversityVisiting Professor, Shenzhen UniversityMBA1034 GOVERNANCE, LAW & ETHICS
  2. 2. • Discussion: CorporateCulture & Governance1• Institutional Investors andEnvironmental, Social &Governance (ESG) Factors2• Case Discussion: TheCollapse of Enron• Video : Enron3Today’s Overview
  3. 3. 1. Open Discussion• Mayer, Colin (2002) “Corporate Cultures andGovernance: Ownership, Control andGovernance of European and USCorporations”, TRANSATLANTICPERSPECTIVES ON US-EU ECONOMICRELATIONS:CONVERGENCE, COOPERATIONAND CONFLICT ,Conference paper, JFK Schoolof Government, Harvard University, April 11-12
  4. 4. The Role of Institutional Investors inCorporate Governance• What is the role of institutional investors incorporate governance, mainly from a UKperspective
  5. 5. Learning Outcomes• By the end of this lecture, you should be able to:• highlight the important monitoring role thatinstitutional investors play in UK corporategovernance• discuss the complex web of ownership that arisesfrom institutional investment• consider ways in which institutional investors arebecoming more active in corporate governance• Appreciate the importance of the Walker Review andthe Stewardship Code
  6. 6. Institutional Investors and CorporateGovernanceAgrawal and Knoeber (1996) emphasized:" . . . concentrated shareholding by institutions .. . can increase managerialmonitoring and so improvefirm performance"
  7. 7. The Transformation of UK InstitutionalOwnershipBerle and Means (1932)• Described share ownership as ‘dispersed’ inUS (UK)• NOWConcentrated in investment institutions:• pension funds• life insurance companies• unit trusts• investment trusts
  8. 8. Ownership of UK listed companies• 1963• 54%individual shareholders• 1992• 51.9% insurance companies and pension funds• 8.5% unit and investment trusts• 20%individual shareholders• 12.8% overseas investors• 1998• 60%institutional investors• NOW• Over 70% institutional investors
  9. 9. A Complex Web of Ownership• Institutional investors are not shareholders• They are intermediaries
  10. 10. Sources of Conflict in Pension Fund InvestmentDirectors of investee companyPension Fund TrusteesInvestment ConsultantsBrokersFund ManagersPension Fund Beneficiaries
  11. 11. Conflict arises due to frictionsbetween parties• Produces frictional transaction costs• Shareholders views not heard by companies• Breakdown in trust between companies andtheir shareholders
  12. 12. The Growth of Institutional InvestorActivism"Given the weight of their votes, the way in whichinstitutional shareholders use their power to influencethe standards of corporate governance is offundamental importance. Their readiness to do thisturns on the degree to which they see it as theirresponsibility as owners, and in the interest of thosewhose money they are investing, to bring aboutchanges in companies when necessary,rather than selling their shares”The Cadbury Report, 1992
  13. 13. Cadbury Report suggested institutional investorsshould :• encourage regular one-to-one meetingswith directors of their investeecompanies (‘engagement and dialogue’)• make positive use of their voting rights• pay attention to the composition of theboard of directors in their investeecompanies
  14. 14. Institutional Investor Voting• Stapledon (1995)–Until 1990s level ofvoting fairly low• Mallin (1999)–Significant increase inrecent years• Hampel Report–Overall voting levelsremain at about 40%
  15. 15. Engagement & Dialogue• Combined Code :• Institutional shareholders should be ready, wherepracticable, to enter into a dialogue with companiesbased on the mutual understanding of objectives.• Higgs Report• Institutional investors should enter into a dialoguewith companies based on the mutual understandingof objectives• Senior Independent Director (SID)• Should represent investors interests on the board
  16. 16. Failure of Engagement in theFinancial Crisis• Institutional investors have been partly blamed for thefinancial crisis• Paul Myners targeted them as a scape goat in speeches• Financial Times (2009) suggested engagement failed to avertthe financial crisis, even though they were aware of theproblems• IMA was questioned by the Treasury Select Committee inJanuary 2009• IMA stated that investors lost confidence in the bankingsector and sold shares in 2005
  17. 17. • Where investors engaged with banks it did not work• Despite 55 meetings between one bank andshareholders before nationalization, the crisis couldnot be averted• Engagement with banks before crisis did not changebehaviour of directors/banks• IMA has concerns that institutional investors do nothave enough information or influence to be able toinfluence board behaviour
  18. 18. The Walker Review• Many codes of corporate governance bestpractice have been reactionary• In the wake of the financial crisis, the WalkerReview has examined the causes of the crisis• Specifically, the review maderecommendation for institutional investors
  19. 19. Walker stated:• The limited institutional efforts atengagement with several UKbanks had little impact inrestraining management beforethe crisis phase• Levels of voting against bankresolutions rarely exceeded 10per cent
  20. 20. Walker recommended• Board evaluation should provide anindication of the nature and extent ofcommunication with major shareholders
  21. 21. Walker recommended:• The FRC’s remit should be extended toinclude establishing Principles of bestpractice in stewardship by institutionalinvestors and fund managers.• The Code on the Responsibilities ofInstitutional Investors, prepared by the ISCshould become the Stewardship Code.• Should have equivalent status to CombinedCode
  22. 22. Walker recommended:• Fund managers should signify on theirwebsites whether they commit to theStewardship Code• Important for ACCOUNTABILITY!.
  23. 23. Walker recommended:• Institutional investors and fund managersshould actively seek opportunities forcollective engagement• Voting powers should be exercised• Voting records should be disclosed• Voting policies should be described onwebsites
  24. 24. Walker identified barriers to engagement• Effective dialogue requireslarge senior resourcecommitment on the partof fund managers• free-rider benefit that maybe generated for thosewho do not contribute tothe engagement process
  25. 25. Barriers to engagement• Resistance of some major boards to engagein effective dialogue• When chairmen engage with majorshareholders there is often a disappointingresponse• Boards dissatisfied with level and quality ofshareholder representation in meetings• Hubris/complacency at board level
  26. 26. The Stewardship Code• Principle 1: Institutional investors shouldpublicly disclose their policy onhow they will discharge their stewardshipresponsibilities• Principle 2: Institutional investors shouldhave a robust policy on managingconflicts of interest in relation tostewardship and this policy should bepublicly disclosed.
  27. 27. Code (cont.)• Principle 3: Institutional investors shouldmonitor their investee companies• Principle 4: Institutional investors shouldestablish clear guidelines on– when and how they will escalate their activitiesas a method of protecting– and enhancing shareholder value
  28. 28. Code cont.• Principle 5: Institutional investors should bewilling to act collectively with other investorswhere appropriate• Principle 6: Institutional investors should havea clear policy on voting and disclosure ofvoting activity• Principle 7: Institutional investors shouldreport periodically on their stewardship andvoting activities
  29. 29. Overall Walker Conclusion“There is a need for better engagement between fundmanagers acting on behalf of their clients as beneficialowners, and the boards of investee companies.Experience in the recent crisis phase has forcefullyillustrated that while shareholders enjoy limited liabilityin respect of their investee companies, in the case ofmajor banks the taxpayer has been obliged to assumeeffectively unlimited liability. This further underlines theimportance of discharge of the responsibility ofshareholders as owners, which has beeninadequately acknowledged in the past… there should beclear disclosure of the fund manager’s business model, sothat the beneficial shareholder is able to make aninformed choice when placing a fund managementmandate”.
  31. 31. Rationale• FRC’s December 2009 review Combined Codefound significant concerns about the quantityand effectiveness of engagement betweeninstitutional investors and boards of listedcompanies• Conclusions of the Walker Report
  32. 32. Consultation asks for views on:• What are the responsibilities for engagement ofinstitutional shareholders to the beneficial owners whoseinterests they represent?• Does the ISC Code cover all the relevant responsibilities?• What are the responsibilities for engagement ofinstitutional shareholders to the UK listed companies inwhich they invest?• Does the ISC Code cover all the relevant responsibilities?
  33. 33. And:• Are the respective responsibilities of the different parts ofthe investment chain sufficiently clear and appropriate?• Does the Code strike the right balance between the need toavoid over-specification that might discourage theapplication of the Code and the need for it to be effectivewith an appropriate degree of transparency?• Are there any parts of the ISC Code where further guidanceis needed, or where the existing guidance should beamended?
  34. 34. Summary• Not only companies have to be accountable• Shareholders, especially institutional investors,need to be responsible by being ACTIVEowners
  35. 35. Environmental, Social and Governance(ESG) Factors in Institutional Investment• Review the increasing importance ofcorporate social responsibility as wellas socially responsible investment.• Discuss the role of institutionalinvestors and governance.• Discuss the principles ofEnvironmental, Social and Governance(ESG) factors in institutional investmentcriteria.
  36. 36. Learning Outcomes• By the end of this lecture, you should be ableto:1. Discuss the definitions of CSR and sociallyresponsible investment (SRI) and how these maychange with an investor’s set of values2. Assess the evidence on whether investors pay aprice for SRI.3. Describe some of the ESG issues faced byinstitutional investors.
  37. 37. Introduction• Corporate governance is the system of checks andbalances, both internal and external to companies,which ensures that companies discharge theiraccountability to all their stakeholders and act in asocially responsible way in all areas of their businessactivity• Therefore, sustainability reporting, social andenvironmental reporting and socially responsibleinvestment all contribute to good corporategovernance• They represent mechanisms which help companiesto discharge a broad accountability and to behave ina socially responsible manner
  38. 38. • Also look at the investor side by reviewingsocially responsible investment(SRI).• SRI is “an investment process that considers thesocial and environmentalconsequences of investments, bothpositive and negative, within the context ofrigorous financial analysis”.Introduction (Continued)
  39. 39. Socially Responsible Investment• SRI funds apply a set of exclusionary and/orinclusionary screens to select their investments.• However, the definition of SRI and the choice ofexclusionary and/or inclusionary screens maychange depending on the values of the investoror index.• E.g., the FTSE KLD Catholic Values 400 Indexexcludes companies that are involved in orsupport– abortion,– contraceptive products, and– the use of embryonic stem cells and foetal tissue.
  40. 40. Socially Responsible Investment(Continued)• SRI has ancient roots– The teachings of Judaism had strict rules on howto invest money– Until the middle ages, there were restrictions onloans and investments for Christians– In the 17th century, Quakers (“Society of Friends”)who settled in America refused to benefit fromthe weapons and slave trade.• The Pioneer Fund, which was set up in 1928,refused to invest in alcohol and tobacco.
  41. 41. • The Pax Fund was created in 1971 in the USAby two Methodists who were opposed to theVietnam war and militarism in general– It refused to invest in weapons contracting.• The 1980s saw increased awareness by thegeneral public of racism (apartheid regime inSouth Africa) and environmental issues(Chernobyl and Exxon Valdez).Socially Responsible Investment (Continued)
  42. 42. So is there a price for socially responsibleinvestment or do SRI funds outperformother funds?•Luc Renneboog, Jenke Ter Horst and ChendiZhang find that SRI funds from Europe, NorthAmerica and the Asia-Pacific region–underperform compared to the market bybetween -2.2% and -6.5% (risk-adjusted returns),but–they do not generally perform worse thanconventional funds from the same country.Socially Responsible Investment (Continued)
  43. 43. CSR for whom?• Companies are producing sustainabilityreports, social and environmental reports,corporate social responsibility reports etc.• BUT to what extent is this being driven by theinstitutional investment community?• If investment institutions are not interestedin this information, it is unlikely thatcompanies will be genuinely interested inproducing it
  44. 44. • Institutional investors own almost 80% ofshares in UK listed companies• The current value of assets managed by theglobal institutional investment community isin excess of 42 trillion dollars• US and UK pension fund investments total7.4 trillion dollarsCSR for Institutional Investors?
  45. 45. Investors & EnvironmentDecisions made by these investors have aconsiderable impact on the environmental andon society as a whole“. . . what we need is a means by which we canwield our influence over businesses to actresponsibly . . . Ethical and environmentalinvestment is that means. “(Hancock, 1999, p. 8)
  46. 46. ESG• We explore the extent to which theinstitutional investment community in theUK, and elsewhere, are becomingincreasingly interested in environmental,social and governance information• We consider how socially responsibleinvestment (SRI) has moved very quickly fromthe periphery to the mainstream ofinstitutional investment
  47. 47. • In 2004 the UK Government endorsed theimportant role institutional investors have toplay in integrating corporate socialresponsibility into business by theirrecognition of the impacts of social andenvironmental factors on long-term businessperformance• Socially irresponsible behaviour is stronglyrelated to bad financial performance andeven corporate failure– Exxon Valdez– Brent Spar– Nike– Huntingdon Life Sciences
  48. 48. Fiduciary Risk• CalPERS (California Public Employees’Retirement System) stated that:“. . . equity in corporations with poorsocial and ethical records couldrepresent an excessive fiduciary riskbecause such firms court boycotts,lawsuits, or labor activity. “
  49. 49. Financial interests• Friends Provident chose SRI:“Good corporate practice on humanrights, child labour and environmentalpollution is good for society, but it’s alsogood for shareholders. As a large investor,it is right that we use our influence withcompanies to encourage responsiblebusiness practices while serving thefinancial interests of our customers.”
  50. 50. Terminology and definitions• From ethical investment to SRI• Socially responsible investment combinesinvestors’ financial objectives with theircommitment to social concerns such asjustice, economic development, peace or ahealthy environment.
  51. 51. Issues of traditional importance to the ethicalinvestorAlcohol Military/MODcontractsPoorworkplaceconditionsAnimaltestingArms exports tooppressiveregimesThird WorldconcernsGambling Nuclear power TobaccoGreenhousegasesOzone depletion WaterpollutionHealth andsafetybreachesPesticides TropicalhardwoodsHumanrights abusesPornographyand adult filmsGeneticallymodifiedfoodIntensivefarmingRoaduse/constructionGenepatenting
  52. 52. Ethical Profile• How to achieve consensus?• Individuals have different ethical profiles• Ask pension fund members for example• Ethical relativism
  53. 53. From SEE/SRI to ESG• Early SRI (2000+)• Institutional investors interested in social,ethical and environmental (SEE) factors• NOW• Environmental, social and governance• (ESG) factors• Shows SEE issues now central to governanceissues
  54. 54. Mercer Investment Consulting (2006)Issues Associated with ESG InvestmentClimatechangeEnvironmentalmanagementSustainabilityCorporateconventionsGlobalization TerrorismCorporategovernanceHealth issuesin emergingmarketsWaterEmployeerelationsHuman rights
  55. 55. Impact on Investment• Mercer Investment Consulting (2006) found thatglobalization and corporate governance were theESG factors viewed as most relevant to mainstreaminstitutional investment analysis• BUT they also found that a high proportion of fundmanagers expect clean water, climate change andenvironmental management to have a materialimpact on investment performance over the nextfive years
  56. 56. Universal Ownership• Emerging concept of universal ownership hasencouraged the integration of ESG issues intomainstream institutional investment• Universal owners:• "large investors who hold a wide range ofinvestments in different listed companies as well asother assets and therefore tied to the performanceof markets of whole economies, rather than to theperformance of individual assets"• They are therefore forced to be concerned aboutlong-term economic prosperity, and must considerESG issues
  57. 57. Statistics on Growth of SRI and ESG• In the UK £4 billion was invested in ‘ethical’ funds inAugust 2001• SRI now an overarching investment criterion for ALLinvestment institutions• 77% of the British public would like their pensionfunds to be invested in a socially responsible way,provided this did not harm financial returns• 80% of pension scheme members require theirschemes to operate an socially responsibleinvestment policy
  58. 58. ESG screening• Mercer Investment Consulting surveyed 195 fundmanagers around the world• 70% of fund managers believe that the integrationof environmental, social and ethical factors intoinvestment analysis will become mainstream ininvestment management within the next three toten years• 60% of fund managers consider that screening forsocial, ethical and environmental factors will bemainstream within the next three to ten years
  59. 59. SRI & ESG• Mercer Investment (2006) canvassed 157international institutional investors• Confirmed that socially responsibleinvestment is continuing to expand at aglobal level• 38% of fund managers surveyed anticipatedincreased client demand for the integrationof ESG analysis in mainstream institutionalinvestment over the next three years.
  60. 60. Socially responsible investmentstrategies• Screening• Best in sector -engagement and dialogue
  61. 61. The financial performance of sociallyresponsible investment fundsJohn Maynard Keynes (1936):“There is no clear evidence from experiencethat the investment policy which is sociallyadvantageous coincides with that which is mostprofitable . . . “
  62. 62. Essential question:• Is it possible to be ethical and still to make aprofit?• Few people are prepared to accept a lowerreturn to investment from investing in asocially responsible manner
  63. 63. SRI & Financial Returns• Solomon and Solomon (2002) foundstrong evidence of a growing perceptionamong the institutional investmentcommunity that SRI enhances financialreturns in the long term• Drexhage (1998) considered thatinvestors and fund managers believe it ispossible to make a difference whilemaking a profit.
  64. 64. Existing academic empirical researchhas produced mixed results• Luther et al. (1992) found half of the trusts studiedoutperformed the market and half underperformed• Mallin et al. (1995) found that both sociallyresponsible and non-socially responsible trustsseemed to underperform the market• Gregory et al. (1997) showed that both sociallyresponsible and non-socially responsible trustsunderperformed the market but thatunderperformance was worse for sociallyresponsible trusts
  65. 65. SRI Benchmark• Development of SRI benchmark indices isclarifying this issue• Williams (1999) predicted growth in SRIperformance benchmarks which should“. . . explode the myth that greenand ethical investors have to acceptthat their investment performancewill be disappointing.”
  66. 66. Cobb, Collison, Power and Stevenson(2005)• Examined the financial performance of theFTSE4Good, and concluded that• Investors are unlikely to be worse off by restrictingtheir investment universe, and may well be betteroff• Their interviews and questionnaires suggested thatinclusion in the FTSE4Good indices was contributingsignificantly to stakeholder relations, as well as tointernal processes such as reporting andmanagement systems on social and environmentalissues
  67. 67. The drivers of SRI• Solomon et al. (2002) Questionnaire survey• Internal drivers:• - fund managers• - clients of the institutional investors• - trustees• External drivers:• - lobby groups• - Government• - society’s interest in CSR• - NAPF, ABI, etc
  68. 68. Rank I believe that the development ofSRI policy by pension funds ismotivated byMean1 The impact of environmental andsocial lobby groupsAgreement2 A general increase in interest insocial responsibility in society ingeneralSomeagreement3 Political parties competing forpowerSomeagreement4 Companies seeking to improvetheir reputation and corporateidentitySomeagreement5 The actions of the NAPF Weakagreement6 European Union legislation Disagreement7 The social dimension ofEuropean Union membershipDisagreement8 The growing interest of pensionfund trustees in SRI issuesDisagreement9 The growing interest of pensionfund managersDisagreement10 A demand from active pensionfund membersDisagreement11 A demand from retired pensionfund membersDisagreement12 The religious beliefs of thegeneral publicStrongdisagreement
  69. 69. A growing demand for social, ethicaland environmental disclosure• ABI guidelines on SEE disclosure (2001)• They would like company boards to state in their annualreports whether or not they:• take regular account of the significance of SEE matters to thebusiness of the company;• have identified and assessed the significant risks to thecompany’s short and long-term value arising from SEEmatters, as well as the opportunities to enhance value thatmay arise from an appropriate response;• have received adequate information to make thisassessment and that account is taken of SEE matters in thetraining of directors;• have ensured that the company has in place effectivesystems for managing significant risks, which where relevantincorporate performance management systems andappropriate remuneration incentives.
  70. 70. ABI Guidelines 2007• Modification of 2001 Guidelines• In 2007 the ABI published a set of guidelines onresponsible investment disclosure (ABI, 2007)• These guidelines represent a modification of thoselaunched in 2001. One of the main reasons for theirupdating was the progress in narrative reportingsince 2001, including the EU AccountsModernisation Directive (resulting as we saw earlierin the Business Review) and the new UK CompaniesAct. Although the new guidelines are similar theyemphasise certain aspects of narrative reportingwhich institutional risks in order to decide whatinformation should be included in the annualreport.
  71. 71. Investors are especiallyinterested in reporting which:–addresses ESG risks, within the companysentire framework of risk management anddisclosures–adopts a forward-looking approach to ESGrisks–addresses board action in managing ESGrisksIt is also notable that the ABI have changed theirterminology from SEE (in 2001) to ESG (in 2007)The Guidelines also contain an appendix which lists aseries of questions for companies to interrogatethemselves in relation to ESG
  72. 72. Investors and SEE Issues• Friedman and Miles (2001) found the City ofLondon was taking SEE issues far moreseriously• Interviews with institutional investors foundthey are dissatisfied with the level of socialand environmental reporting (Solomon 2007)• Public disclosure is inadequate and thereforeprivate disclosure channels are developing
  73. 73. Private social andenvironmental reporting• Sparkes (2002) highlighted the growth in SEEengagement as a main indicator that sociallyresponsible investment is moving away fromthe margin and into mainstream investment• Solomon and Solomon (2006) found frominterviews that engagement in this area hasbecome formalized• It is evolving into a two-way process, withcompanies asking institutional fund managersquestions as well as questions being directedtoward companies by shareholders
  74. 74. Legal perspective : ESG reporting• Freshfields Bruckhaus Deringer (2005) concludedthat shareholder engagement on ESG issues wouldbe considered prudent from a legal perspective, aslong as it is properly motivated, transparent,informed and objective“… targeted and constructive engagementwould be acceptable (and in some casesmandatory) where it is aimed atimproving the financial performance of aninvestment over the relevant time horizon,for example by encouraging betterenvironmental accountability or moreforward-thinking management”
  75. 75. Private Social and Environmental Reporting:Mythisising or Demythologising Reality?• Solomon and Darby (2005) explored whetherthe dialogue between companies and theirinstitutional investors breaking down barriersand misconceptions about social andenvironmental risks and impacts by businessOR• was it simply helping companies to create agreen myth about their attitudes to theenvironment and society?
  76. 76. The Green Myth• Interviews showed that both that companiesand investors were creating anddisseminating a green myth, whichsuggested to society that both companiesand investors were proactively workingtoward improvements in social andenvironmental management
  77. 77. Pension fund trustees and sociallyresponsible investmentPension fund investment is complicated• Pension fund members• Investment analysts• Fund managers• TRUSTEES• ConsultantsDo trustees have a responsibility to adopt anSRI policy for their pension funds?
  78. 78. Trustees ResponsibilityTrustees are concerned about breaching theirfiduciary duties• Under the rubric of ‘fiduciary duty’ much isjustified. The unexceptionable fiduciaryrequirement that trustees may consider ‘solely’ theinterests of beneficiaries is adduced to justify non-involvement in ‘social’ or ‘political’ investments.Activism is dismissed as being unrelated to addinglong-term value to the trust portfolio.Cowan v Scargill legal case spread fear in the hearts oftrustees on SRI
  79. 79. Duty of TrusteesJudge Sir Robert Megarry concluded :‘. . . It is the duty of trustees, in the interest ofbeneficiaries, to take advantage of the fullrange of investments authorised by the termsof the trust, instead of resolving to narrow thatrange.’
  80. 80. Purpose of Trust• Freshfields Bruckhaus Deringer (2005) considers that theCowan v Scargill case has had a misguided impact on trusteebehaviour“… Cowan v Scargill cannot be relied upon to supportthe single-minded pursuit of profit maximization, orindeed any general rule governing investmentdecision-making … Megarrys decision has beendistorted by commentators over time to support theview that it is unlawful for pension fund trustees to doanything but seek to maximize profits for theirbeneficiaries… Read carefully, his decision stands foran uncontroversial position that trustees must act forthe proper purpose of the trust, and not forextraneous purposes. “
  81. 81. Profit Maximisation?• Megarry, revisited his own judgement in 1989• He said his decision did not support the viewthat the fiduciary duties of pension fundtrustees were only consistent with profitmaximisation
  82. 82. Two instances where ESG considerationsMUST be included in fiduciary responsibility:• consensus among the fund beneficiaries thatESG factors should be taken into account• if ESG considerations are reasonablyexpected to have a material impact on thefinancial performance of the investment
  83. 83. Why not profit maximisation?Freshfields Bruckhaus Deringer (2005) gave powerfulreasons why Cowan v Scargill case does notsupport sole pursuit of financial returnmaximisation:– case focused on a narrow issue– Scargill represented himself– Technical legal points were not made - Scargill was nota lawyer– no proper discussion of the case– trustees involved had an ulterior motive for theiractions, supporting the failing coal industry.– Scargill was thought not to have acted with integrity.– The investment plan concerned had nothing incommon with a modern ESG strategy
  84. 84. Pension Funds & SRI• Since July 2000 all UK pension fund trustees have had todisclose the extent to which (if at all) they practise SRI• This requirement [the new SRI disclosure requirement] hashad a significant and wide-ranging impact on the investmentcommunity. The majority of trustees have incorporatedreference to social, ethical and environmental (SEE) issues intheir annual statements in 2001. Most of them havedelegated responsibility for implementing this to fundmanagers which has added significantly to the growingSocially Responsible Investment (socially responsibleinvestment) movement.
  85. 85. UK Pension Fund Trusteesand Climate Change• “Financial ServicesAccountability:How Are Pension Fund TrusteesDealing with Climate Change?”• Research supported by ACCA /ESRC / UKSIF / PMI / NAPF• Preliminary Findings
  86. 86. Climate Change Predictions• The Intergovernmental Panel on Climate Change(IPCC) state by end of C21st global temperatureswill rise by 1.5 to 5.8 degrees centigrade resultingin:–thawing of permafrost–declines in biodiversity–rising sea levels–extreme weather patterns–flooding, droughts and storms–direct, unpredictable and possiblydevastating consequences on humancivilisation
  87. 87. Stern Review (2006): InsuranceCompanies and Climate Change• "The insurance sector will face bothhigher risks and broaderopportunities, but will require muchgreater access to long-term capitalfunding to be able to underwrite theincreased risks and costs of extremeweather events" (Stern, 2006, p.304).
  88. 88. Pension Funds andClimate Change• "Considering that both the physical andmitigation-related policy impacts of climatechange will influence the ability forcompanies to create and maintain wealth forshareholders … pension trustees will want toensure that these risks … are being addressedin relation to the funds in their care" (IPCC,2005).
  89. 89. Climate Change Impact• Innovest Strategic Value Advisors haveestimated that up to 5.1% (and perhapsmore) of market capitalisation may be at riskfrom climate change• Climate change has been identified as acentral issue for institutional investmentstrategy (Mercer Investment Consulting,2006).
  90. 90. The Global Growth of SRI• Socially responsible investment in the USA• USA is a strong advocate of SRI• More than $2 trillion (about 13%) of all USinvestment follows SRI criteria• Freshfields Bruckhaus Detinger (2005) explain thatgiven the US legal framework, ESG considerationsmay be incorporated into investment strategy,provided that they are pursued for genuine reasonsand that they do not compromise the return toinvestment
  91. 91. Socially responsible investment inCanada• Jantzi Social Index• Freshfields Bruckhaus Deringer (2005)• No legislation encouraging trustees to take ESGissues into account• BUT some pension funds have included these issueswithin the context of profit maximization• Ontario Municipal Employees Retirement System(OMERS)• Ontario Teachers Pension Plan Board• The state of Manitoba has amended pension fundlaw to specify that pursuit of ESG factors ininvestment strategy does not represent a breach offiduciary duty
  92. 92. Socially responsible investment inAustralia• Traditionally, Australian fund managers haveconsidered that SRI is incompatible with fiduciaryduty• Freshfields Bruckhaus Deringer (2005) indicatedthat Australia has been slower than the US inintegrating ESG issues• Factors which have hindered SRI:– confusion over what constitutes ESG factors– a perception that SRI leads to underperformance– confusion as to whether ESG investment is consistentwith fiduciary duty– lack of demand from fund beneficiaries.
  93. 93. Socially responsible investment incontinental Europe• European Commission has endorsedSRI as an important instrument forencouraging corporate socialresponsibility• European Social Investment Forum(Eurosif) has helped to promote SRI
  94. 94. Socially responsible investment inJapan• Solomon et al. showed SRI has grown recently inJapan• Japan is a civil law country• Law does not depend on cases• Trust law in Japan stipulates that trustees have aduty of loyalty to carry out their responsibilities ingood faith on behalf of their beneficiaries and toavoid conflicts of interest• No current legislation encouraging ESG issues to beintegrated into institutional investment• Legal framework is an obstacle to SRI in Japan• Freshfields Bruckhaus Deringer (2005) concludesthat ESG in Japan is in its very early stages
  96. 96. Cases - The Collapse of Enron:Governance and Responsibility• Enron was a great business success soaring to amarket capitalization in excess of $60 billion andranking seventh on the Fortune 500 list• Enron was creative in its financial arrangements,entering into numerous partnerships with a variety ofentities– The partnerships allowed Enron to keep substantial lossesoff its financial statements• Under increasing pressure from its own failedinvestments, facing difficulty in obtaining financing,and under scrutiny from Wall Street, on October 16Enron reported:– A third-quarter pre-tax loss of $710 million andsubtracted $1.2 billion from shareholders’ equity
  97. 97. Cases - The Collapse of Enron:Governance and Responsibility• A central component of Enron’s strategy was toutilize subsidiaries and special purpose entities• In 1993 Enron established a partnership namedJEDI (Joint Energy Development Investments)with the California Public Employees’ RetirementSystem (CalPERS) as the limited partner• In 1999 Fastow proposed establishing apartnership LJM Cayman LP (LJM1) for the:– Ostensible purpose of hedging Enron’s investment inRhythms NetConnections by obtaining investmentsfrom outside investors
  98. 98. Cases - The Collapse of Enron:Governance and Responsibility• Raptor was Enron’s name for a partnershipused to hedge its merchant investmentsportfolio in projects and companies• Enron employees participated in 401(k)retirement plans, and most of them heldEnron shares• The Board of Directors was responsible forthe performance of the company and had afiduciary duty to shareholders
  99. 99. Further Reading• Solomon, Jill (2010) Corporate Governance andAccountability 3rd Edition, Wiley, UK. Ch.9-11• Goergen, Marc (2012) International CorporateGovernance, Pearson. Ch.8• Gary, Owen & Adams (1996) Ch.2-4• CIMA - Performance Strategy: Study Text (2012)BPP Learning Media Ltd. Part B : 4• Baron, David P.(2013) Business and itsenvironment, 7th Edition, Pearson
  100. 100. Additional Readings (1)• Mallin, C. A., Saadouni, B. and Briston, R. J. (1995) ‘The financialperformance of ethical investment funds’, Journal of Business Financeand Accounting, 22, 483–96.• Gregory, A., Matatko, J. and Luther, R. (1997) ‘Ethical unit trust financialperformance: small company effects and fund size effects’, Journal ofBusiness Finance and Accounting, 24(5), June, 705–725.• Drexhage, G. (1998) ‘There’s money in ethics’, Global Investor, 109, 56.• Williams, S. (1999) ‘UK ethical investment: A coming of age’, Journal ofInvesting, summer, 58–75.• Hancock, J. (1999) Making Gains with Values: The Ethical Investor,Financial Times/Prentice Hall, London.• Friedman, A. L. and Miles, S. (2001) ‘Socially responsible investment andcorporate social and environmental reporting in the UK: An exploratorystudy’, British Accounting Review, 33, 523–548.• Sparkes, R. (2002) Socially Responsible Investment: A Global Revolution,John Wiley & Sons, Chichester, UK.• Solomon, J. F., Solomon, A. and Norton, S. D. (2002) ‘Socially responsibleinvestment in the UK: Drivers and current issues’, Journal of GeneralManagement, November 2001.
  101. 101. Additional Readings (2)• Mercer Investment Consulting (2005) SRI: What Do InvestmentManagers Think? 12st March, Mercer Human Resource ConsultingLLC and Investment Consulting Inc., New York, USA.• Cobb, G., Collison, D., Power, D. and L. Stevenson (2005)FTSE4Good: Perceptions and Performance, ACCA Research ReportNo.88, Certified Accountants Educational Trust, London, UK.• Freshfields Bruckhaus Deringer (2005) A Legal Framework for theIntegration of Environmental, Social and Governance Issues intoInstitutional Investment, UNEP Finance Initiative, produced for theAsset Management Working Group of the UNEP Finance Initiative,October.• Solomon, J. F. and L. Darby (2005) "Is Private Social, Ethical andEnvironmental Disclosure Mythicizing or DemythologizingReality?", Accounting Forum, Vol.29, pp.27-47.• Mercer Investment Consulting (2006) 2006 Fearless Forecast:What Do Investment Managers Think About ResponsibleInvestment? March, Mercer Human Resource Consulting LLC andInvestment Consulting Inc., New York, USA.• Solomon, J. F. and A. Solomon (2006) "Private Social, Ethical andEnvironmental Disclosure", Accounting, Auditing andAccountability Journal.• Solomon J. F. (2008) Preliminary Report on Pension Fund Trusteesand Climate Change, ACCA (on blackboard).
  102. 102. NEXT Ideas for Discussion• Morck, Randall and Yeung, Bernard(2003) Agency problems in largeFamily Business Groups,Entrepreneurship: Theory andPractice, Summer 2003. Vol. 27, No.4: pp. 367 – 382
  103. 103. QUESTIONS?
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