Socially Responsible Investment (SRI)

Socially responsible investment
Jérémy Morvan
Assistant professor
November 2017
1

 What is SRI?
 SRI is an Investment strategy that seeks both financial
and non-financial returns
Introduction
SRI
Portfolio
management
Return
Risk
Extra-financial
analysis
Screening(s)
Extra-financial
performance2

 What is SRI?
 SRI is a part of financing
 SRI funds invest in notes, bonds and stocks
Introduction
Financing
supply (SRI)
Financing
demand (CSR)
3

 What is SRI?
Introduction
SRI funds
Themed
funds
Community
investing
Religious
funds
€746B
€2920B
€126B
€4486B
$8720B
4

 What is SRI?
 Is SRI financially performant?
 Is SRI socially performant?
5
Introduction

Introduction
6
1. Corporate
social
responsibility
• Shareholder
governance
• Stakeholder
governance
2. Socially
responsible
investment
• Portfolio
management
• Extra-financial
analysis
3.
Performance(s)
of the SRI
• Financial
performance
• Non-financial
performance

 Plan
1. Corporate social responsibility
1. Shareholder governance
2. Stakeholder governance
3. Definition of CSR
2. Socially responsible investment
1. Portfolio management
2. Extra-financial analysis
3. SRI performance(s)
1. SRI financial performance
2. SRI non-financial performance
7
Introduction

Corporate social responsibility
8

 Issues
 What is the corporate objective function?
 How a company does (or must) work?
9

 Plan
10
Introduction

 Agency theory (Jensen & Meckling, 1976)
 Shareholders of corporations have limited liablility
 Shareholders are residual claimers
 The firm’s objective is to create shareholder value
11
“We define an agency relationship as a contract under which one or more
persons (the principal(s)) engage another person (the agent) to perform
some service on their behalf which involves delegating some decision making
authority to the agent” (Jensen and Meckling, 1976)

 Some critics
 Limited governance
 Only managers and financial
claimants are considered
 The theory does not describe the
managerial reality
 Corporate economic power is
growing
 The objective of the firm is
simple
 Creating shareholder value
Managers
Financial
creditors
Shareholders
12

 Plan
13

 Stakeholder theory (Freeman, 1984)
 For academic strategy, there are several stakeholders in
and around companies
 A firm is a "cooperative game" between employees and
shareholders and managers are in charge of all arbitration
between them (Aoki, 1980)
 A firm is a "nexus of contracts ": corporation is made up of
many constituents underlying that governance is not reduced
to ownership and control (Williamson, 1984)
14

Stakeholders Resource Influence Authors
Shareholders Equity Voting rights, governance,
financial markets
Jensen and
Meckling (1976)
Financial creditors Long-term financial debt Financial contracts, financial
markets
Jensen and
Meckling (1976)
Employees Labour, involvement… Social legislation, work contract,
labour conflict…
Aoki (1980)
Suppliers Inputs, quality Trade legislation, business
contract…
Porter (1980)
Customers Sales, reputation Trade legislation, business
contract, competition…
Porter (1980)
Society, communities Skilled staff, solvent customers,
suppliers
Social conventions, social
legislation…
Freeman (1983)
Ecological environment, nature Commodities, basic resources Social conventions,
environmental legislation…
Freeman (1983)
Competitors ? Economic legislation… Porter (1980)
Government Facilities, legislation Tax system, public spending,
legislation(s)…
Smith (1776)
Future generations ? ? Bruntland (1987)
Primary
stakeholders
¨Mute¨,
secondary
stakeholders
Stakeholders
in debate
15
Internal
stakeholders
External
stakeholders

2. Stakeholder
governance
 Expanded governance
with several stakeholders
Managers
Shareholders
Customers
Suppliers
EmployeesCommunities
Environment
Financial
creditors
16
Trade
unions
NGOs
Local
authorities
Media

 Critism
 Complexity
 Stakeholder theory is a better description of the firm’s reality
 Is stakeholder theory descriptive, instrumental and/or normative
(Donaldson et Preston, 1995)?
 Who are the legitimate stakeholders?
17
“Stakeholders include all individuals or groups who can substantially affect the
welfare of the firm – not only the financial claimants, but also employees,
customers, communities, and government officials, and under some interpretations,
the environment, terrorists, blackmailers, and thieves” (Jensen, 2002)

 Critism
 What is the objective of the firm?
 Negative impact on the financial performance of the firm
 Priorization of the stakeholders
 Shareholder value creation over the long-term
 Which social norm in a globalised economy?
18
“The Social Responsibility of Business is to Increase
its Profits” (Milton Friedman, The New York Times
Magazine, September 13, 1970)
“[…] value maximization states that managers should
make all decisions so as to increase the total long-run
market value of the firm. Total value is the sum of the
values of all financial claims on the firm – including equity
, debt, preferred stock, and warrants” (Jensen, 2002)

 Plan
19

3. What is CSR?
 CSR helps to redefine some corporation aspects
 Firm’s objective is to create economic value
 Firm’s governance integrates several stakeholders
 Firms must be more transparent
 Firms have to be more accountable (manage externalities)
20
“CSR policy functions as a self-regulatory mechanism whereby a business
monitors and ensures its active compliance with the spirit of the law, ethical
standards and national or international norms” , Rasche et al. (2017)

3. What is CSR?
 CSR is the set of organizational practices that aim to
respect the principles of sustainable development
Environment
EconomySocial
Sustainable
Bearable Viable
Equitable
21
“Sustainable development is development that
meets the needs of the present without
compromising the ability of future generations to
meet their own needs” (Bruntland Report, 1987)

3. What is CSR?
 "Triple bottom line" (Elkington, 1998)
22
Profit
Planet
People
Difficulties to reconcile the
three dimensions

23

 Issues
 What is SRI?
 How SRI does work?
 What is the SRI fund manager objective?
24

 Plan
25

 Financial activity about investment decision in order to
maximize risk/return ratio
 Security screening according financial criteria
 Efficient portfolio
 A more or less dynamic portfolio management (turn over)
 Buy and sell is costly (management fees)
26

 Efficient frontier (Markowitz, 1952)
 The efficient frontier is defined as the set of optimal
portfolios that offer the highest expected return for a
given level of risk or the lowest risk for a defined level of
expected return
27

 Efficient frontier (Markowitz, 1952)
28
Security i
Security j
Rf
0%
2%
4%
6%
8%
10%
12%
14%
0% 5% 10% 15% 20% 25%
Return(R)
Risk (σ)
Efficient forntier with 2 risky assets
Efficient frontier with a risky asset and a risk-free asset (capital market line)

 Efficient frontier
 Two rules of stochastic dominance
 The greatest expected return for a given level of risk
 The lowest risk for a given expected return
 An efficient portfolio provides an optimal risk and return
combination
 Nowadays, an investor can best optimize his portfolio by
holding close to 50 stocks
29

 The portfolio theory is consistent with the efficient
market hypothesis (EMH) (Fama, 1991)
30
“I take the market efficiency hypothesis to be the simple statement that
security prices fully reflect all available information. A precondition for this
strong version of the hypothesis is that information and trading costs the
costs of getting prices to reflect information, are always 0 (Grossman and
Stiglitz(1980)). A weaker and economically more sensible version of the
efficiency hypothesis says that prices reflect information to the point where
the marginal benefits of acting on information (the profits to be made) do
not exceed the marginal costs (Jensen (1978)).” (Fama, 1991)

 The portfolio theory is consistent with the efficient
market hypothesis (EMH)
 Prices are likely the best estimate of a security’s true value
 Random walk theory
 It is impossible to outperform the market returns
 Market prices convey all the available information
31

 Plan
32

 SRI is a portfolio management strategy with a new
constraint
 Risk and return
 Management fees
Extra-financial rating integrates additional
information that is not (or badly) taken into
account by the financial markets
33

 Negative screening
 Method of security screening proceeds by excluding from
the fund’s investment companies or organizations
harnessing totally or partly their income of activities which
not basically ethical because they are harmful for man’s
health and life
 All other companies are considered ethical
 From the historical standpoint, it is the method used by the
first (religious) SRI funds
34

 Negative screening
 Investors have to decide which industries are not ethical
 Alcohol
 Tobacco
 Gambling
 Armaments & Firearms
 Adult Entertainment
 For example…
35

 Positive screening
 Method of security screening proceeds by including fund’s
investment universe of companies or organizations having
demonstrated their CSR based on their respect of
economic, societal and environmental criteria
 All other companies are considered not socially responsible
 From the historical standpoint, it is the method used by
non-religious SRI funds
36

 Best in class
 Method of security screening proceeds by including in the
fund’s investment universe of the companies which fit with SRI
criteria, without sectorial exclusion
 Best diversification
 Avoid the sectorial bias
 Incentive to develop best practices
37

 Best in universe
fund’s investment universe of the best companies, with
possible sectorial exclusion
 Less diversification
38

 Best efforts
fund’s investment universe of companies which performed the
large efforts in terms of sustainable development
 Well-diversified portfolio
39

 Analysis of the practices of companies in terms of CSR
 The analysis is based on the ESG criteria ESG
 Environment
 Social
 Governance (transparency, anti-corruption…)
40

 Some critics
 Marketing segmentation of the SRI
 Development of themed funds, focused on certain ESG criteria
ESG (carbon finance, islamic finance…)
 Competition among SRI funds and ethics
 May a fund manager outsource the SRI analysis?
 A true SRI fund makes its own extra-financial analysis
 An internal extra-financial analysis may be a black box
41

 Critism
 Is information dealing with the corporation independent?
 Companies publish their own sustainability report
 But some initatives try to develop best practises…
42

 Critism
 Is information on the corporation complete?
 In the environmental field
 "Dieselgate" (2009)
 Greenwashing
43

 Critism
 Is information on the corporation complete?
 In the social field
 Textile industry: 2013 Savar building collapse (Bangladesh, 24th april)
 Digital industry: Apple and Foxconn
44
The quality of the information depends on a
on-the-spot audit work
Public dissemination of such information
can be harmful for corporates

 Critism
 Which social norm in a globalised economy?
 Free speech and
 Is nuclear power low carbon?
 Yes
 No
45

 Issues
 Does socially responsible investing hurt investment
returns?
 Are SRI funds socially responsible?
47
SRI performance(s)

 Plan
48
SRI performance(s)

1. Financial performance of the SRI
 Does socially responsible investing hurt investment
returns?
 Methodological difficulties
 Which funds are SRI funds?
 What is a relevant benchmark?
 Conventional funds
 Market indices
SRI performance(s)
49

 Efficient market hypothesis
 SRI funds underperform conventional funds
 Reducing the range of possible investments
 Including ethical or social considerations in the investment policy
increases total portfolio risk (less diversification)
 More management fees
 Extra-financial analysis is costly
SRI performance(s)
50

 SRI supporters
 SRI funds and conventional funds perform closely in terms
of financial performance
 Firms acting in accordance with certain ethical criteria are less
risky (McGuire et al, 1988)
 Learning effect (Bauer, 2005)
 SRI fund managers tend to underperform when they start their
business but perform as well on a long term as do conventional
funds
SRI performance(s)
51

 Consensus
 The long-term performance of SRI funds is close to long
term performance of conventional funds
 SRI funds don’t have a higher risk
 SRI funds are not underperfomant
SRI performance(s)
52

 Plan
53
SRI performance(s)

2. Extra-financial performance of the SRI
 Few facts
 SRI indices are highly correlated with conventional indices
(>90%)
 (Almost) all large corporations have an ESG rating
 Firms seek to create a positive image of their businessses
(greenwashing)
54
SRI performance(s)

2. Extra-financial performance of the SRI
 Certain funds give priority to the extra-financial
performance
 Benefit-sharing fund: balance between the financial
performance between investors and a NGO
 Communities investing: investments that directly benefits to
low-income populations through community development
banks, credit unions, loan fund or microfinance institution
 In an EMH point of view, SRI funds may have a social impact
that negatively impacts their financial performance (?)
55
SRI performance(s)

2. Extra-financial performance pf SRI
 Is SRI credible?
 Increasing number of labels in France
 All around the world
56
SRI performance(s)

 A new ecosystem?
 SRI is a financial system that operates according to
social and environmental practices
 New financial services : SRI indices, extra-financial rating
agencies, SRI fund managers…
Conclusion
58
Demand
(SRI)
Supply
(CSR)

 SRI performance remains a central issue
 There is a growing consensus on financial performance
 SRI funds are neither more nor less performant than
conventional funds
 There is a growing questioning of extra-financial
performance
 Are SRI funds really effective in SRI?
59
Conclusion

Aoki M. (1980), “A Model of the Firm as a Stockholder-Employee Cooperative Game”, American Economic Reviewv (70)4,
600-610
Bauer R., Koedijk K., Otten R. (2005), “International Evidence on Ethical Mutual Fund Performance and Investment Style”,
Journal of Banking and Finance, (29), 1751-1767
Donaldson T., Preston L. E. (1995), “ The Stakeholder Theory of the Corporation: Concepts, Evidence and Implications”,
Academy of Management Review, (20)1, 65-91
Elkington J. (1998), Cannibals with Forks: The Triple Bottom Line of 21st Century Business, John Wiley
Fama E. F. (1991) “Efficient Capital Markets: II”, Journal of finance, (46)5, 1575-1617
Freeman R. E. (1984), Strategic Management – A Stakeholder Approach, Pitman
Jensen M. C., Meckling W. H. (1976), “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure”,
Journal of Financial Economics, (3)4, 305-360
Jensen M. C. (2002), “Value Maximization Stakeholder Theory and the Corporate Objective Function”, Business Ethics
Quarterly, (12)2, 235-256
Markowitz H. (1952), “Portfolio Selection”, Journal of Finance, (7)1, 77-91
McGuire J. B., Sundgren A., Schneeweis T. (1988), “ Corporate Social Responsibility and Firm Financial Performance”,
Academy of Management Journal, (31)4, 854-872
Rasche A. Morsing M., Moon J. (2017), Corporate Social Responsibility - Strategy, Communication, Governance, Cambridge
University Press
UN (1987), “Bruntland Report”
Williamson O. E. (1984) , “Corporate Governance”, Yale Law Journal, (93), 1197-1230
60
References

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