Introduction to SRI
Socially Responsible Investment has two facets. It is first a policy, the corpo- rate social responsibility of the financial sector, and second its application to financial analysis and fund management involves the financial valuation of corporate social responsibility strategies in other sectors. There is a gap between policy and its implementation. In 2014, responsible investment stra- tegies represented 30% of the sums managed throughout the world, mainly in US and Europe (GSIA, 2015). However, there are different levels of stra- tegies and, in France for instance, Novethic considered that only 8% of SRI strategies are “high impact” or stringent (Novethic, 2015).
Besides national differences, SRI funds may be defined using one of three specific tools developed by SRI industry:
(1) Selection of a socially responsible investment (SRI) universe based on environmental, social and governance (ESG) criteria
(2) Shareholder dialogue, to encourage or compel the company to achieve an ESG target
(3) Extra-financial analysis, integrating long-term risk and opportunity calculations related to ESG issues into traditional financial analysis.
Socially responsible investment remains influenced by the ethical princi- ples of the founders of the first ethical funds that looked for “good” com- panies. But the concept of good or socially responsible company and that of socially responsible investment have evolved, as presented inTable 1.
Table 1prompts three additional comments.
First, religion is not a guarantee of absolute straightforwardness in the decision process. Indeed, the Bible does not take a dogmatic view of these activities (Schneider-Maunoury, Verrax, & Inard, 2010). A dogmatic 141 Socially Responsible Investment Assessing CSR
perspective would imply the exclusion not only of alcohol production (by beverage companies) but also the distribution and sale of alcohol (by retail companies). Extreme example of dogmatic policy could lead a religious fund to exclude oil companies that sell alcohol at their filling stations (and this has happened). However, SRI policies of many religious endowments and foundations clearly state the need for pragmatism.
Second, since the 1980s, the need for environmental, social, and govern- ance data has resulted in the emergence of CSR rating agencies. Indeed, there was no systematic information on CSR policies.
Third, despite some partial attempts such as the United Nations Millennium targets, there is no clear definition of sustainable development as a policy to be complied with. So, the concept of sustainable development has remained very unclear, merely depicted through megatrends (climate change mitigation and adaptation, preservation of natural resources).
Depending on the agency’s perspective on CSR and that of its clients, the assessments provided by CSR rating agency differ both in topics (product/
service, practice, process, performance) and methods (compliance, manage- ment system, risk/opportunity, strategic anticipation/preparedness,Fig. 1).
In the 2000s and 2010s this market consolidated strongly, leaving only four agencies: Sustainalytics (a merger of Dutch, Canadian, American, and German agencies), VigeoEiris (a merger of French, British, Belgian, and Italian agencies) O¨kom (a stand-alone German agency) and MSCI (a subsidy of MSCI, focused on building indices using ESG data). In the early 2000s these agencies helped to build up corporate ESG information and improved the data available.
Table 1. CSR and SRI Motivations and Targets.
CSR Foundation Exclusion/
Selection
Targets of Exclusion from/Selection for SRI Funds
19201950 Religion Exclusion Vice sectors: alcohol, tobacco, weapons, games, pornography
19601980 Non- religious moral
Exclusion Sector and company: nuclear energy and human rights infringements
19902000 Good citizenship Exclusion and selection
Sector and company: exclusion or underweighting of polluting industries, selection, and overweighting of companies with good social policies
2000 Sustainable development
Selection Companies and sectors involved in social or environmental trends’ opportunities (climate change, urbanization).
This diversity of questions around CSR policies explains why CSR rat- ing had to commoditize their products to respond to the different needs of their clients, arbitraging between complexity of analysis and breadth of scope (Fig. 2).
Fig. 1. Objects and Methods of Analysis Used by the Main CSR Rating Agencies in 2003.Source:Schneider-Maunoury (2006).
Fig. 2. CSR Rating Agency Tradeoff between Scope of Compilation and Complexity of Analysis.Source: Based onLucas-Leclin, Desmartin, De Brito, and Perrin (2005).
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This situation left room for newcomers. First Bloomberg started in 2007 to provide ESG data (with large scope of compilation and low complexity of analysis) with traditional financial data. Second, stockbrokers developed their own SRI research teams, notably in France. After ten years of specific research on themes such as climate change, tax evasion, or human capital development, most stockbrokers have withdrawn from this market as there is no valuation of these specific surveys by their clients, except to generate ideas for private banking. Third, and more recently, specialized carbon measurement agencies (Inrate, Trucost) entered the ESG data market.
These agencies focus on the measurement of environmental externalities and provide estimates on CO2emissions and carbon impact.
Given the diversity of methods and tools used for SRI, Frenchsif (French Social Investment Forum), defined SRI in 2013, reminding the tools of SRI (use of extra-financial criteriaenvironmental, social, governancein the financial decision process) and stating clearly its aim of “financing companies and issuers contributing to sustainable development.”
This is a good example of consensus enabling what Celine Louche called the institutionalization of SRI (Louche, 2004) and the development of a market. But it does not answer the question of how socially responsible investors assesses good companies, that is the value of CSR strategies?
Academic Valuation of CSR Using SRI
Most academic studies on SRI focus on the link between CSR and financial performance. According toMargolis and Walsh (2001), as SRI grew in the 1990s, the number of studies showing a positive relation between CSR and financial performance also grew. However these surveys are full of bias, and do not demonstrate any relations.
Let us take the example of Konar and Cohen in 2001. They published a survey on the relationship between Toxic Release Inventory data and equity performance. This survey includes a lot of assumptions that cannot be reduced to mere control variables. Indeed, measuring environmental performance through Toxic Release Inventory disclosure is a rather narrow scope of measurement. It mainly focuses on direct environmental impact made by industrial sectors and considered as illegal by the government. It does not measure risk exposure due to sector or production process. It does not measure management quality. This clearly shows the bias of such stu- dies, identified as early as 2006 (Stanwick & Stanwick, 2006). Similar con- clusions could be drawn from studies on “best companies to work for.”
Indeed, the delivery by companies of services as a Jacuzzi is characteristic of hi-tech sectors, and will introduce bias in favor of hi-tech sectors com- pared with more traditional industries.
Discussions on the measurement of CSR are in fact scientifically pro- blematic, as they confuse facts and beliefs, as identified by Statman in 2000 (Okonomidou, 2011). Therefore, surveys of the link between CSR performance and financial performance assume the veracity of stake- holder theory or wish to demonstrate its erroneousness (binary debate Freeman vs. Friedman).
These discussions are theoretically interesting but do not help the SRI industry to identify CSR performance and its potential link with financial performance. One survey made by a stockbroker in 2008, and unfortu- nately never published in an academic paper, attempted to go beyond such bias (Lucas-Leclin & Nahal, 2006). Socie´te´ Ge´ne´rale CIB considered all the types of bias: sector, country of incorporation, countries where the com- pany is located. All CSR ratings provided by Innovest (later bought by MSCI) were then de-biased. The results provide an explanation for the slow development of SRI on the financial markets. Except for a few sectors, such as mining and the automotive industry, whose EBIT is lower than 20%, there is no significant price variation of more than 15%. In other words, CSR performance has no impact on financial performance, because margins mitigate environmental or social costs.
In Europe, after enormous production of SRI surveys and competition among stockbrokers, the quantity and pace of production has slowed, staff having been reduced. It remains the specialty of some small or medium- sized brokers, either focusing on issues (governance, carbon, tax optimiza- tion), such as Oddo, Exane, or Kepler Cheuvreux, or on investment themes (palm oil, education, water, resources depletion, and recycling) such as Socie´te´ Ge´ne´rale or BofA-Merril Lynch. On these topics, brokers’ surveys make it possible to differentiate a company’s risk exposure and its manage- ment quality.
Another unpublished survey provides an explanation for the imprecision of CSR ratings. Beyond the bias, correlations exist between different com- ponents of CSR ratings, but they can be broken down into different dimen- sions (Grand, Grill, Rousseau, & Schneider-Maunoury, 2005). The survey initially focused on country bias, but its main result is the factor analysis of the five analytical dimensions of Vigeo (human resources, environment, customers-suppliers, shareholders, community) into two components, the first representing environmental and social performance, and the second representing governance performance.
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Given these measurement problems, as early as 2001, Margolis and Walsh recommended a preliminary reflection to enhance understanding of CSR performance, and encouraged the measurement of a single environmen- tal or social corporate issue, for instance training. If CSR cannot be mea- sured, either by academics or by financial analysts using its products, then the question remains of what is CSR? How can it be observed or measured?
What Is a “Good” Company? What Type of CSR Can Be Measured?
Let us start with an example we consider representative of CSR measure- ment in companies: the SRI investor day organized by SEB (a French con- sumer durables company) in 2015.
During its 2015 SRI investor day, SEB presented its CSR strategy. The first item is industrial strategy. With a target of local production wherever it sells products, SEB prefers to internalize 72% of its production in its own factories (highly standardized: 100% OHSAS 18001 and ISO 14001 certi- fied factories, the Chinese site being SA8000 certified), with 30% of its pro- duction still located in France. Moreover, SEB emphasizes its safety policy (with a team of 30 coordinators and decreasing incident frequency rates over the last 5 years). Its environmental policy includes a specific CO2focus (improvement of product design and logistics) but product recyclability is at its core (SEB has set up a network of 3600 certified repair shops, includ- ing many social businesses). Finally, SEB explained how group buyers have been persuaded to take account of environmental and social criteria when selecting suppliers and contractors. Such practices are not made obligatory for moral or ethical reasons but because the buyers understand their com- pany’s interests. Indeed, SEB needs a different supply chain if it wants to differentiate itself from white-brand retailers that mainly position them- selves on price. Similarly the development of a network of certified repair centers is not based on ethics but on the strategic need to make SEB pro- ducts last longer. In a short presentation of internal processes, SEB clearly states that internal auditing and sustainable development work together, not only to track any poor practice and to make it compliant, but also to obtain concrete facts and deep insight on which SEB can base its invest- ment decisions and set more realistic targets for operational management.
The SEB example illustrates well the concept of well-understood interest.
It is an old philosophical example raised by Emmanuel Kant (Kant, 2012).
Emmanuel Kant was asked about a shopkeeper in Ko¨nigsberg on the Baltic Sea “If a shopkeeper gives the correct change to blind people and
young schoolgirls, is this not proof of his moral behavior?” Kant explained that the shopkeeper gives the correct change to vulnerable people because he understands that it is in his interest. Indeed, the young schoolgirl might stay in Ko¨nigsberg and become a client. So it is in the shopkeeper’s interest to develop customer loyalty. This example shows first that, contrary to Adam Smith assumption, there is no morality in business (but amorality, rather than immorality). Second Kant explained that a company must understand its interests, as clearly shown in the example of SEB. CSR mea- surement is thus reduced to two questions: (1) Is the company’s strategy in its “well understood interest”? (2) Does this strategy fit with long-term social and environmental trends?
The first question is typical with regard to strategy. The second and third parts of this chapter endeavor to explain why this question is different from a CSR perspective. But two examples will illustrate why the second question is difficult to answer.
AEM, a former state-owned utility company in Milan, released environ- mental and social information in 2000. The main strategy publicized was the offer of a customer-focused service by a dynamic, experienced team, with a service customized to meet the demands of any customer. The staff was in fact ageing, with an average age of 46. To implement this strategy, AEM planned a training program of 1 hour per employee per year. This example shows that when there is no relevant strategy, CSR policy or dis- closure, reduced to long-term projections, is a mist behind which to hide the lack of strategy.
In 2006, Sodexo, a French catering company, was in a difficult situa- tion. Its development in the United States was under scrutiny, because of racial and sexual discrimination cases. Moreover, its social legitimacy and its value creation story (the chef becoming site manager) was not working anymore in France. Despite some positive communication on diversity (hiding micro-discrimination by its mainly masculine managers against its mainly female employees), on fair wages (hiding the fact that qualified workers were paid only slightly above the minimum wage), Sodexo’s catering business was in trouble due to underinvestment and low manager salaries, which reduced its attractiveness. Moreover, it was involved in a case of discrimination in the United States, although this was quickly resolved by a secret agreement with a trade union. However, its stock price was not really affected, as Sodexo soon diversified by acquiring a more profitable business, where it found a new source of managers. So in the long run, poor strategy might be solved by a smart merger before the market reacts.
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Two last remarks about Kant’s questions. The survey conducted by Grand et al. (2005)on the breakdown of CSR dimensions into two ques- tions confirm the insight based on Kant philosophical discussion. Further research could check whether this result is repeated with other agencies and in other timescales. More pragmatically, in 2015 the Oddo financial group tested and implemented an innovative management measurement system, to be revised yearly (Desmartin, 2015). Assessing governance and human resources issues, this measurement could become a proxy to answer the first of Kant’s questions: Is there a strategy or is there a well- understood interest?
Following the recommendation by Margolis and Walsh, the second part of this chapter will look at corporate social responsibility strategies in more depth through two cases of sample companies.