The Initiative for Responsible Investment, a project of the Hauser Center for Nonprofit Corporations at Harvard University, has prepared this report On Materiality and Sustainability: The Value of Disclosure in the Capital Markets for the Sustainability Accounting Standards Board (SASB). Steve Lydenberg is the report’s author. this report builds on the report From Transparency to Performance: Industry-Based Sustainability Reporting on Key Issues published by the Initiative for Responsible Investment in June 2010.
Looking forward ten, even twenty years, what will Socially Responsible Investing (SRI) have become? What will it have accomplished? What will the field look like? Today, I build a case for a good future. In a word, it will largely be marvelous.
Roughly 15 years ago, I spoke in Jackson Hole, Wyoming. It is a spectacular setting, one that makes a person proud to be in a great nation like ours, one that protects such places. Yet, as I reminded the audience that day, it had not been the public that had kept the Grand Tetons pristine. It was one man, John D. Rockefeller, who had purchased the land and given it to the nation.
This is the classic dilemma we in SRI struggle with every day. It is great that the Grand Tetons are a public treasure, but they became so on the backs of crushed labor forces, pollution and selfishness. One man made his money and then gave it away, but he set in motion the international oil industry, an industry that is robbing us of a climate, a future.
That day I challenged SRI to become relevant. Today, I can see clearly that it has. Over the next twenty years, the positions we have taken and the battles we have fought will lead to a universal understanding that what we have been saying, the way you invest matters, is absolutely correct. We will see our guiding principles integrated into the mainstream. We will be astonished at the acceptance and the impact that we have had.
How We Became Relevant – Performance Matters
Perhaps the most devastating argument we faced early on was the Modern Portfolio Theory (MPT). It argues that the previous “prudent man” idea of buying good stocks alone, created risk. Introduced in 1952 by Harry Markowitz, the original premise was simple: investors should focus on overall portfolio risk. Simply put, even if you love software, you still shouldn’t build an entire portfolio of software stocks. Astonishingly, this revelation won Mr. Markowitz a Nobel Prize in Economics and caused the entire financial services industry to argue that the individual risk characteristics of a company mattered little.
Against this backdrop, SRI seemed hopelessly old fashioned. We argue that each company, by virtue of the industry within which it operates, faces a series of risks that we label as risks to people or the planet. We then argue that taking too large a risk is not necessary and further, that it perpetuates an acceptance of these risks. Wall Street pundits stated with great authority, but with no basis, that our form of analysis flew in the face of Modern Portfolio Theory and so would fail. Our largest barrier was that, to use the vernacular, every smart person knew SRI was stupid.
The evidence proved otherwise. The MSCI KLD 400 Social Index has not only debunked the premise of MPT, but also shown that risk avoidance works. The index has outperformed — and has done so with a lower standard deviation. Clearly, examining the risk of corporate behavior tells us something about a company that is useful to investors.
Why We Are Relevant – An Increase in Reporting
SRI practitioners have pushed for “extra-financial” data and have gotten it. At first, true comparative data on companies was extremely scarce in some areas of keen interest to the concerned investor. Any good researcher understands that the newspapers are a lousy place to start. The fact that we know that Apple sourced from Foxconn does not tell us what Hewlett Packard does. What is needed is data that is universally ascertainable, without the company answering a questionnaire (which allows them to self-define), and the data must be quantitative in nature, e.g. I don’t care as much about a statement that a company seeks diversity as I do about how many minorities have been hired.
Today, thousands of companies self-report. Whereas the one or two companies that issued Social Responsibility reports thirty years ago were real outliers, today it is so mainstream that Forbes magazine maintains a blog to follow them. Accounting giant PWC makes available the 2010 survey of CSR reporting on their website. The highlights: 81 percent of all companies have CSR information on their websites; 31 percent have these assured (or verified) by a third party. Their 2012 update contains examples of what to look for when writing (or reading) them.
Who was pushing for this disclosure? It wasn’t civil society, it wasn’t Wall Street; it wasn’t government. It was a loose confederation of concerned investors who consistently pushed for greater and more standardized “non-financial” information.
Why We Are Relevant – An Increase in Regulation to Disclose
Regulators are beginning to expand on the data corporations are required to disclose. Remember, there was no God-given definition of the right way to report financials to investors. In 1932, when reforms to protect investors began, regulators looked at some of the pre-existing methods and evaluated them. This led to audited annual reports on income statements and balance sheets. It led to quarterly unaudited reports. These had, in the past, come to be viewed as important in judging the financial soundness of a corporation.
However, the regulators did not stop with accounting issues. Given that the 1930s were a period of high unemployment, the number of company employees was considered important, and so its disclosure became mandated. There is no reason that more robust social and environmental reporting shouldn’t be in the financial reports. We already disclose a company’s hometown, without companies complaining of the inappropriateness and burden of so doing.
The Initiative for Responsible Investment at Harvard University maintains a database of Global CSR Disclosure requirements. In it we find 34 nations are taking steps. In 2009, Denmark, required companies to disclose CSR activities and use of environmental resources. In 2010, the United Kingdom required companies that use more than 6,000MWh per year to report on all emissions related to energy use. Malaysia, in 2007, required companies to publish CSR information on a “comply or explain” basis. Regulators, recognizing the societal costs of less than full cost accounting, are moving in to mandate disclosure.
Mainstreaming – With this solid base, here come the “big boys”
Conventional asset managers and the academic community have brought SRI to the mainstream. I began by saying the future for SRI is marvelous. Consider a world in which every major financial asset management firm demands that its staff study the social and environmental implications of the investments they make and bases recommendations upon it.
But this has already begun. Consider MEAG, the American portfolio management branch of Munich Re. Their team buys only publicly traded bonds which then back the insurance the firm issues. They use ESG criteria to give their research the edge and to avoid risk. When I met with their research team, I found that they use several of Domini’s Key Indicators. No, we don’t publish the indicators. It also was not a coincidence. The two firms independently discovered the same indicators to be telling because they both use the same logic in approaching the issues. Or there is UBS Investment Bank, where analysts specifically address the social, environmental or governance risks of a company they are recommending.
Finally, look at the all-important realm of academia, where MPT began. Just three recent examples are telling:
The Impact of a Corporate Culture of Sustainability on Corporate Behavior and Performance by Professors Robert Eccles and George Serafeim, Harvard Business School. “… we provide evidence that High Sustainability companies significantly outperform their counterparts over the long-term, both in terms of stock market and accounting performance. The outperformance is stronger in sectors where the customers are individual consumers, companies compete on the basis of brands and reputation, and in sectors where companies’ products significantly depend upon extracting large amounts of natural resources.”
Corporate Social Responsibility and Access to Finance by Beiting Cheng, Harvard Business School, Ioannis Ioannou, London Business School, and George Serafeim, Harvard Business School. “Using a large cross-section of firms, we show that firms with better CSR performance face significantly lower capital constraints. The results are confirmed using an instrumental variables and a simultaneous equations approach. Finally, we find that the relation is primarily driven by social and environmental performance, rather than corporate governance.”
An FDA (Food and Drug Administration) for Financial Innovation: Applying the Insurable Interest Doctrine to Twenty-FirstCentury Financial Markets, by Eric A. Posner and E. Glen Weyl, Law School, University of Chicago. “We propose that when firms invent new financial products, they be forbidden to sell them until they receive approval from a government agency designed along the lines of the FDA, which screens pharmaceutical innovations. The agency would approve financial products if they satisfy a test for social utility …”
The Next Twenty Years
This article limits its scope to only one leg of the SRI stool. It does not discuss the growth of shareholder activism, which is vibrant. Nor does it address the mainstreaming of selling products with narrow and specific social purpose, also a burgeoning field. Rather, by looking at the application of social criteria to an investable universe alone, we see that barriers have been removed, and that now both a mountain of money, and the force of government and academia, will work with us and introduce our goals into mainstream investment thinking.
We know we can make money, government is increasingly with us, and academia is swinging our way. Now, the rapid acceptance of more robust and integrated accounting has done away with the last barriers. This brings us the assets to have impact. As society sees the full cost of traditional business behavior, SRI will be embraced as the single most important lever towards building a better world than the planet has ever seen.
Domini Social Investments’ Managing Director and General Counsel, Adam Kanzer, has been selected to join the Securities and Exchange Commission’s Investor Advisory Committee (IAC), created under the Dodd-Frank financial reform Act. He served on the SEC’s inaugural Investor Advisory Committee, which was disbanded in 2010 after passage of the Act. The 21-member committee was established to provide the SEC with the views of a broad spectrum of investors on the SEC’s regulatory agenda. Mr. Kanzer participated in the IAC’s first meeting on June 12.
Prior to the IAC appointment, Domini met with SEC Commissioner Luis Aguilar and SEC Chairman Mary Schapiro to discuss the priorities of the social investment community, including swift passage of Dodd-Frank provisions addressing excessive executive compensation, and two provisions relating to peace and government corruption – a provision requiring companies to disclose the sourcing of ‘conflict minerals’ from the war-torn Congo, and disclosure of corporate payments to foreign governments in connection with the extraction of natural resources.
During our meetings, we also asked the Commission to act on a pending rulemaking petition seeking disclosure of the use of corporate resources for political purposes. The petition has broken the record for public comments, with more than 250,000 people writing in support. Domini also reached out to shareholders of the Domini Funds, with an Action Alert.
As a stockbroker in the early 1980’s, Amy Domini got her first glimpse of the potential of socially responsible investing. She realized that many of her clients cared about more than just the bottom line. They cared about where their money was being invested and how profit could be coupled with a vision for sustainability.
Little did she know how big this discovery would be.
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As the daughter of a Neapolitan, I grew up eating pasta with marinara sauce. My father didn't always make it from scratch, but he did so often enough for me to follow his recipe through memories. Fresh tomatoes were not always available, but we canned them so we had the base for the red sauce all year.
The name "marinara" means "mariner's sauce." There is some debate as to whether the sauce got its start with Spanish or Neapolitan sailors' wives. Since Spain owned Naples during the key years (the first recorded recipe book containing the sauce, written in Naples, is dated 1692), it is a meaningless debate. The important thing is that early on, the healing aspects of tomatoes were discovered, and sailors used the sauce to cure and prevent scurvy.
Tomatoes originated in the New World, and while they probably came from Peru, they were grown at least as far north as Mexico by the time the Spanish sailed. Since the fruit could be dried and was acidic enough to stay preserved, it could be carried long distances. The mariners who carried it could survive at sea without fresh vegetables.
But at some point in history, humankind seemed to stop noticing the connection between the benefits of what we eat and our health. We moved away A from herbal remedies toward pills and gadgets. A stiff neck was no longer treated with a wru;m hand towel wrapped firmly around our neck and fastened with a baby diaper pin. Muscle relaxants became the cure of first resort. I've had friends suffer a tom meniscus and have knee surgery, but most of these injuries used to heal with time and quadriceps exercises.
I admit to admiration for Luddites, but I am not one. I enjoy modem comforts. Still, I cannot help but wonder if we are getting less when we modernize. The stories in the press back me up. It turns out that women of a certain age who take calcium tablets don't benefit as much as women who rely on diet to meet that need. Milk does it better.
I recently read Michael Pollan's In Defense of Food, in which he advises us to eat "real" food. I had to laugh when I read that. I remembered my mother scooping something called "Cool Whip" onto some heated pears for dessert. My father leapt to his feet. "What are you doing? Are you feeding our children plastic?" It wasn't plastic, but it also wasn't exactly whipped cream. In 2007, Patrick Di Justo wrote in a Wired magazine article entitled "Cool Whip" that it is mostly water and air, although it costs twice as much as homemade whipped cream.
Old-fashioned food is cheaper and better for you. Eating a garlic clove when you start to feel sick isn't nearly as expensive as cold pills; gargling with warm salt water actually feels pretty good (I admit, eating garlic does not) and does relieve most sore throats... but where's the profit?
How many ancient wisdoms have we let fall aside because they were more trouble and less entertaining than being a patient and getting a pill? My mom boiled water to clear her sinuses. I don't know; maybe pills do a better job, but they cost a lot and might do some damage, too.
My father took my temperature by touching his forehead to mine. If mine felt hot to him, I had a temperature. Then came the mercury thermometer. Probably the worst part of that was uncovered in 2001 when 7.4 tons of mercury-contaminated glass from a thermometer factory was found to be polluting the area watershed after having been dumped unprotected. Unilever eventually paid a fine, closed the factory and cleaned up the mess. At least thermometers aren't made of mercury anymore. Mercury thermometers have been banned in most of the world.
When I was upset, I was given hot milk. When it was hot out, I sat with my feet in a bucket of ice water. Sleeping pills were not even considered. Oh, and generating electricity to cool homes and retail spaces ultimately means that power companies, which typically bum fossil fuels, bum more. This leads to greenhouse gases, higher global temperatures and more air-conditioning.
One of the concerns I have with the miracles of capitalism is that it has run over the miracles of nature. Corporate profits lie behind much of the erosion of land and the poisoning of air and water. Responsible investors use a battery of approaches to shine light on these issues. But let us also be mindful of what we can do to keep alive the wisdom of prior generations and not fall prey to the marketing myth of ever newer and "better" products.
From the Social Sustainability Resource Guide, published by the Interfaith Center on Corporate Responsibility (June 2011).
In August 2010, Domini Social Investments, announced that it had reached an agreement with Nucor, the largest steel producer in the United States, to address the company’s exposure to slavery and illegal deforestation in its Brazilian supply chain. The agreement followed three years of dialogue with the company...
I hate to date myself, but I'm old enough to remember having three pairs of shoes. The Buster Browns were for all the time; these sturdy brown lace-ups were for school, play and most activities. Next in usefulness were the black patent leathers with the velvet bow; these were for birthday parties, church, dinner with my grandparents and holidays. Finally came the Keds. Keds were only for playing tennis. Yes, this is true, and although it was a long time ago, it was in my lifetime.
This would never work today. Possessions have swamped us. Shoes have become specialized; so have scissors, batteries, candles and razors. Most observers agree that the demand for stuff has horrific implications. It creates ghastly environmental effects as we rip out raw materials to make things. It bankrupts families.
In Culture and Consumption, Canadian cultural anthropologist Grant McCracken introduced the concept of the Diderot effect, the unintentional transformation a simple acquisition sets in motion. In "Regrets on Parting with My Old Dressing Gown," French Enlightenment philosopher Denis Diderot bemoaned the sorry state of his life, the result of a gift of an elegant red dressing gown from a well-meaning friend. The dressing gown had been so fine that he had replaced his straw chair with one covered in Moroccan leather. He had replaced his prints along with his desk and updated his study. This improvement process went on until one day he felt unwelcome in his own study. He had become a slave to a level of fashion befitting his new dressing gown and regretted it.
It may seem a silly story, but we sense its rightness. And I would argue it gives us a special insight. Perhaps some types of consumption are positive change agents. Consumption is an enormously influential force. It affects behavior patterns of individuals at the personal level in such a way that whole societies are transformed. When anthropologists attempt to open communications with a jungle tribe, they leave pots and other goods the tribe finds useful and values. The door is opened.
We know this. Now we must harness it.
I look at my own consumption. A sneaky change took place over the past decade. Maybe it started with purchasing Ben & Jerry's yummy ice cream. I found I read the carton and wondered why other ice creams didn't tell me what a fine person I am. Then came Stonyfield's yogurt. I got so educated that I wandered into a Whole Foods. After three visits, I gave up on fruits and vegetables if they weren't organic.
Pretty soon, I was getting political about this. I boycotted coffee shops that didn't offer fair trade coffee; I started reading more and more about the politics of hunger and the dangers of pesticides. I noticed which politicians were raising my issues. It changed me. My eccentric Aunt Sylvia doesn't buy any clothing first hand. She's in her eighties and has saved what is rumored throughout the family to be a fortune. But she thinks buying new clothing is just plain wasteful. I've gone from thinking she was an oddball to thinking she's fantastic.
Now I'm becoming the oddball. When plastic bags come from a dry cleaner, I tie off the opening where the hanger was and use them as garbage bags. Last Christmas, my adult children came over to take the ribbons, boxes, papers and cards I'd saved, sometimes for several years running. It's a lucky thing they do, because I gave up physical gifts four years ago so have no use for the trimmings. It isn't that I'm against giving. I put three dollar bills in my pocket each morning and give them to the first three people who ask.
Did buying Ben & Jerry's ice cream make me a more tolerant woman? It did mark the beginning of a change. Like Diderot, I am caught in a continuous process of expanding and improving my new sense of self. But unlike Diderot, it feels right. I feel more and more welcome. I feel more and more a part of something important and good.
I'm hoping the purchase of mutual fund shares from a responsible fund family does the same thing. The investor has taken a casual, perhaps thoughtless, step, little suspecting he or she has begun ajoumey of personal redefinition. At some level, this person is no longer one of the overwhelmed, buffeted by forces beyond his or her control. This individual will take small steps: shop more deliberately, vote more deliberately, read the newspapers differently and be a more engaged (and tolerant) citizen.
Originally Appeared on Huffington Post
From The Landscape of Integrated Reporting: Reflections and Next Steps, published by Harvard Business School (November 2010)
an interview with Adam Kanzer by author and journalist Marc Gunther (August 2010)