Socially Responsible Finance and Investing

Financial Institutions, Corporations, Investors, and Activists

John R. Nofsinger, H. Kent Baker

• Publisher: Wiley
• Year: 2012
• Print ISBN: 9781118100097
• eBook ISBN: 9781118237014
• Edition: 1
• Topic: Business
• Subtopic: Finance
• Index: Business

A detailed look at the role of social responsibility in finance and investing

The concept of socially responsible finance and investing continues to grow, especially in the wake of one of the most devastating financial crises in history. This includes responsibility from the corporate side (corporate social responsibility) as well as the investor side (socially responsible investing) of the capital markets. Filled with in-depth insights and practical advice, Socially Responsible Finance and Investing offers an important basis of knowledge regarding both the theory and practice of this ever-evolving area of finance.

As part of the Robert W. Kolb Series in Finance, this book showcases contributed chapters from professionals and academics with extensive expertise on this particular subject. It provides a comprehensive view of socially responsible foundations and their applications to finance and investing as determined by the current state of research.

• Discusses many important issues associated with socially responsible finance and investing, like moral hazard and the concept of "too big to fail"
• Contains contributed chapters from numerous thought-leaders in the field of finance
• Presents comprehensive coverage starting with the basics and bringing you through to cutting-edge, current theory and practice

Now more than ever, we need to be mindful of the social responsibilities of all investment practices. The recent financial crisis and recession has changed the financial landscape for years to come and Socially Responsible Finance and Investing is a timely guide to help us navigate this difficult terrain.

CHAPTER 1

Socially Responsible Finance and Investing: An Overview

H. KENT BAKER

University Professor of Finance and Kogod Research Professor, American University

JOHN R. NOFSINGER

Professor of Finance and Nihoul Faculty Fellow,Washington State University

INTRODUCTION

What is the main goal of a business firm? Many have debated this question over the years. The response largely depends on one’s view of to whom the firm is responsible. Some contend that corporations are only responsible to their shareholders and do not have other obligations to society besides complying with applicable laws, ethical standards, and international norms. Hence, corporations should operate to meet the best interests of shareholders within these constraints. Others take the broader view that corporations have responsibilities to stakeholders other than shareholders. Stakeholders refer to those who have an interest or concern in the firm because of how its activities affect them. Stakeholders consist of owners, management, employees, suppliers, customers, the local community, and others.

Donaldson and Preston (1995) discuss three versions of stakeholder theory: normative, instrumental, and descriptive. Normative stakeholder theory views a firm’s behavior through an idealistic social or moral lens. That is, this version focuses on how firms “should” act. Instrumental stakeholder theory views stakeholder relationships as the means to some end, such as maximizing firm value. By contrast, descriptive stakeholder theory uses the stakeholder model as a tool for describing the activities and interests of the firm. In general, instrumental stakeholder theory seems to fit the needs of performance-oriented investors better than other approaches. Others provide an extensive treatment of stakeholder theory (Friedman and Miles 2006; Freeman, Harrison, Wicks, Parmar, and de Colle 2010; Phillips 2011).

Jensen (2001, p. 8) offers the following observation about a firm’s goal:

How do we want the firms in our economy to measure their own performance? How do we want them to determine what is better versus worse? Most economists would answer simply that managers have a criterion for evaluating performance and deciding between alternative courses of action, and that the criterion should be maximization of the long-term market value of the firm. …This Value Maximization proposition has its roots in 200 years of research in economics and finance.

Most financial economists would agree that the fundamental purpose of a business firm, especially a corporation, is to maximize returns to its shareholders. This view is consistent with instrumental stakeholder theory, which considers the stakeholder network as the means to the end of wealth creation. For example, Friedman (1962, 1970) treats shareholders as ends to firm performance and explicitly measures performance as profit. As Friedman (1970, p. 32) notes, the responsibility of business firms “will generally be to make as much money as possible.” Proponents of this view contend that the notion of corporate social responsibility (CSR), which is also called corporate conscience, corporate citizenship, social performance, and responsible business, distracts from the economic role of business.

Others, such as Freeman (1984, 1998), have different views. Freeman (1998, p. 126) states that “we must reconceptualize the firm around the following question: For whose benefit and at whose expense should the firm be managed?” He proposes replacing the narrow focus on shareholders with a broader set of obligations. Porter and Kramer (2011) echo this sentiment by proposing that the purpose of the corporation be viewed as creating shared value and not just profit. They maintain that corporations can make more long-term profits by embracing CSR. According to Baker and Powell (2005), achieving shareholder wealth maximization assumes that managers operate in the best interests of shareholders, avoid actions designed to deceive financial markets in order to boost the firm’s stock price, and act in a legally and socially responsible manner. Given these assumptions, Baker and Powell (p. 12) state that “shareholder wealth maximization is consistent with the best interest of stakeholders and society in the long run.”

Although shareholder wealth maximization has gained considerable traction in the academic and business communities, the concept of social responsibility has also gained momentum. Socially responsible finance includes responsibility from the corporate side (corporate social responsibility) as well as the investor side (socially responsible investing) in the capital markets.

CORPORATE SOCIAL RESPONSIBILITY

In the late twentieth century, an increasing number of corporations started to think about their effect on society at large, mainly because of growing consumer awareness of corporate activities around the world. Some corporations decided to embark on corporate social responsibility programs designed to offset some of their effects on the world while also generally improving corporate practices (Campbell 2007). Corporate social responsibility (CSR) is a form of corporate self-regulation integrated into a business model. That is, CSR is the decision-making and implementation process that guides all company activities in protecting and promoting international human rights, labor and environmental standards, and compliance with legal requirements within its operations and in its relations to the societies and communities where it operates (Carroll 1999). CSR involves a commitment to contribute to the economic, environmental, and social sustainability of communities through the ongoing engagement of stakeholders, the active participation of communities affected by company activities, and the public reporting of company policies and performance in the economic, environmental, and social arenas.

In theory, CSR policy functions as a built-in, self-regulating mechanism whereby business should monitor and ensure its support to law, ethical standards, and international norms. Thus, business should embrace responsibility for the impact of its activities on the environment, consumers, employees, communities, stockholders, and all other members of the public sphere. Also, CSR-focused businesses should proactively promote the public interest by encouraging community growth and development, and voluntarily eliminating practices that harm the public sphere, regardless of legality. Norman and MacDonald (2004) show how CSR deliberately attempts to include public interest into corporate decision-making and focuses on a triple bottom line: people, planet, and profit.

The practice of CSR is much debated and criticized. Not surprisingly, CSR has both fans and detractors. Proponents contend that a strong business case exists for CSR. They argue that corporations can benefit in multiple ways by operating with a perspective broader and longer than their own immediate, short-term profits. Critics maintain, however, that CSR distracts from the fundamental economic role of businesses. Others argue that CSR is nothing more than superficial window-dressing while still others contend that it is an attempt to pre-empt the role of governments as a supervisory body over powerful multinational corporations (Archel, Husillos, and Spence 2011; Harrison, Bosse, and Phillips 2010).

SOCIALLY RESPONSIBLE INVESTING

Socially responsible investing (SRI), also called ethical investing and green investing, is an investment that is considered socially responsible because of the nature of the business the company conducts. SRI uses environmental, social, and corporate governance (ESG) criteria to generate long-term, competitive financial returns and positive societal impact (SIF 2010). That is, investors limit their investment alternatives to securities of firms whose products or actions are considered socially acceptable (Bollen 2007). For example, socially responsible investors might avoid investment in companies that produce or sell addictive substances such as tobacco, liquor products, or gambling and might seek out companies engaged in environmental sustainability and alternative energy/clean technology efforts (Statman 2004). Unlike traditional investing that focuses only on financial returns, SRI combines both financial goals and social responsibility (Derwall, Koedijk, and Ter Horst 2011).

Socially conscious investing is growing into a widely-followed practice. For example, retail investors can make socially responsible investments in individual companies, follow SRI indexes, or through a socially conscious mutual fund or exchange-traded fund (ETF). Mutual funds and ETFs provide an added advantage in that investors can gain exposure to multiple companies across many sectors with a single investment. Yet some question whether investors sacrifice performance for the sake of ideology (Hong and Kacperczyk 2009). That is, just because an investment touts itself as socially responsible does not mean that it will provide investors with a good return.

PURPOSE OF THE BOOK

The purpose of this book is to provide a comprehensive view of the growing field of socially responsible finance and investing. It discusses the socially responsible foundations and their applications to finance as determined by the current state of this research. The book is written by noted scholars—both academics and practitioners—who provide a synthesis of what is known about each topic no matter whether the evidence is flattering or not. Of the books currently available in this area, many tend to focus on one narrow topic, such as how to measure socially responsible activities in a firm, and to be written from a proponent’s point of view. This is not the case with Socially Responsible Finance and Investing, which takes a wide-ranging view and offers multiple perspectives.

The socially responsible framework for viewing business activities is likely to increase in popularity. This movement is already becoming popular with the European business community and scholars there. The ideas are now gaining a foothold in the United States. With a focus on the recent financial collapse, other bailouts, and the environment, the U.S. interest in socially responsible finance is likely to continue increasing.

FEATURES OF THE BOOK

Socially Responsible Finance and Investing has several distinguishing features.

• Perhaps the book’s most distinctive feature is that it provides a comprehensive discussion of the theory, empirical work, and practice within the various topics covered in socially responsible finance and investing. The book not only attempts to blend the conceptual world of scholars with the pragmatic view of practitioners, but also to synthesize important and relevant research studies including recent developments. The book takes an objective view and avoids an advocacy position.
• The book contains contributions from numerous authors. The breadth of contributors assures a variety of perspectives and a rich interplay of ideas.
• This volume discusses the results of empirical studies that link theory and practice. The objective is to distill them to their essential content so that they are understandable to the reader.
• Each chapter contains discussion questions that help to reinforce key concepts. This feature should be especially important to faculty and students using the book in classes.

INTENDED AUDIENCE

This book should appeal not only to an academic audience—researchers, professors, and students—but also to industry professionals, lawmakers, and regulators. For example, both academics and practitioners who are interested in socially responsible finance should find this book to be useful given the scope of the work. It should also be appropriate as a stand-alone book for undergraduate or graduate-level business courses related to the topics contained in this book. Further, libraries should find this work to be a suitable reference book.

STRUCTURE OF THE BOOK

The remaining 23 chapters are organized into four sections. A brief synopsis of each chapter by section follows.

Section I. Foundations and Key Concepts

Chapters 2 through 6 provide the foundation for understanding socially responsible finance and investing. Chapter 2 offers an in-depth discussion of stakeholder analysis, while Chapter 3 examines how different business disciplines view CSR. Chapter 4 introduces the concept of business models and social entrepreneurship. Chapter 5 discusses the legal framework in which SRI operates. Chapter 6 concludes this section by examining various international and cultural views toward SRFI.

Chapter 2 Stakeholder Analysis (Lloyd S. Kurtz)

Social investors often incorporate elements of stakeholder theory into their work. Many believe that firms with good stakeholder relationships should be viewed as better managed and therefore likely to offer superior financial performance. Empirical research has strengthened the case for a correlation between good stakeholder management and superior firm-level financial outcomes. These findings strongly suggest that a stakeholder worldview has validity and that analyzing stakeholder relationships can aid in investment analysis. Although many theoretical approaches are available, a modified form of instrumental stakeholder theory seems to fit best with the needs of investors. In this framework, good management may be defined as the efficient allocation of resources to stakeholder management, such that a large surplus remains for owners and managers. Stakeholder analysis of this type aids in assessing management quality and clarifies the relationships among stakeholders, owners, and managers. The resulting insights are often relevant for the valuation of the firm. Stakeholder analysis therefore has the potential to improve fundamental analysis, and stakeholder relationships deserve the attention not just of social investors, but of managers and investors in general.

Chapter 3 Corporate Social Responsibility (Heather Elms and Michelle Westermann-Behaylo)

This chapter identifies varying approaches to CSR in the business ethics, finance, accounting, and marketing literatures. In particular, it identifies a series of current themes in the business ethics literature that are not yet reflected in the finance, accounting, and marketing literatures as evidenced by a review of the articles published in the high-quality journals of these functional disciplines. The analysis suggests that greater consideration of these themes by the functional literatures and greater appreciation of the focus of the functional literatures by the business ethics literature may lead to a better understanding of the CSR phenomenon.

Chapter 4 Business Models and Social Entrepreneurship (Michael A. Pirson)

The 2007–2009 financial crisis caused many to question the basic premises of the current business system and the financial services industry. Some suggest that corporations should aim to regain legitimacy by pursuing shared value rather than mere financial value. Managers may be able to look at the field of social entrepreneurship to learn how to create such shared value. This chapter presents the concept of social entrepreneurship and introduces two areas in which social entrepreneurs have created novel business models: microfinance and social impact investing. The lessons that can be learned for shared value creation are discussed for the financial industry as a whole and those interested in socially responsible finance. The chapter concludes by presenting several caveats.

Chapter 5 Fiduciary and Other Legal Duties (Benjamin J. Richardson)

In common law legal systems, such as in the United Kingdom and the United States, fiduciary duties ex...

Table of contents

• Cover
• Wiley Global Finance
• Series
• Title Page
• Copyright
• Acknowledgments
• Chapter 1: Socially Responsible Finance and Investing: An Overview
• Part I: Foundations and Key Concepts
• Part II: Finance and Society
• Part III: Corporate Engagement
• PART IV: Socially Responsible Investing
• Answers to Chapter Discussion Questions
• Index
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