Monday, May 19, 2008

Risk and reward, part II

Above is an amusing short clip of a group singing about economist Milton Friedman's views on corporate responsibility. I couldn't resist including it as part of a discussion on risk and SRI.

In my last post, I spoke about direct investor risk. As I mentioned, though, there are other risks to consider that may nonetheless impact investors. Wall Street Journal columnist Carolyn Cui wrote about this recently in her article "For Money Managers, A Smarter Approach To Social Responsibility":

"Oil giants, power plants, mining companies and steelmakers get blamed for contributing to global warming. The business risk is that they will face taxes or penalties as legislators around the world increase their efforts to reduce pollution. For instance, as of January 2009, New York and nine other Northeastern states will start a program to cap and trade carbon-dioxide emissions. Last year, California passed an act aiming to reduce the state's greenhouse-gas emissions. And earlier this year, the U.S. Supreme Court ruled that the Environmental Protection Agency has the authority to regulate greenhouse-gas emissions as pollutants.

"Investment funds holding stocks of electric utilities, coal producers, oil companies and other carbon-intensive sectors are starting to measure their exposure to risks like these, partly under pressure from investors. In September, the Carbon Disclosure Project, a nonprofit coalition of institutional investors with $41 trillion of assets under management, released its annual report based on a survey of more than 2,000 companies around the world.

"Soon, U.S. mutual funds themselves will get measured based on their carbon 'footprints,' or the collective carbon emissions of the companies they invest in, by Trucost PLC, a London research company that focuses on the environmental impact of business activities. The firm released a report in July 2007 that surveyed 185 U.K. investment funds and found 37% of the funds were exposed to greater potential carbon liabilities than the U.K.'s broad stock-market index."

Amy Domini, of Domini Social Investments fame, makes a similar case in her book Socially Responsible Investing: Making a Difference and Making Money: "The real financial benefit of shareholder dialogue lies in the fact that it accomplishes several things simultaneously. Companies are made aware of potential liabilities before they grow larger, and investment managers have access to more information about the company they are considering investing in. Most shareholder-sponsored resolutions simply ask for reports about progress in addressing certain problematic issues. Any fiduciary would ask for the same, once made aware of the issue. It is, after all, only prudent to want management to report on progress toward removing risks. It is hard to argue that shareholder responsibility through filing and/or voting costs anything to investors and easy to see that it acts to reduce risks.

As Cui points out, though, skeptics of SRI risk assessment certainly remain. "Critics...cite a scarcity of corporate information on nonfinancial issues such as human rights, and a lack of methods for quantifying such matters. Skeptics think some such indicators are too subject to personal choices." In addition, there is the general question of who is best positioned to assess risk - corporate management or advocacy groups - and the question raised by Friedman of whether it is ethical for corporations to act on some vague conception of "conscience" when they have a duty to shareholders. That latter question, at least, shifts when it it is shareholders who are seeking change in corporate practices and governance.

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