Jane Nelson: Turning ethical values into business value
Business leaders in almost every industry sector and country face a complex and often contradictory set of stakeholder expectations.
They are under pressure to demonstrate outstanding performance, not just in terms of competitiveness and market growth, but also in their corporate governance and their corporate citizenship.
They are being called on to engage with activists as well as analysts, to be accountable for their non-financial as well as their financial performance, to manage social and environmental risks as well as market risks, and to cooperate as well as to compete – often with non-traditional partners focused on unfamiliar issues.
As a result, the concepts of corporate social responsibility and corporate citizenship are moving beyond the boundaries of legal compliance and philanthropy, to a more central and challenging position alongside issues of corporate purpose, governance, strategy, risk management and reputation.
This trend, which has been underway for a number of years, received added impetus during 2003 from a combination of new legal requirements, governance and ethical failures, and growing stakeholder activism. It has also been furthered by voluntary leadership on the part of some industries and business leaders, and the emergence of new accountability frameworks, market mechanisms and competitive pressures.
What role for institutional investors?
Institutional investors – beyond the active but small socially responsible investment (SRI) community – have rarely been seen as one of the drivers toward more responsible business practices.
If anything, the opposite has often been the case, both in reality and perception. The massive pressure on corporate executives during the past decade to make the numbers and to deliver on ever-rising short-term forecasts has been one of the drivers of recent corporate governance and ethical crises.
This short-term approach has also been a factor in major cost-cutting exercises, which have seen companies laying off employees, squeezing suppliers and dropping local community partners. In some cases, it has been accompanied by efforts to cut corners on social and environmental legislation and norms.
“Our investors don’t care” has become a common refrain – both from leading companies, which have been frustrated by a lack of investor support for their efforts to improve social and environmental performance, and from the laggards, who are happy to have a ready-made excuse for their lack of attention and vision in this area.
A survey of chief executives carried out in 2002 by the World Economic Forum’s Global Corporate Citizenship Initiative (GCCI) asked business leaders to identify the stakeholder groups that create the greatest pressures or incentives for their corporate citizenship activities. Investors were ranked only seventh – after employees, government bodies, customers, local communities, NGOs and boards of directors.
In a new survey to be launched at Davos this year, focused specifically on communicating corporate citizenship issues to investors, most CEOs, chief financial officers and investor relations officers commented on the low level of shareholder interest in this area.
Several claimed that investors had not asked them a single direct question relating to their social and environmental performance over the past few years. Probably not surprisingly, sell-side analysts were cited as being particularly disinterested.
To be fair, a lack of information flow on a company’s sustainability or social performance is a dual responsibility. Research by SAM Sustainable Asset Management covering over 1,300 major companies shows that only 26% of them provide comprehensive and regular coverage on their sustainability performance in their analyst presentations and investor websites and reports. However, the research showed that 23% provided none at all.
And corporate pension funds are no better than others when it comes to offering their beneficiaries sustainability or SRI options. SAM’s research indicates that some 70% of the major companies they surveyed do not offer such an option, 16% did and 13% didn’t know if they did or didn’t.
Signs of change in the financial sector
The picture is not entirely bleak for those who believe that the financial community has a vital role to play in helping to shift corporate behaviour toward more sustainable patterns of growth.
During 2003, some of the world’s major institutional investors started to flex their muscle on issues related not only to improved corporate governance and ethics, but also to broader issues of corporate responsibility.
Toward the end of 2003, for example, a group of US state and city treasurers, and trustees with fiduciary responsibility for some of America’s largest and most influential pension funds, made public calls for governance changes at the New York Stock Exchange.
They also joined environmental groups and more traditional SRI fund managers to call for greater investor focus on the risks and opportunities posed by climate change.
In February 2003, the Association of British Insurers (ABI), whose 400-plus members transact some 95% of the insurance business in the United Kingdom and account for over 20% of investments in the London Stock Exchange, issued up-dated disclosure guidelines on socially responsible investment.
In doing so, the ABI stated that “public interest in corporate social responsibility has grown to the point where it seems helpful for institutional shareholders to set out basic disclosure principles, which will guide them in seeking to engage with companies in which they invest”.
The Federation of Labor and Congress of Industrial Organizations (AFL-CIO) in the United States – which represents the interests of some 13 million working men and women with over $6 trillion invested in health, pension and savings funds – also intensified its Capital Stewardship campaign, aimed at using workers’ shareholder muscle to encourage more long-term, sustainable value creation.
Also in 2003, the research departments of major financial institutions such as Swiss Re, JP Morgan, Morgan Stanley, UBS Warburg and HSBC produced reports analyzing the material business risks and opportunities created by issues such as climate change, obesity, HIV/Aids and the Millennium Development Goals.
While such actions remain limited among major institutional investors and financial institutions – and some observers query the wisdom of pension funds and their trustees expanding the concept of fiduciary responsibility beyond the maximization of short-term results – these are developments worth watching.
The review of company law and the implementation of new disclosure requirements in countries such as the United Kingdom, United States, France, Sweden, Germany, Belgium and Australia, are likely to intensify the dual focus on corporate responsibility and corporate governance.
At the same time, the SRI movement, while still representing a tiny percentage of global funds under management, continues to grow in terms of size, sophistication, geographic scope and influence.
According to the Social Investment Forum, between 2001 and 2003, socially screened funds in the United States grew by about 6.5%, while the broader universe of professionally managed portfolios fell 4%. Shareholder advocacy increased by 15% over the same period and a wide array of SRI products are now available in more than 21 countries.
Although negative screening remains an option for many ethical investors, most SRI fund managers have moved beyond this limited approach. They also offer investment strategies such as positive screening, best-in-class stock selection and industries of the future, with a strong emphasis on both the financial and non-financial performance of companies.
The credible performance of many SRI funds and indices, such as the Dow Jones Sustainability Index and FTSE4Good, belies the old adage that this is an asset class purely for people with values, who don’t care too much about value.
Another trend in the financial sector has been the emergence of collective voluntary initiatives by major investors, insurance companies and banks – all aimed at improving performance on social and environmental issues.
One example is the Carbon Disclosure Project – a group of 89 institutional investors, with assets of US$9 trillion under management, who have contacted the chairmen of the FTSE500 companies requesting ‘investment-relevant information relating to greenhouse gas mitigation’.
During 2003, a number of SRI fund managers in the United Kingdom joined forces to call on pharmaceutical companies to improve their disclosure on access to medicines and on the extractive industry to become more transparent in reporting the revenues they pay to governments in developing countries.
The Financial Sector Initiative of the UN Environment Programme continued to attract the support of leading banks and insurance companies. And some of the world’s largest banks joined forces with the International Finance Corporation – the private sector arm of the World Bank – to launch the Equator Principles. These aim to integrate social and environmental risk management criteria into project finance.
Issues of strategic importance
Few, if any of these actions are being driven by altruism. The rationale is clear. In the past decade the rules of the game have started to change for business – driven by changing societal expectations and the impacts of globalization, technology and growing political openness.
Issues once confined to “the philanthropy department” – and some that were not even on the radar screen of most companies – are becoming material business risks and opportunities.
The following few brief examples serve to illustrate the strategic importance of these issues to particular industry sectors.
» First, access to essential medicines has become a strategic issue that goes to heart of the business model and intellectual property rights for many pharmaceutical companies – whether it is addressing medical benefits for the elderly and non-insured in OECD economies, or providing access to treatments against HIV/Aids, TB and malaria in developing economies. This calls not only for product donation programmes, but also new pricing models and new types of public-private partnership to improve healthcare delivery in the public sector.
» Managing social and environmental risks involving suppliers has also become a strategic issue for many companies – whether it is sustainable agriculture and fair trade in agribusiness companies, labour conditions in contractors’ factories in developing countries that produce apparel, footwear and other manufactured goods for western consumers, or access to HIV/Aids treatments for employees, sub-contractors and their families.
» Looking at the other end of the value chain – at product distribution and use – there are also new risks and opportunities to be assessed and managed. These include efforts in the auto, tourism, transport and logistics sectors to improve road safety and to cut carbon emissions. They include the growing awareness of the risks of obesity in the food and beverage sector and the business opportunities of offering more healthy lifestyle options, including efforts in the alcohol industry to promote responsible drinking.
» Tackling bribery and corruption, and increasing the transparency of revenue flows between governments and companies, have become issues for most industries – but most particularly the mining, energy, infrastructure and financial sectors. Linked to this has been growing awareness of the need to tackle human rights issues, especially in zones of conflict and in conditions characterised by weak or bad governance.
Failure to meet changing stakeholder expectations and to manage the risks in these and other areas of corporate responsibility can have a negative impact on a company’s reputation and brand equity, its ability to attract and retain the best employees, and even its legal and social licence to operate.
Alternatively, innovative and creative responses – or, even better, the ability to predict future social and environmental trends – can improve a company’s operational efficiency and cost structure, offer new business opportunities, create new markets and enhance competitiveness.
In almost every survey carried out looking into the business case for corporate responsibility, languishing near the bottom of most rankings is the ability to attract capital. Yet, if some of the developments outlined above become more mainstream trends, enhancing or protecting access to capital may also become a key driver for improving corporate social and environmental performance.
Looking forward
The majority of the CEOs, CFOs and investor relations officers (IROs) eyed for the World Economic Forum’s Values and Value report agreed that mainstream investor interest in corporate citizenship issues is likely to increase in the future.
In a 2003 European survey of almost 400 fund managers – carried out by Deloitte, Euronext and CSR Europe – 52% of the fund managers and analysts and 47% of IROs believed that social and environmental considerations will become a significant aspect of mainstream investment decisions over the next two years.
Furthermore, a 2003 international survey of some 400 institutional investors carried out by Russell Reynolds Associates found that the majority of respondents (59%) in the United States, the United Kingdom, France, Germany, Japan and China claimed that they would prefer companies they invest in to be ‘socially responsible’ rather than ‘solely returns-focused’.
The devil is, of course, in the details. Despite these trends and statistics, many in the investor community – pension fund trustees, fund managers, buy and sell-side analysts, researchers and financial consultants – appear to remain focused almost exclusively on short-term results and financial performance indicators.
They rightly argue that their ability to take social and environmental considerations into account is impeded by the lack of common and rigorous definitions on corporate citizenship, sustainability and corporate social responsibility, and the lack of quantifiable and comparable performance metrics.
These factors, combined with a mismatch in time horizons and lack of relevant skills and competencies in both the corporate and investment community, suggest that we are still a long way from seeing socially responsible investment practices move from niche product to mainstream investment strategy.
Yet, by starting the conversation and experimenting with new approaches, leaders in both the corporate and financial sectors can move the agenda forward. They can support initiatives such as the Global Reporting Initiative and UNEP’s Finance Initiative.
They can engage in joint efforts to develop key performance indicators and to improve the measurement of social and environmental impacts. And they can take a leadership role in communicating why good corporate citizenship matters, both to business and society.
The Values and Value report proposes the following ‘four golden rules for communicating the importance of corporate citizenship’ and provides examples of how leading CEOs and their companies are putting these into action. These are:
First, to ensure clarity of corporate purpose, principles and values. Even when speaking to investors, corporate citizenship needs to be about more than simply making a business case linked directly to bottom line benefits. It should also be a statement about what the company stands for even if this sometimes incurs costs or results in a lost business opportunity.
Second, companies need a credible business case and sustainability metrics. Each board of directors and each executive team needs to be able to define, explain and ultimately measure the ethical, social and environmental risks and opportunities faced by its company.
Third, there must be confidence in the social contribution of business. Business leaders need to be less defensive about their core role in society. They need to be able to demonstrate the contribution made by their economic multipliers such as employment and income generation, technology transfer, training, supply chain development, innovation and wealth creation.
Finally, companies need a consistent and coherent message. One great cause of distrust, among investors and other stakeholders, is inconsistent messages and policies from business. Corporate leaders need to say the same things in their annual reports as they do in their community reports. They must ensure that their social and environmental commitments extend to all aspects of the company – from public policy positions to pension fund options, and from head-office functions to far-flung operations.
A great fallacy about corporate citizenship is that it is easy – a philanthropic cheque written here and a compliance box ticked there. Nothing could be further from the truth.
Balancing long-term goals with short-term imperatives, and managing and accounting for a plethora of non-traditional risks and opportunities, calls for new leadership skills and new approaches to communication. It also calls for new types of cooperation.
Investors and corporations can do much to work together in a manner that makes sound business sense, while also increasing our common ability to manage risk and promote prosperity.
Jane Nelson
Jane Nelson is director of business leadership and strategy at The International Business Leaders Forum and a senior fellow at Harvard’s Kennedy School of Government.
Information on WEF’s Global Corporate Citizenship Initiative and the Values and Value report can be obtained from the GCCI project manager Caroline Bergrem at [email protected]
