The Backlash of Social Investing

October 14, 2002

By Jon Entine

This should be the best of times for advocates of corporate social responsibility. For years its acolytes have inveighed against the evils of corporate excess, waiting for a backlash that would open the floodgates into social investing. Then the perfect storm hits. With clamoring for accountability, where better to turn than to those who monitor companies and claim they can "make money and do good." What could be more socially responsible than bringing corporate desperados to heel?

If only it were so. Social investing, which has never focused on governance or transparency--issues now resonating across America--has been almost invisible as the process for reform has unfolded. As a consequence the public, which could benefit from an independent corporate ethics monitoring service, is losing out.

The missed opportunity can be traced to the anti-business history of the movement.

It originated with pacifist Quakers and was later adopted by liberal church groups to rail against corporate villainy. Serious money began moving into social funds in the 1980s during the boycott of South Africa. They became a favorite of suburban Baby Boomers, then trading up from Beetles to BMWs. Social investing embraced a bouillabaisse of trendy causes: targeting "sin" tobacco, alcohol and military manufacturers and "polluters" like energy and industrial firms wages, while promoting animal and feminist rights. Even today, protecting the monarch butterfly from the evils of genetic engineering takes precedence over traditional stakeholder measures of corporate responsibility such as product quality, consumer satisfaction, the local environmental impact of a company, employee security, vendor relations and shareholder return.

This problematic legacy was underscored recently when Julie Gorte of Calvert Group, which oversees the largest stable of social funds, was asked why Calvert has never screened for accounting or governance issues. "This is a meteor," she said, clearly bewildered by the scandals' impact. "We're still measuring the depth of the crater." Calvert apparently never noticed the savings-and-loan debacle, the controversy over offshore tax havens, or dozens of other corporate scandals that have graced front page in past years.

Social investing's historical blend of social propriety with reflexively anti-business views has led to bizarre contradictions. Merely hypocritically, anti-alcohol screens ban liberal oenophiles from investing in California wineries. More troubling, defense firms--those developing missiles to protect Tel Aviv and San Francisco from Scud missile attacks--are rejected as warmongers. And while some funds screened out Enron Corp. on the principle that all energy firms are "bad," its limp commitment to renewable energy and its now infamous ethical-sounding Code of Conduct made it a favorite among the largest firms like Domini Social Investments.

This ideological mishmash delivered the spectacle of cases like Levi Strauss & Co., a favorite in the 1980s because of its social policies, such as its pledge to manufacture in the U.S. and subsidize limited day-care. Yet it made increasingly shoddy products, treated piece workers poorly and eventually saw its CEO mismanage the company into the ground. It was ultimately forced to shutter its American facilities, leaving thousands of employees in the lurch. In essence, Levi Strauss' ethical stands proved worthless in real terms.

The scandals are exposing the contradictions of social investing. First, there is no evidence that companies that meet liberal standards of propriety are more ethical. Enron, WorldCom, Quest, Adelphia, and Citibank all passed social screens with flying colors. The most widely held socially screened stock is none other than the company convicted of the most egregious anti-consumer violations in the history of antitrust law, Microsoft.

Second, screened companies do not outperform the market. Because it invested in superficially ethical telecom and financial stocks, which have been hit the hardest, broadly screened social funds managed by Dreyfus, Citizens, Calvert, Parnassus and Domini are getting slammed more than most.

It's fair to ask whether there is much worth salvaging here. In fact, social investing retains the potential to benefit investors and evolve into an important reform tool. After all, it has proved a durable brand-marketing concept, garnering extraordinary, often uncritical media attention despite its tiny financial footprint. Relentless carnival barking aside, only two social funds have close to a billion dollars in assets and most hold under $100 million, tadpoles in the $3 trillion mutual fund ocean.

Corporate social responsibility advocates must break with their obsession with pop issues to focus on corporate ethics: the real impact of corporations on the lives of their stakeholders, with transparency and governance as the centerpiece. The social funds must erase the perception that they pander to clients who think that emulating Neville Chamberlain or eating rainforest nut ice cream is a mark of corporate social responsibility.

In other words, like the aging Boomers it caters to, socially responsible investing has to grow up.

Its leaders might do well to ponder the wisdom of economist Milton Friedman, whose views on corporate responsibility are often unfairly caricatured. He expected responsible corporations to engage in "free competition, without deception or fraud." But he also recognized a fundamental responsibility that the best and most responsible companies take care of business, for so many stakeholders, from shareholders to employees, depend on them. Failing companies don't have the luxury to "do good" or even guarantee their employees' pensions. With more refined screening criteria built around corporate transparency and accountability, social investing could become a player in the process--and fulfill its promise to encourage more socially and environmentally responsive corporate behavior.

Jon Entine is an adjunct fellow at the American Enterprise Institute, scholar-in-residence at Miami University, and contributing author to "Case Histories in Business Ethics."