CSR as Standards and Reporting

Logo of Global Reporting Initiative

Last week I had a short blog about stakeholder engagement and some of the events leading up to the tendency for businesses and organizations to look beyond clients and suppliers. But in order to be effective a systematic approach is needed that will enable organizations to categorize and absorb the knowledge gained from a more outgoing approach.

Other forms of stakeholder engagement can come through compliance and reporting on the corporations’ ability to conform to certain standards. There are many good reasons why corporations engage on compliance strategies. The main arguments are:

  1. Stamp of approval through accreditation
  2. Attractiveness to social responsible investors, and
  3. Branding the company as a social responsible member of the community (Locke et al, 2006:1f).

Initiatives such as Global Compact (GC), Global Reporting Initiative (GRI) or the supplementary Principles for Responsible Investments (PRI), enables companies to increase their transparency level (United Nations Global Compact, 2008, UNEP Finance Initiatives, 2005, Global Reporting Initiative, 2006). Some of these initiatives are sponsored by the United Nations (UN) and thereby giving companies that abide to the standards, a stamp of approval from a world recognised institution. Other standards organisations are private or semi-governmental institutions that have created systems for governing sustainable behaviour as for example systems issued by the International Organisation for Standardization[1].

Systems can also be grouped by industry or be customized to the individual company where they are called Code of Conduct or similar systems. Common for Codes of Conduct are that they in some form are linked to universal agreed treaties such as the human rights, labour standards or environmental agreements. There are, however, some drawbacks in relying too heavily on these systems. A company like e.g. Nike has adopted a comprehensive Code of Conduct system of standards and control which both rely on internal and external auditing, but has found that this does not safeguard the company from criticism on labour standards in its supply chain (Locke et al, 2006). The lessons learned from Nike is that standards and systems should not stand alone but should be complimented by other forms of stakeholder engagement such as joint training with suppliers and frequent meeting activities both formal and socially to increase cultural exchange between the parties (Locke & Romis, 2006).

The second driver for stakeholder engagement can be the access to social responsible investors. While only a few years ago the Social Responsible Investments (SRI) constituted a fraction of the total investment portfolio it was in 2008 representing investments of over 18 trillion USD (UNEP Finance Initiatives, 2005). For many companies it can be a benefit to be part of a SRI portfolio as it gives access to funds that other companies might not have access to. In addition, the system of control and auditing can enable the company to streamline its processes and get rid of organisational risk that might affect long-term profitability. Investigations into the link between profitability and CSR shows that companies that rate their CSR effort positively also have a significant better financial performance than companies that does not (Economist, 2008:6).

The third reason for adopting a compliance strategy is the potential for positive branding. The GC is now consisting of approximately 5000 companies (United Nations Global Compact, 2008) from around the world. Grouping with other well-branded businesses who subscribe to the GC standard can boost their corporate brand and increase the collective brand value of all. Other companies use CSR actively to differentiate themselves in an otherwise competitive market.

Pros and cons for third-party evaluation of SRI investments

How much should you trust third party evaluation of your SRI portfolio companies? As a SRI interested investor or researcher you might want to have some their party have a look at the companies that you are investigating but how much can you really trust their evaluations? This question comes up more and more frequently as third part evaluations become much more freely available.

I have compiled a short list of issues that you might want to take a look at when evaluating if the intelligence can be used in your investigation of companies.

  1. Transparency is of cause a major concern and just because a report or paper is made from somebody outside the company it does not necessary make it more useful. It is not that third-party investigations are necessary biased but you need approach their reporting in much the same way you would corporate self-evaluation and reporting, with a fair amount of scepticism. Take a look at how they present their data and look for their source of information is if the raw material is available for your own analysis it is the best if they only present the conclusions then take it with a grain of salt.
  2. To what extend does the analysis base its conclusions on Corporate data? A lot of analysis only have corporate self-reporting as it source but might come up with very different conclusions that internal analysis came up with. What you need to do is look for triangulation of data sources. Were interviews or questioners conducted during the process, were experts included and what was their background (if it is just people from the analyst own group they might not be as reliable as other experts might be) or were data verified by other means. I recommend that you at least look for one other source of aw data other than corporate information. This will show you that some efforts were put into doing the report and some level of forensics were conducted.
  3. The analyst themselves can have a big impact on how reliable the data is. Some analysis are doing the analysis on a part time basis while others does it for a living. This does not mean that the work of the amateur cant be very valid it just means that when you evaluate technical data you might place more reliance on what the professional have to say. The person who sits with data on finances, CO2-emissions, supply and value chain data have a great deal of routine in looking at these numbers and have a good idea when they are off the mark so to speak.
  4. Standards are a big issue within CSR not just because they are evaluated against but also because they are seen as normative truths. We all know standards like the Global Compact (GC) and reporting according to Global Reporting Index (GRI) or the new ISO 26000 but just because standards are used they o not constitutes the truth. Look at them as a way to present data not as a factor for goodness. A A+ rating just not represent a higher degree of goodness than a C rating in GRI it just shows you what corporate data should be available to you for analysis.
  5. The Scope of data within CSR is constantly being debated. Some would include everything others limit their scope to just include the 10 principles in the GC. When you do your analysis you should scope what you perceive as valid data and collect sources of material that fits this scope. If you find evidence that is outside the scope but have a impact on your analysis you should put it aside for further analysis later one when the rest of your investigations have been included. This exercise will help you not only evaluate your ability to create a correct scope but also understand the complexity of your target company.
  6. Academics or not just academics. I would whish that academics could be seen as beacons of truth but the fact is that many have to make a living too and some do this by making reports for different institutions. This does not mean that it is not quality work that is being produced it just means that you can look at the reporting as you would a academic paper which have been evaluated by peers. Do not judge a report by the name on the cover.

Spread your investment risk using multiple ethical screens

One of the things that made me curious when I was doing the investigation into the Norwegian Government Pension Fund investment strategy was the use of multiple screens for ethical investments. The fund did have a bit of a problem with its investments in Burma it did present new ways of screening, while at the same time keeping a sound and diversified portfolio.

The screens that they use are:

  • International Collaboration and contribution to the development of best practice (Best in class strategy)
  • Targeted Investment programs (Positive screening)
  • Research and Investigation (Integrated analysis)
  • Active ownership (Shareholder activism)
  • Exclusion of Companies (Negative screening)

This thinking is not totally new as the Danish pension fund ATP used a similar screening system. While it is not as elaborate as the Norwegian one it shows that multiple screenings can reduce the risks that you are facing and still insure a stable high return. ATP is one of the most successful pension funds in Denmark and a market leader into ethical investments. It is not the considered a big fund in international terms but in Denmark it is one of the biggest funds around. The screenings that ATP uses are:

  • Active ownership (Shareholder activism)
  • Research and Investigation (Integrated analysis)
  • Negative screening against ATP own ethical guidelines (Negative screening)

The interesting thing is that more and more pension funds are fining out that this approach is making sense and can be managed effectively. Funds like APG in the Netherlands and others across Europe are finding out that adopting similar models can reduce risk and at the same time keep the investment returns at market level and in some case above what the market normally delivers.

So why is this? Conventional wisdom would dictate that the more screen one uses the smaller the pick of companies one can choose from increasing the risk of making lower returns. While screening might help in the way that it reduces social risk it will present a challenge in the area of fund diversification. The more screens you have the less will you be able diversify and thereby exposing one self to increased financial risks, or at least that is the theory.

So why are things not as they seem? At appears that these funds see the need for integrating social responsible investment and risk policies to become more financial and ethical robust but at the same time more agile. It would look like that they through their improved business intelligence abilities are able to react more quickly to changing market conditions. That they have been able to take advantage of new opportunities within a framework in which they have the knowledge and resources to measure, understand and manage risk exposures.

For most large funds that have the resources available to them to do multiple screenings it will within their ability to do such screenings. However, for smaller or medium size companies it might be an issue as the complexity of the portfolio management increases. The result will be that the smaller funds will have less screening criteria than large ones resulting in that they will be exposed to more social risk while unable to package their portfolio as good as the major large funds.

I think that the prospects of multiple screenings are promising and the benefits to both institutional investors and other investors interested in SRI are clearly there. Both ATP and the Norwegian pension fund are doing really good with their strategy and it is catching on with other actors in the market. There is no real research into the field of a multiple screening system as “common sense” has dictated that it is not a good investment strategy, however, it is clear that there is evidence to the contrary. If you know of anybody looking into the subject please let me know.

Portfolio management

SRI strategies entails that you create a portfolio made up of assets which in some way have been screened for the ethical behavior. I have been researching different alternatives in order to “spice” up my own ideas for screening and this is the list I came up with.

  1. Ethical Negative Screening: Avoiding Companies based on ethics, moral or religious grounds
  2. Environmental/social negative screening: Avoiding companies based on their damage to the environment or due to social issues. 
  3. Positive Screening: The active inclusion of companies based on their environmental or social benefit.
  4. Community and social investing: Allocation to capital to companies whos mission is to produce social returns.
  5. Best in class: Invest in companies that show bet is class capabilities in their industry in relation to environmental and social issues.
  6. Financial weighted best in class: Actively inclusion of companies who outperform their peers on financially material environmental and social criteria.
  7. Sustainability themes: Investing in companies who have a “green” product.
  8. Constructive engagement: Invest and encurage dialouge with companies to include more ESG issues.
  9. Shareholder activism: Use shareholder rights to pressure companies to change environmental, social and governance issues.
  10. Intergrated analysis: Actively include ESG criteria within conventional fund management.
  11. Norms-based Screening: Avidong companies who do not subscribe to international standards and norms such as Global compact and OECD guidelines for governance etc.