Socially responsible investment and pro-social change.

Author:Starr, Martha A.

Beginning with 1980s activism intended to stop foreign investment in South Africa, there has been a rise in "socially responsible investment" (SRI) in the United States and Europe. While definitions vary somewhat, SRI generally refers to the selection of investments based both on traditional financial criteria and on key dimensions of firms' social performance. Commonly identified aspects of social performance include: producing safe and useful products; minimizing adverse environmental impacts; implementing workplace practices that favor workers' well-being; adopting labor standards for overseas operations; and contributing positively to surrounding communities. SRI may also involve engaging in dialogue with companies about ways to improve their social performance through shareholder advocacy and resolutions.

While there has been a considerable amount of financial and business research on socially responsible investment and the related phenomenon of corporate social responsibility (CSR), (1) social responsibility has attracted much less attention in economic research. This is unfortunate both because the idea of social responsibility poses a number of problems for core economic ideas, and because it is a phenomenon of sufficient empirical importance as to have some potential to re-shape patterns of production and consumption in the global economy. The basic mechanism via which businesses are induced to show greater concern with social dimensions of performance is activism by socially-concerned groups, including religious organizations, interest groups oriented to specific issues (environment, labor, human rights, animal welfare, etc.), consumer activists, and institutional investors and mutual funds that practice SRI. Upon expression of concern about a business's practices, many businesses voluntarily take actions to address identified problems, not out of social concern per se but rather to minimize adverse publicity, stem loss of sales, and/ or mitigate adverse effects on the stock price. The change in the business context then, wherein businesses can anticipate having problematic aspects of their social performance come under scrutiny, creates incentives for them to address problems preemptively, at least when the expected benefits are sufficiently high to offset the costs. It is conceivable at least, that if the pressure exerted by newly evolving norms of social responsibility are sufficiently strong, they could produce a "race-to-the-top" wherein companies compete along social and financial dimensions, in contrast to the "race-to-the-bottom," wherein profits are exclusively prioritized, that has been of much concern in recent years.

The phenomenon of SRI poses a number of interesting problems for core economic ideas. For one, as much as the idea of "moral sentiments" has been a part of economic thinking since Adam Smith, there has been little rigorous work until recently on the nature and composition of social preferences--that is, preferences toward ways in which social and economic life are patterned. (2) It is increasingly recognized that contrary to predictions of standard economic theory, people often behave in "other-regarding ways," that is, as though they are concerned about the implications of their actions for the well-being of others. Thus, for example, much recent research finds that in experimental situations, people often interact according to norms of fairness, rather than pursuit of individual gain. (3) Other work claims to identify basic social preferences common among people, such as "inequity aversion," wherein people seek to reduce inequalities within a group, even at a cost to themselves. Certainly such "social preferences"--as institutional and social economists have long argued--should be seen not as hardwired into human cognition, but rather as reflecting complex combinations of psychological predispositions and institutional and cultural processes, where both are evolutionarily shaped. (4) Yet at a conceptual level it remains poorly understood how social preferences arise and what sustains them; and at an empirical level, apart from the limited senses in which they are investigated in the lab, it is poorly understood what common patterns of social preferences are or how they could be identified in a given context. The case of socially responsible investment is interesting in this regard: because SRI is motivated by the desire to reduce the distance between social life as it is and social life as it should be, it yields interesting insights into what one group of people--admittedly of a socially concerned bent--thinks about the latter.

Another core economic idea for which SRI poses a challenge concerns the issue of social welfare maximization in an economic system dominated by private, profit-seeking businesses. Traditional economic theory holds that social welfare will be greatest when businesses are allowed to operate relatively freely, save for the occasional intervention to correct problems of externalities, public goods, and other market failures. But it is the government that is expected to address these occasional deviations between private and social optima, in part on the grounds that collective action can be enormously hard to initiate and sustain in "large n" social problems. In socially responsible investment, however, as in the social-responsibility movement in general, small numbers of people seem to be able to induce notable changes in corporate behavior, even in situations where the government seems unable to concretely address problems of broad-based public concern (e.g. sweatshops). This by itself presents a puzzle in terms of the standard economic view of government's role in market economies. It also raises the question as to whether responsibility-oriented actions have sufficiently strong effects on corporate behavior as to be able to close gaps between private and social optima, rather than just narrowing them: because it is up to corporations to decide what dimensions of social responsibility to address and how much action to take, there is no guarantee that their voluntary social improvements will be welfare-maximizing.

The purpose of this paper is to examine the phenomenon of socially responsible investment, with a view toward evaluating whether it has potential for promoting pro-social change. The next section discusses conceptual aspects of the idea of "social preferences" and the role they may play in SRI, drawing ideas from recent research on fairness-related behavior in games. It is shown that the principle of "reciprocal fairness"--wherein people treat kindly those people who have treated them well, but treat negatively those who have treated them poorly--is quite important in SRI. Specifically, decisions about what stocks to include in an SRI portfolio are largely a matter of oblique reciprocal fairness, wherein companies are selected into or out of the portfolio based on how they treat their various "stakeholders," including customers, workers, surrounding communities, all those affected by the company's ecological footprint, as well as shareholders. The third section examines the specific criteria used to select stocks for SRI portfolios, using them to derive insights into the "revealed preferences" of SRI investors. Their preferences suggest strong aversions to certain business practices, including: cultivating and profiting from harmful dependencies rooted in addiction; profiting from and facilitating the use of deadly force; and callously profiting from the desperation of the poor and the helplessness of animals. The fourth section argues that SRI should be understood as part of a broader effort to shift social norms governing businesses and their relationships to society. It is argued that part of why social-responsibility actions have potential to succeed where government efforts may be less effective is that they work from within the dominant business logic: because they affect businesses' profits, such actions, in combination with forces of competition, can impel businesses to "care" about social performance, creating some scope for pro-social change.

Social Preferences and their Relation to SRI

The role of social preferences in investment behavior has not been much explored. The standard paradigm for understanding stockholders' behavior frames them as caring only about pecuniary risks and returns. (5) However, given that material gains and losses are not the only things about which people care, there is no a priori reason to assume that their decisions about selecting and managing financial assets are not influenced by other factors. Of course, in the mainstream of the investment world, social and moral values above and beyond those spelled out in laws or financial regulations would seem to play an ignorable role in the everyday financial conduct of investment professionals and individual investors. (6) Still, as Milton Friedman himself pointed out, this does not mean that typical shareholders are devoid of interest in how the companies in which they hold stock perform socially:

In a free enterprise, private property system, a corporate executive ... has direct responsibility to [the owners of the business]. That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom (1970, 17, italics added). That is, they may not care much about social performance as long is it remains pretty much in line with prevailing social norms--although Friedman does not elaborate. (7)

In contrast, social considerations are treated as a central aspect of investment decisions in the SRI sub-sector. Yet what exactly these considerations are and how they should be conceptualized are not clear. A standard paradigm for thinking about the role of "social...

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