Real ESG

If you care about corporate social impact, start measuring consumer surplus. 

From the NBER:

An Economic View of Corporate Social Impact

Hunt Allcott, Giovanni Montanari, Bora Ozaltun & Brandon Tan

WORKING PAPER 31803

ISSUE DATE October 2023

The growing discussions of impact investing and stakeholder capitalism have increased interest in measuring companies' social impact. We conceptualize corporate social impact as the welfare loss that would be caused by a firm's exit. To illustrate, we quantify the social impacts of 74 firms in 12 industries using a new survey measuring consumer and worker substitution patterns combined with models of product and labor markets. We find that consumer surplus is the primary component of social impact (dwarfing profits, worker surplus, and externalities), suggesting that consumer impacts deserve more attention from impact investors. Existing ESG and social impact ratings are essentially unrelated to our economically grounded measures.

Meanwhile, the Financial Times provides an excellent synopsis of the other version of corporate ESG.

Born in sanctimony, nurtured with hypocrisy and sold with sophistry, ESG grew unchallenged for a decade, but it is now facing a mountain of troubles, almost all of them of its own making.

The problems of investing with an environmental, social and governance framework start with assessing what it measures, which has changed over time and reflects its revisionist history.

ESG started as a measure of goodness, built around a UN document enunciating the principles for responsible investing, with significant establishment buy-in. As the selling of ESG to investors ramped up, its salespeople recognised that goodness had limited selling power. So they switched gears, arguing that ESG was an instrument for delivering higher returns without concurrent risk.

That case worked well through much of the last decade, mostly because of ESG investors’ abhorrence of fossil fuels and embrace of technology firms, but the Russian invasion of Ukraine changed the calculus. As sector funds underperformed, advocates moved on to claim that higher ESG scores lead to less risk and lower costs of capital. Perhaps because both risk claims are questionable, they now contend that ESG’s primary purpose is disclosure about material issues.

It serves ESG advocates to keep the definition amorphous, since, like the socialists of the 20th century whose response to every socialist failure was that their ideas had never been properly implemented, the defence against every ESG critique is that it is incorrectly defined or implemented. The truth is that ESG scores today measure everything — consequently, they measure nothing.

Consumer surplus is more reliable. 

Afternoon roundup

The afternoon's closing of the browser tabs:

• Tons of port workers have been avoiding getting vaccinated. In principle this should have been simple: have public health nurses drive out to the sites and administer it. But it's not been compulsory, antivax stuff has been influential among those workers, and they're probably (and rightly) pissed off with the regular nasal swab test requirements that could have been replaced by saliva testing over seven months ago - which would feed into a strong 'not gonna do whatcha told me' attitude. More results are out on the effectiveness of the Illinois protocol saliva tests - the one that the government doesn't want to use. And, just for fun, a plague ship berthed at Taranaki, where port worker vaccination rates are low. Let's hope we keep getting lucky, despite tapdancing on landmines. Looks now like only 11 of 98 border workers involved in this one had any vaccine. 


• Bernard Hickey has a chat with me and Oliver about Oliver's column last week. The prior link is to his column; the podcast is here. Our Insights newsletter column, reprinted in the Stuff papers, called on the government to extend residence to everyone who has been here with us since last year's March/April lockdowns - as a way of rectifying some of the harm that our immigration system has imposed since then. Oliver, Matt and I chatted about it here as well. 


• We'll be getting proof-of-vaccination that can work as a vaccine passport, but so far only intended for use in international travel. If Covid is ever here circulating, I will be happy to pay a premium to exclusively attend establishments requiring proof-of-vaccination for entry. 


• Damian Grant has a superb column on corporate social responsibility. 


• Union leader Matt McCarten on the merits of not banning speech. I agree with him. 


• The Taxpayers Union points to some odd-looking public health grants. This stuff wouldn't bug me so much if they were also putting appropriate funding into classical public health - contagious disease, vaccination promotion, the usual kinds of stuff that you might expect in the context of a global pandemic. But I could only see two grants in the whole set that seemed to have anything to do with the pandemic, and a third on measles. Just under $900k to try to get an assessment tool gauging barriers to vaccination and $1.2m looking at mucosal delivery for vaccines (not specifically to Covid, but in general). Both of those seem like really good ideas. They're also putting $1.16m toward waning measles immunity - good! But they're also putting $1.2m toward research on alcohol warning labels. It feels like infectious disease is still the poor cousin of whatever public health has more recently turned into. 


• Donal summarizes the Competition conference that was on in Wellington this past weekend. I missed it; these things usually cost an arm-and-a-leg, presumably due to cartel activity by conference organisers in preventing other conferences from emerging. Plus, I was in Christchurch Friday and Saturday teaching Canterbury's MBA students about the Emissions Trading Scheme. The session on three waters regulation would have been excellent.

Diversity in the Boardroom

I just loved Isabelle Solal and Kaisa Snellman's piece over in Organisation Science. 

They look at the effect of the gender of a company board appointment on subsequent sharemarket performance (Tobin's q). They summarise the existing literature, concluding (in line with the rest of the academic literature) that there is no particular effect of boardroom gender on company performance.

But then they do something rather neat. They look at how things vary based on company rankings on the KLD corporate social performance index. That index ranks companies by their commitment to corporate social responsibility objectives, and includes an index ranking a company's commitment to gender diversity.

They find that the gender of a board appointee has no effect on sharemarket performance, among firms with a low ranking on the KLD index. But firms with a high ranking on the KLD index, the appointment of an additional female director reduces Tobin's q. They reason that investors infer different things in the two cases:

We examine investor responses to board diversity and highlight a previously unexplored mechanism to explain negative market reactions to senior female appointments. Drawing on signaling theory, we propose that an increase in board diversity leads investors to update their beliefs about firm preferences. Specifically, we argue that a gender-diverse board is interpreted as revealing a preference for diversity and a weaker commitment to shareholder value. Consequently, firms with more female directors will be penalized. We test our argument using 14 years of panel data on U.S. public firms. We find that firms that increase board diversity suffer a decrease in market value and that this effect is amplified for firms that have received higher ratings for their diversity practices across the organization. These results suggest that observers respond to the presence of female leaders not simply on their own merit but as broader cues of firm preferences and that firms may counteract any potential signaling effect through careful framing.

I liked the piece enough that I made it my column over in the Fairfax papers today.

It is too easy to convince ourselves of things that are not true.

We all do it and it is hard to avoid. Some beliefs, from religion to sport, are just comforting. And when some comforting beliefs are very popular, being the one to say otherwise can be a bit risky.

But, at least in business, believing things that are not so can eventually get you into trouble. Businesses face the market test. And, for publicly listed companies, share prices can provide a quick signal that you may have made a bad decision.


The latest issue of Organisation Science, a top academic management journal, provides a wonderful case study.

...

And that helps us to understand why investors might respond in the way that Solal and Snellman discovered.

It may now be a bit passé to say it but improving shareholder value is a company's ultimate responsibility. There are plenty of wonderful things that companies do to help the communities they serve, but shareholder value is a hard bottom line. It is part of the market test.

Companies that keep that sharp focus on the bottom-line will make board appointments that they think will do the most to improve the company's performance.

When investors have little worry that the latest board appointment was made for any reason other than improving the company's performance, the gender of the latest board appointment has no effect on share prices. Investors simply expect that the best candidate was chosen.

But among firms highly rated for their commitment to gender diversity, an additional female appointment to the board reduced the firm's market value relative to the value of the company's physical assets (Tobin's q) by almost 6 per cent.

Solal and Snellman suggest that investors infer, in those cases, that the company is less worried about shareholder value than about other objectives. And that can be a worry if you care about your portfolio's returns.

While the literature showing no particular effect of boardroom gender on corporate performance is rather substantial, Solal and Snellman's results are still just one study. Others could yet overturn it.

But it does provide a bit of a warning for companies that put substantial effort into advertising their corporate social responsibility credentials.

If Solal and Snellman are right, then investors can be quick to infer that companies demonstrating their commitment to popular but mistaken beliefs have taken their eye off the ball.

The market test matters. And mistaken beliefs can be costly. 

The piece has not met with universal acclaim.

Over at LinkedIn, Sky director Rob Campbell writes:

I’m not sure whether Dr Crampton has ever worked in a listed company or been a director of one. As an academic he would not get much traction by grabbing one study in a quite active literature, even one based on meta analysis, and building an argument on it. The academic world has its own rigour.

But back in the listed corporate world the thinking runs a good deal deeper than “let’s appoint a woman or two and see if it lifts the share price”. We are all looking to improve the performance levels of our boards and management and it would be foolhardy to ignore the negative impacts of mono gender, mono ethnicity, mono experience on that. Not least because our shareholders (rightly) demand that we make the shift. So sell your shares in any business I’m involved with Dr Crampton, we will keep searching for better solutions.

It's a bit funny really. I note how desperately people want to believe something to be true that isn't true, and pointed to the metastudies of dozens of prior studies that show that there is no effect of boardroom gender on company performance, and that's the reply.

I hadn't known about the KLD index before. Someone's likely already done this study, but if it hasn't been done, it would be a lot of fun.

I'd be keen to know whether firms subject to greater regulatory risk show up differently in the KLD index. Maximising shareholder value, for some firms, also involves making sure that the regulators have warm feelings towards a firm because the regulatory risk is substantial. Anticipating the social preferences of those regulators and working to demonstrate shared values could be a way of buying friendlier relationships with the regulators.

Different firms and industries will face different regulatory risks from different administrations. There'd then be potential for identifying effects by looking at the composition of congressional oversight boards, or changes in the Presidency as the regulatory agencies will be affected by the tone set in the Executive, or firms that face regulatory risks in different states as well as federally.

You might think that, in general, firms that depend more on friendly relations with regulators will invest more in CSR efforts where doing so buys friendlier relations. It would be neat to see whether that's the case. One does hear incredibly interesting anecdotes consistent with that kind of story, but does it show up in the data?

Morning Roundup

The closing of a big set of browser tabs brings a few gems.

• Rohan Pearce at Computerworld notes a warning from the Law Council of Australia that Oz's encryption law breaks a few international privacy standards, and could then come into conflict with GDPR. 
• Jacob Sullum at Reason goes through some shonky anti-vaping research that claims vaping causes heart attacks, but that ignores that the heart attacks happened before the smokers switched to vaping.
• Shoeshine over at the NBR warns that woke investment strategies do not always pay off. I particularly wonder about NZX here. NZX's report on Corporate Social Responsibility suggests that boards with stronger gender diversity show higher returns - but the academic literature says there is no effect. And there's now a Kiwisaver Fund that makes sure not to invest in firms that have inadequate boardroom gender diversity. It all makes for fun pondering. If an investor picked up that Fund based on NZX's assertions about the excess returns to be had through that investment strategy, and was disappointed, could there be recourse?
• A sad end for Capital Liquor, which seems set to be hounded out of existence by the Police and Medical Officer of Health through the DLC process. They've not done anything wrong - they just want to operate during the hours allowed for under the Local Alcohol Policy. But the District Licencing Commission look to be trying to set a 6pm closing time for downtown bottleshops, licence by licence. 
• In this week's coming NBR column, I make passing reference to underarm bowling. One of the younglings here didn't know what I was talking about. If you don't know what that means, watch the documentary or get ready for the re-education camps. Discussion of the docco here. 

Other people's money

When you're playing with other people's money, you have different incentives. Take Corporate Social Responsibility, for instance.

Suppose that there's a trade-off between profitability and CSR mandates. Why might this be the case? Any CSR initiatives that increased profitability would have already been adopted under normal profit-seeking strategies.

Managers want to think themselves good people and enjoy doing CSR things. They get approbation from others for doing so. They'll get in trouble with shareholders if profitability drops too much, so they won't do the nuttiest things. But they'll take some CSR as consumption.

NBER points to some relevant evidence. From the abstract of Cheng, Hong and Shue's new paper:

We find support for two key predictions of an agency theory of unproductive corporate social responsibility. First, increasing managerial ownership decreases measures of firm goodness. We use the 2003 Dividend Tax Cut to increase after-tax insider ownership. Firms with moderate levels of insider ownership cut goodness by more than firms with low levels (where the tax cut has no effect) and high levels (where agency is less of an issue). Second, increasing monitoring reduces corporate goodness. A regression discontinuity design of close votes around the 50% cut-off finds that passage of shareholder governance proposals leads to slower growth in goodness.

In short, the more skin that decision-makers have in the game, the less they go for CSR policies. And the more that those with skin in the game can monitor the decision-makers, the less they go for CSR policies. It's slack in the principal-agent relationship that allows managerial consumption of "do-good" benefits.

Sometimes, we need Larry the Liquidator.