I checked out the greencapitalism.org site someone mentioned in a different thread, and it reminded me of a question I've wondered about. I'd be curious to get opinions.

Is there any benefit to investing in socially responsible companies (presumably in place of socially irresponsible companies)?

I have my own opinion on this, but I'd like to hear other points of view...

Thanks,
Sam

I'm not an expert on this, but have been following the field for many years.

The way I see it, there are two basic approaches followed by socially responsible investment firms:

1. Screen to exclude "bad" companies (those directly involved in activities that "socially responsible" investors want to avoid, such as tobacco, resource extraction, human rights violations, military support, etc.).

2. Screen to find "good" companies (those that demonstrate exceptional environmental and/or social performance).

You ask if there's any benefit to socially responsible investing, which is a question that can itself be viewed in two ways: 1. Is there a benefit to society and the environment, and 2. is there a benefit to the investor?

In terms of the benefit to society and the environment, I think the second strategy above (screening to find good companies) has more effect, because it creates an incentive for more companies to do better. If you know that your firm is likely to become attractive to socially responsible investors, it might encourage you to improve your performance on the environment and social issues. But because socially responsible investing is still a relatively small subset of all investment ($2.3 trillion in 2005 compared with $24 trillion overall in professionally managed investments), I don't get the sense that the "punishment" of "bad" companies by withholding investment money has had much effect so far.

In terms of benefit to the investor, I guess the most obvious benefit is knowing that your investment money is not directly supporting companies that are doing things you abhor. Some of your money might get to them eventually through indirect means, but not as much as if you were in an index fund or other conventional investments. The price you pay, however, is higher management fees and often lower performance. For many investors who care about social and environmental issues, however, the penalty is worth it.

You're right -- I should have been more specific.

I meant to ask if there was a societal benefit to socially responsible investment.

What I don't understand is how buying stock in a company "supports" that company or the way it does business. Buying its products supports the company. Telling others to buy its products supports the company. But buying the stock doesn't support the company. If I buy 1 million shares of Whole Foods, because I approve of their business practices, Whole Foods doesn't see a penny of that transaction. Wall Street, however, sees quite a few pennies from it.

In fact, ironically, choosing to buy or sell a stock based on a company's perceived morals creates an inefficiency in the market, which will be exploited by those who don't care about the company's behavior. So in a very real sense, it seems to me that socially responsible investment allows those who don't care about a company's behavior to profit at the expense of those who do.

I must be missing something here, but I don't see what..



Sam

Sam, I think this is an interesting question, and it's something that I've only covered briefly in the past. I'm willing to bump this to the blog, if you're interested.

My understanding of how the stock market works is admittedly hazy, but if you buy 1 million shares of Whole Foods would that not in fact help increase the value of the stock, attracting more investors to it and thus raising more capital for the company? If they saw no benefit from selling shares, why would companies have any incentive to go public in the first place.

brad,

Whole Foods would have an indirect benefit from you buying 1 million shares. However, as samerwrite indicated, Whole Foods would not receive a single penny of the 1 million shares you purchased. Only the individuals that sold the shares to you would get that benefit. The indirect benefit comes if Whole Foods decides to issue more (new) shares into the market. There is another effect of a high share price. It prevents takeovers of the company and instability in top management.

Companies do receive a benefit when the first go public. However, since you're buying the shares after this event, the company doesn't receive that benefit.

squished

Squished covered it pretty well, but here's my stab at an example; I suspect the stock market is quite a bit more complex than I'm giving it credit for, but here's my simplistic take on the situation.

Let's say Fred owns a lemonade stand. He makes a profit of $100 per year, and all indications are that he will continue to make precisely $100 per year in perpetuity. Fred uses recycled cups and organic lemons. He smiles at the neighborhood children and tips his hat to the ladies. Fred is a socially conscious lemonade stand owner.

Meanwhile Joe operates a lemonade stand next to Fred. Joe also makes a profit of $100 per year, and will continue to make $100 forever. Not only does Joe not use recycled cups, but he throws rocks at the neighborhood dog every time it walks past, and never tips the paperboy.

Joe and Fred both have IPOs, so you can buy stock in either company on the open market. One should expect the market capitalization of both companies (price per share times number of shares) to be identical, that is the present value of $100 per year, every year, forever. One could calculate this, given some assumptions about the discount rate, but I'm too lazy to do it. Let's assume that this value is $1000, and that each company issues 10 shares that wind up being priced at $100 each.

If you are willing to pay *more* than that price for Fred's company, because Fred is socially responsible, you will have no problems finding people to sell you their share of Fred's company. Why? Because you're willing to give them more money for their share than its intrinsic value. If you offer someone $105 for something that is worth $100, they'll jump at the chance. But unless there are a lot of kind souls out there willing to throw away $5, the price is going to drop back down immediately to $100 per share, because that is the "fair" price.

Meanwhile, let's say that you decide *not* to buy any stock in Joe's lemonade stand, because Joe is a bad apple. In theory that reduces demand for Joe's stock and it should drop a bit. But If Joe's stock were to drop below its intrinsic value, that would indicate a buying opportunity. If people have the ability to buy something worth $100 for $95, they'll jump on the opportunity and the stock will rise back to $100.

Note that regardless of what you do, the companies continue to operate as usual. Fred buys recycled cups and Joe throws rocks at dogs. The market puts no value on these activities. The market puts value on the companies earnings. It should be possible to see an example of this in real life. Find a penny stock with low volume, and offer $10 per share for 100 shares or so. You'll likely see the price go absolutely bonkers for a brief period as people try to figure out what the heck happened, then it will drop right back down where it was before. Just because you were willing to pay $10 per share doesn't mean anyone else is willing to do it. (I actually saw an article perhaps a decade ago where a guy tried that very experiment).


Sam

I should also mention that it is possible that consumers will recognize Fred's good deeds, and reward him by buying more lemonade. *That* may help his company earn more than $100 per year, thus justifying a higher stock price. But that is completely independent of any investment in the company's stock by a socially responsible investor (or fund).

I'd contend that, if you had $600 to invest and you were a socially conscious investor, you would be better off buying 6 shares of Joe's company giving you a majority ownership interest. Then fire Joe, and hire a nicer lemonade barista.



JD: If you think your readers would enjoy the topic, by all means post it. I'll be interested to read the comments.



Sam

This is fascinating stuff, thanks for the explanations. I have a friend who works for one of the socially responsible investing firms in NYC, and I'll have to ask him what he thinks about all this.

The topic of the stock markets efficiency is complicated as it relates to socially conscious investing. By purchasing a share of a company you are providing yourself the ability to have a legal voice in the governance of that company. As an individual investor my voice is relatively small if I own small fractions of a percentage of stock. Owning a million dollars of Whole Foods may allow a person to have a larger voice in the business practices of that company. Shareholder meetings are the vehicles that exist for stakeholders in companies to voice their opinions.

It is my gut feeling that individuals within the community of Get Rich Slowly lack the funds to become major players in the management practices of companies. Therefore, our individual ability to push a company to go "green" is not available. However, the managers of Calvert Funds have large holdings in individual companies. They have this ability based on individuals investing in their mutual funds. Calvert Funds, and others, have gone to shareholder meetings to request that socially responsible business behavior be expanded or that anti-social behavior be stopped. Calvert's threat to sell their stock holding may change the way a business behaves.

I believe that the value of owning socially conscious mutual funds or individual stocks requires a balance between person’s financial goals and the personal principles. If a person is starting their retirement savings in their mid-twenties, then they do not require a relatively strong return on their dollar invested or a lot of money to invest initially to accomplish a modest retirement goal. A person starting later or not in a position to invest vast amounts of funds will require a greater return on investment to reach a similar retirement goal as the person in their mid-twenties. This is the challenge in my eyes. Can you afford to accept investing only in the socially conscious investment pools of individual stocks or mutual funds? Can the earth afford our not environmentally responsible investing principles?

There must be societal benefits for investing either in mutual funds, individual stocks or purchasing products from "good" companies. I base this on my view of BP's (formerly British Petroleum) and General Electric’s corporate behavior over the years. It is my feeling that they would not be highlighting their socially responsible behaviors (not that I condone their other behaviors) if it did not benefit their bottom line. Our voting with dollars and owning stocks is a metric that companies measure while making decisions on how they act.

This is an interesting question, and it's been really quite a surprise to me to read answers along the line that the price of a company's stock doesn't really matter to the company itself.

I'm hardly an economist, so I invite correction if I'm wrong, but I'm given to understand that stock prices are an indication of the value of the company to investors--this in contrast to income generated by the company, which is an indication of the value of the company to customers/consumers.

So what do investors value?

If there's no connection between how much money a company makes through its business and how much money people are willing to pay for a share of stock, why do stock prices rise or fall? Why do people buy stocks anyway? (This is mostly rhetorical--though I do have some catching up to do on the financial literacy video series.) Obviously the answer for the average Joe is "to make some money", but the idea that these things are somehow totally divorced from the performance of the company is ludicrous.

To follow upon the lemonade stand example, if the good guy's stock is stronger than the bad guy's, can't the good guy more effectively raise cash (by selling his own shares, or issuing more shares) in order to expand his business? Presumably one benefit to buying shares in a companies--resulting in more demand for their stock, and so rising stock prices--is to help them financially in this way. If it matters to you that some companies are ethical or environmentally consicous or have good labor practices, why not put your money toward helping them grow, rather than their less honorable competitors? Is anyone here old enough to remember the drive to divest from South African companies in the late 80s, as a way of forcing change about apartheid?

And how about dividends? That's another way that shareholders are compensated for their investments. Do you value where your cash comes from? Do you really want to accept money that's been generated by companies that make poisonous products (like cigarettes), or generate massive pollution, or run factories with appalling labor practices?

I'm new to the whole capitalist thing. The idea of getting some money as a result of owning something rather than doing something takes some getting used to. Maybe as a result, I feel strongly that now my money is doing something when I put it someplace in an investment. Having had family members affected by poisonous products and massive pollution, you bet I'm troubled by the idea of making a profit by associating with the companies that do those things. Will my Socially Consicous fund make less money than other investments? Maybe so, but I'm not so greedy that I'm willing to support active harm of others to turn an extra buck.

Angie,

You could say the price is what investors perceive as the value of the company, in a way. I think its a tool of raising capital and nothing more. Companies split stocks all the time.

And, owning is doing something, isn't it?

OK, then, why not choose to put your hard-earned capital toward companies that "do good while doing well"? Isn't that something that an investor can value?

I don't agree that owning is always "doing something", particularly when it comes to investing as it's typically practiced by Little Guys Like Us. Do people who have some money in a mutual fund "own" any part of the companies that the fund is invested in, in any meaningful way? How about the small shareholder? certainly you're not required to do more than park your money someplace. I think it's more common for people to think of the returns on their investments as "free money"--certainly not something they labored to get, not "earned income".

Angie,

You can invest in whatever you want. However, when I look at investments, I consider what my expected return, and potential downside / upside. Socially responsible firms tend to not have a large upside in the current market. Therefore their funds don't perform as well, ceteris paribus. Since, being a self-interested individual, I want to maximize my investments, I put them elsewhere.

I think that, if you want to encourage socially responsible investments, it's probably best to frequent companies after-tax with purchases of their products. It really helps them more. For instance, there's a sugar substitute called Xylitol that I love, and its much better for you than sugar or any substitute. So I buy them. I like farmer's markets to support local growers.

Being an economist, I view my work as earning my salary, but if I invest that money, my work is yielding again. To invest, I do a good bit of research, use time and resources. I *own* my investments, so I care that they perform. I don't think people look at investment returns as free money (I dont think alot of folks understand investments, hence why I really dig this site).

I certainly agree that it's good to support socially responsible companies as a consumer.

Samerwriter's original question was, "Is there any benefit to investing in socially responsible companies (presumably in place of socially irresponsible companies)?"

I believe there is a benefit beyond dollars and cents to putting your investment dollars in socially responsible companies, too.

Do you not find it even a little bit reprehensible that major corporations might, say, use sweatshop labor? Or build factories in third world countries because there are few to no restrictions on air and water pollution compared to those in the US? Both of these things are common in this great globalized world of ours, and many companies regard these as legitimate ways to cut expenses, boost the bottom line.

Is the bottom line really all that matters? Just tough luck to the manufacturing workers in the US whose jobs, with all those unprofitable labor-law protections, were sent to cheaper plants overseas--they're just proles who lose as a matter of course? Tough luck to the locals near those factories who have to live downstream of the factory?

Some upside. Do you really think those chickens won't come home to roost someday? Do you really think they're not coming home to roost already?

All this seems very far away when you're staring at the bold print on your quarterly statement, but if you're going to be a Provider of Capital, it's worth giving some thought to who you're providing it to, and what they're going to do with it. Or does being an investor mean that you're exempted from being a good citizen, too?