Why Investors Can View Companies as Leaders and Laggards

Socially responsible investment (SRI) techniques use screens to include — or exclude — companies in portfolios based on social or environmental performance. SRI is gaining traction — eleven percent of professionally managed U.S. assets were invested using these principles in 2007.

Though many investment firms use screens, each typically employs its own methods. Boston-based KLD Research & Analytics, Inc., for example, evaluates firms on seven strengths (e.g. pollution prevention) and seven concerns (e.g. regulatory problems).

A lack of go-to metrics for social and environmental performance means each firm sets its own priorities. This leads to questions such as: do you reward the high-polluting firm that is investing in new technologies for tomorrow? Or the firm with a lower environmental impact today?

Investors are forced to make a number of tradeoffs in evaluating firms. For instance, should the focus be on issues that are important to measure, or those for which data is readily available? Which environmental problems are more important for firms to address — urgent issues with short-term financial impacts (such as regulation of GHG emissions) or those that might lead to greater environmental impact in the long-run?

Measuring companies’ environmental performance typically involves three categories of indicators: environmental impact (e.g. emissions), regulatory compliance (e.g. fees for violations) and company processes (e.g. reporting). Investors weight these categories depending on their objectives — for some, environmental performance is used as an indicator of overall good management; for others, very poor performance is a signal of risk.

Researchers Magali Delmas (University of California, Los Angeles) and Vered Doctori Blass (University of California, Santa Barbara) examined the criteria for comparing companies and the pros and cons of current SRI screens. In their Business Strategy and the Environment article, they developed a case study of 15 publicly traded chemical companies including giants such as Avon Products, Inc., DuPont Company, Johnson & Johnson and Proctor & Gamble.

The authors found firms can be “good” and “bad” at the same time. Those scoring poorly on environmental performance (like toxic releases) and compliance with regulation also provided better reporting and took on more pollution-preventing activities. For example, Dow and DuPont ranked best on environmental reporting but worst on toxic releases, while Avon and Clorox two firms that were amongst the best for toxic releases were the worst reporters.

This work clearly demonstrates the drawbacks of using any single indicator. There is also a need for greater consistency and transparency in measurements across investment firms. Given the current piecemeal approach to valuing environmental and social performance, there is a risk investors will lose confidence in socially responsible investment methods.