THE CAPITALIST ROAD
THE CAPITALIST ROAD
2004-01-30 at 10:10:00 am #4886
The Greening of American Capitalism
For decades the environmental movement has been characterized as being at odds or out of touch with the bedrock assumptions of U.S. capitalism. According to the common view, investors will sacrifice returns if they allow social values such as clean air and clean water to influence their investment choices. Similarly, any strengthening of environmental protections by the government will add deadweight costs to a company’s bottom line, thus undercutting efficiency and dragging down general prosperity. For these and other reasons, even the simplest environmental reforms are required to run a gauntlet of dense cost-benefit calculations to win approval as sound economics.
But what if this familiar lore turns out to be dead wrong? In the realm of abstract economic analysis, the conventional logic may seem unassailable. In reality, however, companies with superior performance on environmental matters (as well as other social concerns) are producing better returns in the stock market for shareholders, partly because those companies face fewer environmental risks to their future profitability. I am not simply talking about green startup companies on the leading edge of innovation — the ones designing new solar panels. I am talking about the largest industrial corporations, from DuPont to Intel, across virtually every sector, including those sectors that are typically notorious polluters. In the bowels of capitalism, it turns out, environmental values make good business sense.
This revelation opens an entirely different path to achieving deep change in our economic and political systems, change that is driven from within the capitalist structure by people who act collectively as investors, consumers, workers, and citizens. Government at present is captured or stymied by dominant economic interests and unable to make fundamental advances, especially in the regulatory system. Business and finance, though, can become surprisingly pliable in their strategies and business models once citizens learn to locate the precise points of leverage. The connection between financial investing and environmental progress is one such point.
The bow wave for clarifying this issue was launched by the pioneers in socially responsible investing, or SRI. Often belittled by Wall Street, a number of the leading socially screened investment funds attracted notice during the 1990s, when they produced better records of return than did the broad market they compete with for investor dollars.
Mainstream brokerages, at the very least, recognized a new niche market and began opening their own SRI funds. Even the Dow Jones Company, which promotes its economic orthodoxy in the Wall Street Journal, caught the wave in 1999 with its global sustainability index, tracking the top 10 percent of the most environmentally, economically, and socially conscientious companies worldwide. (These companies, according to Dow, include 3M, Procter & Gamble, Intel, Volkswagen, Unilever, Siemens, and others.) The new index is beating Dow’s broader global index by 2 to 3 percentage points. These differences are not trivial; when trillions of dollars are in play, 1 percent better adds up to real money.
SRI’s edge in performance remains in contentious dispute among Wall Street bankers and brokers, and most of them, it is safe to say, still don’t buy it. Environmentalists, who start from a broader understanding of what constitutes efficiency and value, may find it easier to appreciate the underlying logic. American business, despite its inventiveness and supposed obsession with efficiency, actually operates in a swamp of everyday wastefulness, as environmental thinkers have contended for years. It stands to reason that a company reducing toxic effluence from its plants, or modifying products and production processes to reduce collateral damage in nearby rivers or forests, is also engineering internal efficiencies that will be reflected in the bottom line.
Innovest, an upstart financial advisory firm with offices in New York, Toronto, Paris, and London, has taken this logic a step further, gathering abundant specific evidence that companies with better environmental records generally produce better returns for investors. Innovest has developed investment-risk ratings for 1,500 corporations, a grade that resembles the credit-risk ratings by Moody’s or Standard & Poor’s. In this case, a corporation’s environmental performance and viability are evaluated according to 150 concrete indicators, including its liabilities for past pollution, risks of hazardous waste disposal, the energy efficiency of its production systems, exposure to future regulatory costs, and scores of other markers.
Based on these factors, the firm assigns risk ratings from AAA to CCC. The CCC rating signifies “a company where there are significant doubts about management’s ability to handle its environmental/social risks and liabilities and where these are likely to create a serious loss.”
The grading system allows Innovest to compare performance in the stock market; a portfolio of several hundred companies with higher eco-ratings is matched against several hundred “bad guys” with poor ratings. If a pension fund, for instance, invests its billions on highly rated companies and ignores those with lousy environmental records, it will reap higher returns — 1.5 to 3 points higher than if the pension fund follows standard practice and invests passively across the entire stock market. Why then should pension trustees, mutual funds, and foundations park their money with the suspect performers?
The simple and obvious truth Innovest captures with its analysis is that companies are vastly different in how they perform and the risks they assume, even when they look alike by Wall Street’s usual financial measures. Innovest ratings uncovered considerable differences within high-risk sectors like oil and chemicals. The performance of companies in the top half of the chemical industry — those more environmentally responsible — was 15.9 percent above the bottom half. In a sense, Innovest is separating the sheep from the goats. The firm also examined the potential financial risk of climate change to 26 American electric-utility companies and found company risk varied by a factor of 50. Suppose that as global warming worsens, public alarm finally overwhelms industry’s political resistance, and that controls are enacted to compel utilities to reduce carbon emissions. What is the risk to their bottom line? Innovest, using a hypothetical carbon tax as a proxy, found that one utility company would pay costs of only 38 cents per share, based on its relatively modest carbon emissions, while another company would pay $14 a share. Even if government does not act, imagine how this kind of information could affect stock prices once investors learn to consider the unseen risks in retrograde corporations.
“Our ultimate purpose is to reengineer the DNA of Wall Street,” explains Matthew Kiernan, Innovest’s founder and chief executive: “If you want to change corporate behavior, you have to start with their financial oxygen supply, producing solid information from social-environmental areas that have been completely opaque to financial markets.”
American investors recently learned a lot about the opacity of Wall Street, not to mention its fallibilities and sly deceptions. The Innovest ratings may actually provide insight into what Wall Street analysts so often got wrong in the 1990s — the overall soundness of a corporation’s top management. “What you’re really discovering with the Innovest screen is something fundamental about the company,” says Wall Street veteran Peter M. Camejo, who established the first environmentally screened fund at Merrill Lynch in 1990 and later founded Progressive Asset Management, a socially responsible investment firm now based in Oakland, California. “A company that has a very high rating on the environment is doing everything right,” he observes. “The management team has got its head on straight. They avoid litigation; they know how to handle themselves; they’re thinking ahead. With a company that’s very bad, that cuts corners and gets into trouble all the time, you may be discovering that they have internal management problems they don’t admit to, maybe don’t even recognize.”
The potential impact on investing practices is obvious. Here’s a powerful tool to punish the bad guys and reward the virtuous in terms that they all understand: the cost and availability of capital. But that brings us to the hard part — overcoming the backward habits and assumptions of Wall Street institutions.
The primary target for leverage, therefore, has to be the fiduciary institutions that hold the vast savings of Americans at large and invest trillions on their behalf. These holders of great wealth, including pension funds and mutual funds, own 60 percent of the 1,000 largest corporations in America. They have decisive influence over investment values — if they will use it. Instead, more often than not, they meekly align their investment strategies with Wall Street’s narrow-minded choices. This status quo is changing gradually, at least on the margins, as SRI firms demonstrate success and labor unions, environmentalists, progressive shareholder groups, and other activists raise challenges. Innovest, which counts former executives from Citicorp and TIAA-CREF on its board of directors, is slowly breaking into the larger market. The firm is now the strategic adviser for some $900 million in five investment funds, one of which is organized notably by ABP, the Dutch pension fund that is currently the largest in the world.
Still, any strategy to move U.S. financial markets must work on two fronts. First, investors must organize to educate managers of mutual funds about what represents sound investment — and threaten to cut off their “oxygen supply” if they don’t get it.
The second front involves pension funds, large and small, which are required by law to invest only in the long-term interest of their “beneficial owners,” the future retirees. The fund trustees must be persuaded that they are likely in legal violation of their fiduciary duty when their investment strategies fail to distinguish between the social behavior of good guys and bad guys. Trustees could in theory be held liable for ignoring the facts and exposing pension returns to avoidable risks. If major pension funds absorb the message, they will be compelled at a minimum to begin auditing the behavior and potential risk of the individual companies. Then funds would have a clear basis for making active distinctions about where to park their capital.
Once a few of the largest pension funds begin using such assessments to guide their investing, Wall Street brokerages and other private firms will have no choice but to employ the same techniques — or risk losing their largest customers. And the corporations will have to do the same, if only to defend their share price. This leverage is real power that in time can alter the fundamentals of corporate behavior, with or without much help from government. As long as government remains unable or unwilling to seriously confront the destruction of nature, the capitalist road may actually be the most promising route to initiating real change.