- The Washington Times - Wednesday, November 18, 2009

Industry consolidation through mergers and acquisitions sometimes can spell trouble for socially minded consumers and investors. As firms become larger and competitors become scarce, incentives can weaken to offer quality products at competitive prices and maintain socially responsible business practices. However, the recent consolidation of one industry, socially responsible investing, could deliver several benefits to those who care about social impact.

Socially responsible investing considers the social and environmental implications of a company’s practices. The idea dates back at least to the beginning of the 19th century, when Quakers avoided investing in companies involved in slavery, and it enjoyed a resurgence during the final years of South Africa’s apartheid regime. Today, more than $2 trillion is under management in socially responsible investments (adding up to one of every nine dollars invested), with growing involvement from individual investors and large institutional players such as public pension funds.

Most social-investment funds offer negative screens, in which tobacco, alcohol, arms and other “sin” industries are screened out so investors can be assured their portfolios are aligned with their values. The drawbacks of this approach are that it limits diversification opportunities and no incentives are provided for firms within “sin” industries to improve their social responsibility. Thus, a new generation of metrics has offered “best in class” methodologies, in which firms are ranked in part based on their industry. Under this rubric, an oil company competes with other oil companies on responsible environmental practices rather than against Whole Foods or Starbucks.

Social investors have diverse motives. Some want to invest in companies that pay all employees a livable wage with benefits, while others think they will get the highest financial and social return by investing in companies with strong environmental records. Investors depend on ratings to deduce which companies are leaders and which need a wake-up call.

The problem has been that numerous ratings schemes exist, along with myriad magazine rankings of most-admired companies and best places to work. Without a common definition of social responsibility, almost any firm can be deemed a socially responsible investment. The fact that firms like Countrywide Financial, whose questionable lending practices contributed to our current financial crisis, routinely made these lists is clearly a source of concern.

Finally, it has been difficult to tie the metrics that social raters use, such as the publication of a corporate sustainability report or the existence of a recycling program, to tangible social impact. Thus, the remaining challenge will be to design more transparent and consistent environmental, social and governance ratings of companies.

A potentially important step in this direction happened last week, when RiskMetrics Group acquired KLD Research and Analytics, a leading provider of responsibility ratings. Coupled with their purchase of Innovest Strategic Value Advisors earlier this year and Institutional Shareholder Services in 2007, RiskMetrics is poised to assume a dominant position in the industry. Consolidation offers an opportunity to forge a consensus on how to measure the social, environmental and governance aspects of corporations, providing better guidance to social investors.

Of course, there still will be disagreements over key issues, such as whether to include a tobacco company with a notable philanthropy record in a social index. Furthermore, while part of any rating scheme will remain proprietary, social raters ought to make their ratings as transparent as possible so independent bodies can assess the quality and logic of their rankings.

With trillions of dollars invested in global capital markets, channeling capital to firms that make profits while creating social good is a powerful idea. As interest in corporate social responsibility grows, a new generation of metrics is required to realize the tremendous promise of social investing. As the industry evolves around a few large players, there will be many opportunities to improve our methods, increase our knowledge and ultimately deepen social impact.

c Aaron K. Chatterji is an assistant professor at Duke University’s Fuqua School of Business and a fellow at the Center for American Progress in the District. Christopher Gergen is the director of the Entrepreneurial Leadership Initiative within the Hart Leadership Program at Duke University’s Terry Sanford School of Public Policy and co-author of “Life Entrepreneurs: Ordinary People Creating Extraordinary Lives.” Send e-mail to authors@ lifeentrepreneurs.com.

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