Does “doing the right thing” in corporate affairs result in lower profits? Do people who buy stock only in firms that follow certain ethical practices pay a penalty in terms of lower returns?
The question resonates today amid allegations of corporate malfeasance.
The issue emerged in the mid-1980s, when smaller mutual funds began to invest in firms that did not make harmful products, such as tobacco or firearms, that did not harm the environment, that did not discriminate in employment, and so forth.
Some conservative economists pointed out that such funds inevitably pay lower returns over the long run. Firms maximize profits, they reasoned, and if most firms polluted, discriminated and did harmful things, it must be because doing such things is profitable. Firms that chose not to run with the pack would be less competitive and less profitable than those that stretched the limits of what was ethical.
These objections parallel cases in which advocacy groups tried to convince state and private pension plans to divest the plans of tobacco stocks or stocks of corporations that did not adhere to anti-apartheid principles in South Africa. Plan members sued in several venues arguing that the purpose of the plans was to maximize income and not achieve any social justice objectives.
The judicial outcomes were mixed, but both sides frequently seemed to accept that doing the “right thing” would inherently cost at least a bit more in terms of lower income.
I don’t own any individual stocks, but I do have pension funds with TIAA-CREF, the huge private college teachers’ pension organization. In early 1990, TIAA began to offer a “social choice” fund in addition to its regular stock and bond funds. I have allocated some portion of my contributions to that fund for many years, more out of curiosity than conviction. How has my experiment fared?
Over the 10 years to June 30, the actively managed traditional stock fund has achieved total returns of 9.8 percent per year. The “social choice” fund return is 10.1 percent. That slight edge for “do the right thing” investing holds across every time interval on the TIAA Web site: one-year, five-year, 10-year, “since inception” and “year to date.”
TIAA introduced an “equity index” fund in 1994 that is essentially a Standard & Poor’s 500-stock index fund. It was up 3.66 percent per year over the last five vs. 5.26 for the social choice. It is down over 16 percent for the year vs. less than 9 percent for “doing the right thing.”
The performance of one set of funds is not proof. However, broader studies of various mutual fund and pension groups, at different times in the last 10 years, generally come up with the same result. Firms that meet certain codes of conduct in terms of the environment, employment and treatment of employees are not less profitable than firms as a whole.
Cynics may argue that agreeing to some code of conduct drawn up by advocacy organizations does not necessarily mean that a firm will change the way it does business in any substantial way. The auditing and compliance mechanisms of the fund organizers and of the advocacy groups are admittedly imperfect. But they are not nonexistent.
The economists who predicted poorer performance by social choice funds have some explaining to do. Practical businesspeople may be less surprised by how well these funds have done. For every Ken Lay, Bernard Ebbers or Joseph Nacchio who makes the headlines there are dozens of less flamboyant businesspeople for whom honesty has always been the best policy.
© 2002 Edward Lotterman
Chanarambie Consulting, Inc.