Corporate Social Reporting, CSR

1. ASPECTS OF CONTROL :
CORPORATE SOCIAL
REPORTING
MSC ACCOUNTANCY & FINANCE :
CORPORATE GOVERNANCE
& OPERATIONS RISK ANALYSIS AND CONTROL
Stephen Ong
BSc(Hons) Econs (LSE),
MBA International
Business(Bradford)
Visiting Fellow, Birmingham City University
Visiting Professor, Shenzhen University

2. • Discussion : Global Corporate
Social Performance
1
• Corporate Social Responsibility,
Environmental, Sustainability &
Ethical Issues
• Employee Issues
2
• Case Presentation: Premier
Oil3
Today’s Overview

3. Casestudy 3 : Premier Oil
1. Read and prepare the Casestudy on
Premier Oil (Monks & Minow (2011)) for
discussion next class. Identify the
corporate governance issues faced.
2. You are required to:
– Analyse the scenario’s in the
case study and plot the resulting
risk analysis on an appropriate
risk map.
– Map out the stakeholder
power/interest issues, and
propose the appropriate
corporate actions.

4. Risk Map Action
High
Medium
Low
Low Medium High
S
I
G
N
I
F
I
C
A
N
C
E
PROBABILITY
Requires close
monitoring
Manage and monitor Significant focus and
action
Accept but monitor
Management effort
worthwhile Manage and monitor
Accept risks
Accept but
periodically review
Accept but monitor

5. Stakeholder mapping: the power/interest matrix
Figure 4.4 Stakeholder mapping: the power/interest matrix
Source: Adapted from A. Mendelow, Proceedings of the Second International Conference on Information Systems, Cambridge, MA, 1986

6. 1. Open Discussion
• Foo Nin Ho, Wang Hui-Ming Deanna and
Vitell, Scott J.(2012) A Global Analysis of
Corporate Social Performance: The Effects of
Cultural and Geographic Environments,
Journal of Business Ethics, 2012:107: pp.423–
433

8. 2.1 CORPORATE SOCIAL
RESPONSIBILITY,
ENVIRONMENTAL,
SUSTAINABILITY
& ETHICAL ISSUES

9. The Role of Institutional Investors in
Corporate Governance
• What is the role of institutional investors in
corporate governance, mainly from a UK
perspective

10. Learning Outcomes
• By the end of this lecture, you should be able to:
• highlight the important monitoring role that
institutional investors play in UK corporate
governance
• discuss the complex web of ownership that arises
from institutional investment
• consider ways in which institutional investors are
becoming more active in corporate governance
• Appreciate the importance of the Walker Review and
the Stewardship Code

11. Institutional Investors and
Corporate Governance
Agrawal and Knoeber (1996) emphasized:
" . . . concentrated shareholding by institutions
. . . can increase managerial
monitoring and so improve
firm performance"

12. The Transformation of UK
Institutional Ownership
Berle and Means (1932)
• Described share ownership as ‘dispersed’
in US (UK)
• NOW
Concentrated in investment institutions:
• pension funds
• life insurance companies
• unit trusts
• investment trusts

13. Ownership of UK listed
companies
1963
• 54% individual shareholders
1992
• 51.9% insurance companies and pension funds
• 8.5% unit and investment trusts
• 20% individual shareholders
• 12.8% overseas investors
1998
• 60% institutional investors
NOW
• Over 70% institutional investors

14. A Complex Web of Ownership
• Institutional investors are not
shareholders
• They are intermediaries

15. Directors of investee company
Pension Fund Trustees
Investment Consultants
Brokers
Fund Managers
Pension Fund Beneficiaries
Sources of Conflict in Pension
Fund Investment

16. Conflict arises due to frictions
between parties
• Produces frictional transaction
costs
• Shareholders' views not heard by
companies
• Breakdown in trust between
companies and their
shareholders

17. The Growth of Institutional
Investor Activism
"Given the weight of their votes, the way in which
institutional shareholders use their power to
influence the standards of corporate governance is of
fundamental importance. Their readiness to do this
turns on the degree to which they see it as their
responsibility as owners, and in the interest of those
whose money they are investing, to bring
about changes in companies when
necessary, rather than selling their shares”
The Cadbury Report, 1992

18. Cadbury Report suggested
institutional investors should :
• encourage regular one-to-one meetings
with directors of their investee
companies (‘engagement and
dialogue’)
• make positive use of their voting rights
• pay attention to the composition of the
board of directors in their investee
companies

19. Institutional Investor Voting
• Stapledon (1995)
–Until 1990s level of
voting fairly low
• Mallin (1999)
–Significant increase in
recent years
• Hampel Report
–Overall voting levels
remain at about 40%

20. Engagement & Dialogue
• Combined Code :
• Institutional shareholders should be ready,
where practicable, to enter into a dialogue with
companies based on the mutual understanding
of objectives.
• Higgs Report
• Institutional investors should enter into a
dialogue with companies based on the mutual
understanding of objectives
• Senior Independent Director (SID)
• Should represent investors' interests on the
board

21. Failure of Engagement in the
Financial Crisis
• Institutional investors have been partly blamed
for the financial crisis
• Paul Myners targeted them as a scape goat in
speeches
• Financial Times (2009) suggested engagement
failed to avert the financial crisis, even though
they were aware of the problems
• IMA was questioned by the Treasury Select
Committee in January 2009
• IMA stated that investors lost confidence in the
banking sector and sold shares in 2005

22. • Where investors engaged with banks it did not
work
• Despite 55 meetings between one bank and
shareholders before nationalization, the crisis
could not be averted
• Engagement with banks before crisis did not
change behaviour of directors/banks
• IMA has concerns that institutional
investors do not have enough
information or influence to be able to
influence board behaviour
Failure of Engagement in the
Financial Crisis …

23. The Walker Review
• Many codes of corporate governance
best practice have been reactionary
• In the wake of the financial crisis, the
Walker Review has examined the causes
of the crisis
• Specifically, the review made
recommendation for institutional
investors

24. Walker stated:
• The limited institutional
efforts at engagement with
several UK banks had little
impact in restraining
management before the crisis
phase
• Levels of voting against bank
resolutions rarely exceeded
10 per cent

25. Walker recommended
• Board evaluation should provide an
indication of the nature and extent of
communication with major shareholders

26. Walker recommended:
• The FRC’s remit should be extended to
include establishing Principles of best
practice in stewardship by institutional
investors and fund managers.
• The Code on the Responsibilities of
Institutional Investors, prepared by the ISC
should become the Stewardship Code.
• Should have equivalent status to Combined
Code

27. Walker recommended:
• Fund managers should signify on their
websites whether they commit to the
Stewardship Code
• Important for ACCOUNTABILITY!.

28. Walker recommended:
• Institutional investors and fund
managers should actively seek
opportunities for collective
engagement
• Voting powers should be exercised
• Voting records should be disclosed
• Voting policies should be described
on websites

29. Walker identified barriers to
engagement
• Effective dialogue
requires large senior
resource commitment on
the part of fund managers
• free-rider benefit that
may be generated for
those who do not
contribute to the
engagement process

30. Barriers to engagement
• Resistance of some major boards to
engage in effective dialogue
• When chairmen engage with major
shareholders there is often a
disappointing response
• Boards dissatisfied with level and quality
of shareholder representation in
meetings
• Hubris/complacency at board level

31. The Stewardship Code
• Principle 1: Institutional investors
should publicly disclose their
policy on how they will discharge
their stewardship responsibilities
• Principle 2: Institutional investors
should have a robust policy on
managing conflicts of
interest in relation to stewardship
and this policy should be publicly
disclosed.

32. The Stewardship Code …
• Principle 3: Institutional investors
should monitor their investee
companies
• Principle 4: Institutional investors
should establish clear guidelines on
–when and how they will escalate their
activities as a method of protecting
–and enhancing shareholder value

33. Code cont.
• Principle 5: Institutional investors should
be willing to act collectively with other
investors where appropriate
• Principle 6: Institutional investors should
have a clear policy on voting and
disclosure of voting activity
• Principle 7: Institutional investors should
report periodically on their stewardship
and voting activities
The Stewardship Code …

34. Overall Walker Conclusion
• “There is a need for better engagement between fund
managers acting on behalf of their clients as beneficial
owners, and the boards of investee companies.
• Experience in the recent crisis phase has forcefully
illustrated that while shareholders enjoy limited liability
in respect of their investee companies, in the case of
major banks the taxpayer has been obliged to assume
effectively unlimited liability.
• This further underlines the importance of discharge
of the responsibility of shareholders as
owners, which has been inadequately acknowledged
in the past…
• there should be clear disclosure of the fund manager’s
business model, so that the beneficial shareholder is
able to make an informed choice when placing a fund
management mandate”.

35. FINANCIAL REPORTING COUNCIL
JANUARY 2010
• CONSULTATION ON A STEWARDSHIP
CODE FOR INSTITUTIONAL INVESTORS

36. Rationale
• FRC’s December 2009 review
Combined Code found significant
concerns about the quantity and
effectiveness of engagement
between institutional investors and
boards of listed companies
• Conclusions of the Walker Report

37. Consultation asks for views on:
• What are the responsibilities for engagement
of institutional shareholders to the beneficial
owners whose interests they represent?
• Does the ISC Code cover all the relevant
responsibilities?
• What are the responsibilities for engagement
of institutional shareholders to the UK listed
companies in which they invest?
• Does the ISC Code cover all the relevant
responsibilities?

38. And …
• Are the respective responsibilities of the
different parts of the investment chain
sufficiently clear and appropriate?
• Does the Code strike the right balance
between the need to avoid over-specification
that might discourage the application of the
Code and the need for it to be effective with
an appropriate degree of transparency?
• Are there any parts of the ISC Code where
further guidance is needed, or where the
existing guidance should be amended?

39. Summary
• Not only
companies have to
be accountable
• Shareholders,
especially
institutional
investors, need to
be responsible by
being ACTIVE
owners

40. Environmental, Social &
Governance
• To consider the important role that
institutional investors are playing in
broadening the corporate governance
agenda and in driving corporate social
responsibility, by increasingly taking
account of environmental, social and
governance (ESG) factors in their
investment decisions

41. Learning Outcomes
• After this lecture, you should be able to:
1. highlight the importance of corporate social
responsibility and greater accountability to a broad
range of stakeholders;
2. consider the growth of socially responsible investment
in the UK and elsewhere, highlighting the ways in
which socially responsible investment has moved from
a marginal to a mainstream area of institutional
investment;
3. discuss the potential implications of the socially
responsible investment movement for companies,
their stakeholders and ultimately for society
4. evaluate new evidence on the integration of
environmental, social and governance factors into
institutional investment

42. Introduction
• Corporate governance is the system of checks and
balances, both internal and external to
companies, which ensures that companies
discharge their accountability to all their
stakeholders and act in a socially responsible way
in all areas of their business activity
• Therefore, sustainability reporting, social
and environmental reporting and socially
responsible investment all contribute to
'good' corporate governance
• They represent mechanisms which help
companies to discharge a broad accountability
and to behave in a socially responsible manner

43. Reporting for whom?
• Companies are producing sustainability
reports, social and environmental reports,
corporate social responsibility reports etc.
• BUT to what extent is this being driven by the
institutional investment
community?
• If investment institutions are not interested
in this information, it is unlikely that
companies will be genuinely interested in
producing it

44. Institutional Investors
• Institutional investors own
almost 80%of shares in UK
listed companies
• The current value of assets
managed by the global
institutional investment
community is in excess of 42
trillion dollars
• US and UK pension fund
investments total 7.4
trillion dollars

45. Ethical & Environmental investment
• Decisions made by these
investors have a considerable
impact on the environmental
and on society as a whole
“. . . what we need is a means
by which we can wield our
influence over businesses to
act responsibly . . . Ethical
and environmental
investment is that
means. “ (Hancock, 1999,
p. 8)

46. ESG & SRI
• We explore the extent to which the
institutional investment community in the
UK, and elsewhere, are becoming
increasingly interested in environmental,
social and governance information
• We consider how socially responsible
investment (SRI) has moved very quickly
from the periphery to the mainstream of
institutional investment

47. Impact
• In 2004 the UK Government endorsed the important
role institutional investors have to play in integrating
corporate social responsibility into business by their
recognition of the impacts of social and environmental
factors on long-term business performance
• Socially irresponsible behaviour is strongly
related to bad financial performance and even
corporate failure
–Exxon Valdez
–Brent Spar
–Nike
–Huntingdon Life Sciences

48. USA View
CalPERS (California Public
Employees’ Retirement
System) stated that:
“ . . . equity in corporations
with poor social and
ethical records could
represent an excessive
fiduciary risk
because such firms court
boycotts, lawsuits, or
labor activity. “

49. SRI
Friends Provident chose SRI:
“Good corporate practice on
human rights, child labour
and environmental pollution
is good for society, but it’s
also good for shareholders.
As a large investor, it is right
that we use our influence
with companies to encourage
responsible business
practices while serving the
financial interests of our
customers.”

50. Terminology and definitions
• From ethical investment to SRI
• Socially responsible investment
combines investors’ financial
objectives with their commitment
to social concerns such as justice,
economic development, peace or
a healthy environment.

51. Issues of traditional importance to the ethical investor
Alcohol Military/MOD
contracts
Poor
workplace
conditions
Animal
testing
Arms exports to
oppressive
regimes
Third World
concerns
Gambling Nuclear power Tobacco
Greenhouse
gases
Ozone depletion Water
pollution
Health and
safety
breaches
Pesticides Tropical
hardwoods
Human
rights abuses
Pornography
and adult films
Genetically
modified
food
Intensive
farming
Road
use/construction
Gene
patenting

52. Ethical Profile
• How to achieve
consensus?
• Individuals have
different ethical
profiles
• Ask pension fund
members for
example
• Ethical relativism

53. From SEE/SRI to ESG
• Early SRI (2000+)
• Institutional investors interested in
social, ethical and environmental (SEE)
factors
NOW
• Environmental, social and governance
(ESG) factors
• Shows SEE issues now central to
governance issues

54. Mercer Investment Consulting (2006)
Issues Associated with ESG Investment
Climate
change
Environmental
management
Sustainability
Corporate
conventions
Globalization Terrorism
Corporate
governance
Health issues
in emerging
markets
Water
Employee
relations
Human rights

55. Relevant ESG
• Mercer Investment Consulting
(2006) found that globalization
and corporate governance were
the ESG factors viewed as most
relevant to mainstream
institutional investment
analysis
• BUT they also found that a high
proportion of fund managers
expect clean water, climate
change and environmental
management to have a material
impact on investment
performance over the next five
years

56. Universal Ownership
• Emerging concept of 'universal
ownership' has encouraged the
integration of ESG issues into
mainstream institutional
investment
• Universal owners:
– "large investors who hold a wide
range of investments in different
listed companies as well as other
assets and therefore tied to the
performance of markets of whole
economies, rather than to the
performance of individual assets"
• They are therefore forced to be
concerned about long-term
economic prosperity, and must
consider ESG issues

57. Statistics on Growth of SRI and ESG
• In the UK £4 billion was
invested in ‘ethical’ funds
in August 2001
• SRI now an overarching
investment criterion for
ALL investment institutions
• 77% of the British public
would like their pension
funds to be invested in a
socially responsible way,
provided this did not harm
financial returns
• 80% of pension scheme
members require their
schemes to operate an
socially responsible
investment policy

58. ESG next 10 years
• Mercer Investment Consulting
surveyed 195 fund managers
around the world
• 70% of fund managers believe
that the integration of
environmental, social and ethical
factors into investment analysis
will become mainstream in
investment management within
the next three to ten years
• 60% of fund managers consider
that screening for social, ethical
and environmental factors will be
mainstream within the next three
to ten years

59. ESG Analysis
• Mercer Investment (2006)
canvassed 157 international
institutional investors
• Confirmed that socially
responsible investment is
continuing to expand at a
global level
• 38% of fund managers
surveyed anticipated
increased client demand for
the integration of ESG
analysis in mainstream
institutional investment
over the next three years.

60. Socially responsible
investment strategies
• Screening
• Best in sector - engagement and
dialogue

61. The financial performance of socially
responsible investment funds
John Maynard Keynes
(1936):
“There is no clear
evidence from
experience that the
investment policy
which is socially
advantageous
coincides with that
which is most
profitable . . . “

62. Essential question:
• Is it possible to be ethical and still to
make a profit?
• Few people are prepared to accept a
lower return to investment from
investing in a socially responsible
manner

63. SRI & Profits
• Solomon and Solomon (2002) found
strong evidence of a growing perception
among the institutional investment
community that SRI enhances financial
returns in the long term
• Drexhage (1998) considered that
investors and fund managers believe it
is possible to make a difference
while making a profit.

64. Existing academic empirical research
has produced mixed results
• Luther et al. (1992) found half of the trusts
studied outperformed the market and half
underperformed
• Mallin et al. (1995) found that both socially
responsible and non-socially responsible trusts
seemed to underperform the market
• Gregory et al. (1997) showed that both socially
responsible and non-socially responsible trusts
underperformed the market but that
underperformance was worse for socially
responsible trusts

65. SRI Index
• Development of SRI benchmark indices
is clarifying this issue
• Williams (1999) predicted growth in
SRI performance benchmarks which
should
“. . . explode the myth that green and
ethical investors have to accept that
their investment performance will be
disappointing. “

66. Cobb, Collison, Power and
Stevenson (2005)
• Examined the financial performance of the
FTSE4Good, and concluded that
• Investors are unlikely to be worse off by
restricting their investment universe, and may
well be better off
• Their interviews and questionnaires suggested that
inclusion in the FTSE4Good indices was contributing
significantly to stakeholder relations, as
well as to internal processes such as reporting and
management systems on social and environmental
issues

67. The drivers of SRI
Solomon et al. (2002) Questionnaire survey
Internal drivers:
- fund managers
- clients of the institutional investors
- trustees
External drivers:
- lobby groups
- Government
- society’s interest in CSR
- NAPF, ABI, etc

68. Rank I believe that the development of
SRI policy by pension funds is
motivated by
Mean
1 The impact of environmental and
social lobby groups
Agreement
2 A general increase in interest in
social responsibility in society in
general
Some
agreement
3 Political parties competing for
power
Some
agreement
4 Companies seeking to improve
their reputation and corporate
identity
Some
agreement
5 The actions of the NAPF Weak
agreement
6 European Union legislation Disagreement
7 The social dimension of
European Union membership
Disagreement
8 The growing interest of pension
fund trustees in SRI issues
Disagreement
9 The growing interest of pension
fund managers
Disagreement
10 A demand from active pension
fund members
Disagreement
11 A demand from retired pension
fund members
Disagreement
12 The religious beliefs of the
general public
Strong
disagreement

69. A growing demand for social, ethical
and environmental disclosure
• ABI guidelines on SEE disclosure (2001)
• They would like company boards to state in their annual
reports whether or not they:
– take regular account of the significance of SEE matters to the
business of the company;
– have identified and assessed the significant risks to the
company’s short and long-term value arising from SEE
matters, as well as the opportunities to enhance value that
may arise from an appropriate response;
– have received adequate information to make this assessment
and that account is taken of SEE matters in the training of
directors;
– have ensured that the company has in place effective systems
for managing significant risks, which where relevant
incorporate performance management systems and
appropriate remuneration incentives.

70. ABI Guidelines 2007
• Modification of 2001 Guidelines
• In 2007 the ABI published a set of guidelines on
responsible investment disclosure (ABI, 2007)
• These guidelines represent a modification of those
launched in 2001. One of the main reasons for their
updating was the progress in narrative reporting since
2001, including the EU Accounts Modernisation
Directive (resulting as we saw earlier in the Business
Review) and the new UK Companies Act. Although the
new guidelines are similar they emphasise certain
aspects of narrative reporting which
institutional risks in order to decide what
information should be included in the annual report.

71. Investors are especially interested
in reporting which:
• addresses ESG risks, within the company's
entire framework of risk management and
disclosures
• adopts a forward-looking approach to ESG risks
• addresses board action in managing ESG risks
It is also notable that the ABI have changed their
terminology from SEE (in 2001) to ESG (in
2007)
The Guidelines also contain an appendix which
lists a series of questions for companies to
interrogate themselves in relation to ESG

72. Lack of Disclosure
• Friedman and Miles (2001) found the City of
London was taking SEE issues far more
seriously
• Interviews by Solomon with institutional
investors found they are dissatisfied with the
level of social and environmental reporting
• Public disclosure is inadequate and
therefore private disclosure channels are
developing

73. Private social & environmental
reporting
• Sparkes (2002) highlighted the growth in SEE
engagement as a main indicator that socially
responsible investment is moving away from the
margin and into mainstream investment
• Solomon and Solomon (2006) found from
interviews that engagement in this area has
become formalized
• It is evolving into a two-way process, with
companies asking institutional fund managers
questions as well as questions being directed
toward companies by shareholders

74. ESG & Shareholders
• Freshfields Bruckhaus Deringer (2005)
concluded that shareholder engagement on
ESG issues would be considered prudent from a
legal perspective, as long as it is properly
motivated, transparent, informed and objective
“… targeted and constructive engagement
would be acceptable (and in some cases
mandatory) where it is aimed at improving
the financial performance of an investment
over the relevant time horizon, for example by
encouraging better environmental
accountability or more forward-thinking
management”

75. Private Social and Environmental Reporting:
Mythisizing or Demythologising Reality?
• Solomon and Darby (2005) explored
whether the dialogue between companies
and their institutional investors breaking
down barriers and misconceptions about
social and environmental risks and
impacts by business
OR
• was it simply helping companies to create
a green myth about their attitudes to
the environment and society?

76. Green Myth
• Interviews showed that both
that companies and investors
were creating and
disseminating a 'green' myth,
which suggested to society
that both companies and
investors were proactively
working toward
improvements in social and
environmental management

77. Pension fund trustees and socially
responsible investment
Pension fund investment is complicated
• Pension fund members
• Investment analysts
• Fund managers
• TRUSTEES
• Consultants
Do trustees have a responsibility to adopt an
SRI policy for their pension funds?

78. Trustee Fiduciary Duty
Trustees are concerned about breaching their
fiduciary duties
• Under the rubric of ‘fiduciary duty’ much is
justified. The unexceptionable fiduciary
requirement that trustees may consider
‘solely’ the interests of beneficiaries is
adduced to justify non-involvement in ‘social’
or ‘political’ investments. Activism is
dismissed as being unrelated to adding
long-term value to the trust portfolio.
Cowan v Scargill legal case spread fear in the
hearts of trustees on SRI

79. Interest of Beneficiaries
Judge Sir Robert Megarry concluded
‘. . . It is the duty of trustees, in the
interest of beneficiaries, to take
advantage of the full range of
investments authorised by the terms
of the trust, instead of resolving to
narrow that range.’

80. Profit Maximisation?
• Freshfields Bruckhaus Deringer (2005) considers that
the Cowan v Scargill case has had a misguided impact
on trustee behaviour
“… Cowan v Scargill cannot be relied upon to support the
single-minded pursuit of profit maximization, or
indeed any general rule governing investment
decision-making … Megarry's decision has been
distorted by commentators over time to support the
view that it is unlawful for pension fund trustees to do
anything but seek to maximize profits for their
beneficiaries… Read carefully, his decision stands for
an uncontroversial position that trustees must act for
the proper purpose of the trust, and not for
extraneous purposes.

81. Or not only profit max?
• Megarry, revisited his own
judgement in 1989
• He said his decision did
not support the view that
the fiduciary duties of
pension fund trustees
were only consistent with
profit maximisation

82. Two instances where ESG considerations
MUST be included in fiduciary responsibility:
• consensus among the fund beneficiaries
that ESG factors should be taken into
account
• if ESG considerations are reasonably
expected to have a material impact on
the financial performance of the
investment

83. Cowan vs Scargill
Freshfields Bruckhaus Deringer (2005) gave powerful
reasons why Cowan v Scargill case does not support
sole pursuit of financial return maximisation:
• case focused on a narrow issue
• Scargill represented himself
• Technical legal points were not made - Scargill was
not a lawyer
• no proper discussion of the case
• trustees involved had an ulterior motive for their
actions, supporting the failing coal industry.
• Scargill was thought not to have acted with integrity.
• The investment plan concerned had nothing in
common with a modern ESG strategy

84. Trustees & SRI
• Since July 2000 all UK pension fund trustees have had
to disclose the extent to which (if at all) they practise
SRI
• This requirement [the new SRI disclosure
requirement] has had a significant and wide-ranging
impact on the investment community. The majority of
trustees have incorporated reference to social, ethical
and environmental (SEE) issues in their annual
statements in 2001.
• Most of them have delegated responsibility
for implementing this to fund managers which has
added significantly to the growing Socially
Responsible Investment (socially responsible
investment) movement.

85. UK Pension Fund Trustees and
Climate Change
• “Financial Services
Accountability:
How Are Pension Fund
Trustees Dealing with
Climate Change?”
• Research supported by
ACCA / ESRC / UKSIF /
PMI / NAPF
• Preliminary Findings
• Report

86. Climate Change Predictions
• The Intergovernmental Panel on
Climate Change (IPCC) state by end
of 21st century global temperatures
will rise by 1.5 to 5.8 degrees
centigrade resulting in:
– thawing of permafrost
– declines in biodiversity
– rising sea levels
– extreme weather patterns
– flooding, droughts and storms
– direct, unpredictable and
possibly devastating
consequences on human
civilisation

87. Stern Review (2006): Insurance
Companies and Climate Change
"The insurance sector will face both
higher risks and broader
opportunities, but will require
much greater access to long-term
capital funding to be able to
underwrite the increased risks
and costs of extreme weather
events" (Stern, 2006, p.304).

88. Pension Funds and Climate Change
"Considering that both the physical
and mitigation-related policy
impacts of climate change will
influence the ability for companies
to create and maintain wealth for
shareholders … pension trustees will
want to ensure that these risks …
are being addressed in relation to
the funds in their care" (IPCC, 2005).

89. Climate Change
Risk
• Innovest Strategic Value
Advisors have estimated
that up to 5.1% (and
perhaps more) of market
capitalisation may be at
risk from climate change
• Climate change has been
identified as a central issue
for institutional investment
strategy (Mercer
Investment Consulting,
2006).

90. The Global Growth of SRI
• Socially responsible investment in
the USA
• USA is a strong advocate of SRI
• More than $2 trillion (about
13%) of all US investment
follows SRI criteria
• Freshfields Bruckhaus Detinger
(2005) explain that given the US
legal framework, ESG
considerations may be
incorporated into investment
strategy, provided that they are
pursued for genuine reasons and
that they do not compromise the
return to investment

91. Socially responsible investment
in Canada
• Jantzi Social Index
• Freshfields Bruckhaus Deringer (2005)
• No legislation encouraging trustees to take ESG issues
into account
• BUT some pension funds have included these issues
within the context of profit maximization
• Ontario Municipal Employees Retirement System
(OMERS)
• Ontario Teachers' Pension Plan Board
• The state of Manitoba has amended pension fund law
to specify that pursuit of ESG factors in investment
strategy does not represent a breach of fiduciary duty

92. Socially responsible investment in
Australia• Traditionally, Australian fund
managers have considered that
SRI is incompatible with fiduciary
duty
• Freshfields Bruckhaus Deringer
(2005) indicated that Australia
has been slower than the US in
integrating ESG issues
• Factors which have hindered SRI:
– confusion over what
constitutes ESG factors
– a perception that SRI leads to
underperformance
– confusion as to whether ESG
investment is consistent with
fiduciary duty
– lack of demand from fund
beneficiaries.

93. Socially responsible investment in
continental Europe
• European Commission
has endorsed SRI as an
important instrument
for encouraging
corporate social
responsibility
• European Social
Investment Forum
(Eurosif) has helped to
promote SRI

94. Socially responsible investment
in Japan
• Solomon et al. showed SRI has grown
recently in Japan
• Japan is a civil law country
• Law does not depend on cases
• Trust law in Japan stipulates that
trustees have a 'duty of
loyalty' to carry out their
responsibilities in good faith
on behalf of their
beneficiaries and to avoid
conflicts of interest
• No current legislation encouraging ESG
issues to be integrated into
institutional investment
• Legal framework is an obstacle to SRI
in Japan
• Freshfields Bruckhaus Deringer (2005)
concludes that ESG in Japan is in its
very early stages

95. 2.2 EMPLOYEE ISSUES

96. Employee Rights & Corporate
Governance Systems
• Employees are a key corporate stakeholder.
• We review how various theories on corporate
governance assess the impact on firm value
of improvements in workers’ rights.
• We also review the level of investments in
employee training, the strength of employee
representation and voice across corporate
governance systems and possible breaches
of trust by management of implicit contracts
they have with their employees via takeovers.

97. Learning Outcomes
• By the end of this lecture, you should be able to:
1. Contrast the views of the law and finance literature and the
varieties of capitalism (VOC) literature on how improvements of
workers’ conditions impact on firm performance and investor
rights
2. Compare the comparative advantages and disadvantages of
economies based on networks and strong employee voice with
those of economies based on flexible and highly liquid markets
3. Assess how investment in human capital varies across corporate
governance systems
4. Evaluate the degree of employee voice and representation
across corporate governance systems and their impact on firm
performance and efficiency
5. Critically review the literature on employee ownership
6. Appraise the existing evidence on breaches of trust of implicit
contracts.

98. Introduction
• The focus so far has been on
the providers of finance, i.e.
shareholders and
debtholders.
• However, corporations also
deal with other important
stakeholders such as
employees.
• The strength of
employee rights
in a country is intrinsically
linked to the generally
accepted objective of the
firm in that country.

99. Figure 1 – Dividend cuts or employee lay-offs
Notes: The number of firms surveyed is 68 for France, 105 for Germany, 68 for Japan, 75 for the UK and 83 for the USA.
Source: Yoshimori, M. (1995), “Whose Company is It? The Concept of the Corporation in Japan and the West”, Long Range
Planning 28, p.35.

100. Introduction (Continued)
• The law and finance literature assumes that
the relationship between shareholders and
employees is a zero-sum game.
• The rights of one party can only be improved
by weakening the rights of the other one.
• We revisit the taxonomies of corporate
governance, but also review the literature on
– employee ownership,
– employee board representation, and
– breaches of trust of implicit employment
contracts.

101. The Law and Finance Literature
• Most of this literature is based on the premise
that institutions act as constrainers or
facilitators on rational, profit-maximising
individuals.
• The focus of this literature is on property
rights, i.e. investor protection, as well as its
enforcement.
• According to this literature, the level of
investor protection dictates the size of a
country’s capital market and, in turn, its
economic growth and development.

102. The Law and Finance Literature …
• Mark Roe’s theory on the political
determinants of corporate governance is the
only theory from this literature that does not
advocate the superiority of corporate
governance systems that provide strong
investor rights.
• Nevertheless, Roe still assumes that strong
investor rights cannot be
combined with strong employee
protection.

103. • Roe argues that different countries have
different ways of ensuring social peace.
• The social democracies of Continental Europe
maintain social peace via strong workers
rights.
• The USA focus on investor rights.
The Law and Finance Literature …

104. • Marco Pagano and Paolo Volpin concentrate on
electoral systems.
• They distinguish between proportional systems
and majoritarian system.
• They argue that politicians focus on
homogenous social groups such as workers and
managers in proportional systems and hence
focus on improving employee rights.
• In majoritarian systems, the focus is on the
rights of investors who inhabit the pivotal
voting district.
The Law and Finance Literature …

105. • Pagano and Volpin also assume zero-sum game
between investor protection and employee
rights.
• La Porta et al. argue that weak law, in particular
weak investor rights, make it easier for
corporate stakeholders, such as managers and
employees, to expropriate the shareholders.
• Improving the rights of workers can only be done
at the expense of the owners.
The Law and Finance Literature …

106. • La Porta et al. and Juan Botero go one step
further.
• They study the regulation of labour markets in 85
countries.
• Their results suggest that countries with more
strongly regulated labour markets have
– higher unemployment rates, especially for younger
workers, and
– lower participation rates.
• They find that politics matters, but that legal
families are better at explaining the degree of
regulation.
The Law and Finance Literature …

107. The Varieties of Capitalism Literature
• The law and finance literature attributes a
central role to law, government and electoral
systems and is firmly grounded in path
dependence.
• In contrast, the VOC literature allows for
institutions to co-evolve over time and to adjust
to the changing and evolving environment.
• Importantly, the VOC literature is based on the
concept of complementarities whereby the co-
existence of two institutions increases the
efficiency or productivity of one or both of
them.

108. The Varieties of Capitalism Literature …
• It also focuses on relationships, i.e. it is embedded
in patterns of expectations and activities that
reflect not just norms and rules, but also attitudes
and values.
• In contrast, the law and finance literature is much
more mechanistic and also more fatalistic given its
strong emphasis on path dependence and history.
• Peter Hall and David Soskice have proposed two
broad varieties of capitalism, i.e.
– liberal market economies (LMEs), and
– coordinated market economies (CMEs).

109. • The main difference between
the two varieties is the way
they tackle economic
coordination problems.
• LMEs resolve economic
coordination problems via
markets.
• Hence, markets – including
capital and labour markets –
are highly developed and
liquid and regulation is kept
to a minimum.
• Firms invest in generic assets
than can be easily sold off.
The Varieties of Capitalism Literature…

110. • Given the flexible labour
markets, downsizing of the
workforce in economic
downturns is common
practice.
• However, they also enable
workers to switch between
firms or even industries.
• Firms are unwilling to
invest heavily in
training given the risk that
competitors may free-ride on
their efforts.
The Varieties of Capitalism Literature …

111. • CMEs rely on complex networks to address
economic coordination problems.
• The role and size of markets will be limited and
heavy regulation will prevent their development.
• Firms invest in specific, less generic assets given
the lack of liquid markets.
• The heavily regulated labour market makes it
difficult for firms to reduce their workforce.
• Employees will also find it more difficult “shop
around” for a better job.
The Varieties of Capitalism Literature …

112. • Firms are willing to provide industry-specific
training and any attempts by competitors to free-
ride will be kept to a minimum by powerful
employer associations.
• One of the limitations of the dichotomous approach
of the VOC literature is that, apart from the role of
markets, it ignores other institutional differences
between systems.
• However, there are more complex taxonomies in
the VOC literature.
The Varieties of Capitalism Literature …

113. • For example, Richard Whitley
distinguishes between six
different types of capitalism
– “compartmentalized” (LMEs),
– “collaborative” (Western
European type CMEs),
– “industrial districts” (used to
explain regional synergies in
Italy),
– and three others which largely
describe business systems
found in the Far East.
The Varieties of Capitalism Literature …

114. • Two of the shortcomings of Whitley’s approach is
that
– it ignores the peculiarities of Mediterranean capitalism,
and
– it does not distinguish between “Rhineland” and
Scandinavian economies despite the marked
differences in job protection, wage bargaining and
financial systems.
• In contrast to Whitley’s a priori approach, Bruno
Amable’s taxonomy is systematically grounded on
comparative empirical, rather than sometimes
anecdotal case study, evidence.
The Varieties of Capitalism Literature …

115. • Amable proposes five different types of
capitalist systems which do a better job in terms
of taking into account differences across Europe
– “Asian capitalism” (e.g. Japan)
– “market-based economies” (or LMEs)
– “social democratic economies” (Scandinavia),
– “Continental European capitalism” (France,
Germany, Benelux), and
– “south European capitalism” (Italy, Greece, etc.)
CMEs
The Varieties of Capitalism Literature …

116. • Indeed, within the broader group of the
CMEs, there are significant differences
between Scandinavia and many Rhineland
economies.
• Germany, Austria, Switzerland and Sweden
can be characterised as high job-security
CMEs.
• Denmark and Norway operate so called
flexicurity policies, which combine job
market flexibility with some degree of job
security.
The Varieties of Capitalism Literature …

117. • Flexicurity policies reduce job security, but they
also give a greater role to government in the
development of skills and unemployment
benefits are better than in LMEs.
• South European capitalism has features of both
LMEs and Continental European capitalism
– Similar to LMEs, its firms compete on price
– In common with Continental Europe, its firms have
concentrated control
– While job security is high in large firms, it is less so in
small firms and the enforcement of labour law is
weak.
The Varieties of Capitalism Literature …

118. • France and Italy share many
features of CMES such as
– the relatively small size of
their stock markets, and
– the high job security.
• However, France has moved
closer Anglo-Saxon type
capital markets in recent
years.
• Similarly, Italy is a capitalist
system with ambiguous
characteristics.
The Varieties of Capitalism Literature …

119. • There are also marked differences in terms of
training and education between the varieties of
capitalism.
• The flexibility of labour markets reduces the
provision of vocational training by employers in
LMEs to a minimum.
• In the UK, the government has focused on the
provision of good quality tertiary, vocational
training.
• This ensure cheap, short-term labour for firms.
• It also enables employees to use their generic skills
in various jobs and to switch jobs quickly.
The Varieties of Capitalism Literature…

120. • This also facilitates the distribution of ideas and
knowledge to a greater extent than would
otherwise be the case under high competition.
• The USA is often characterised by the dualistic
nature of employment and work practices.
• At one extreme, there is mass production of
standardised products and basic services
requiring cheap, unskilled workers.
• At the other extreme, there is a highly-skilled
labour force working in highly innovative
industries.
The Varieties of Capitalism Literature …

121. • The high job-security CMEs of e.g. Austria,
Germany and Sweden rely heavily on employees
with firm-specific skills and strong vocational
training.
• Good job tenure provides employees with the
right incentives to acquire firm-specific skills.
• A highly developed state welfare system
operates as a safety net to support workers
made redundant in an economic downturn.
The Varieties of Capitalism Literature …

122. • In contrast, firms in LMEs will focus on
basic induction training, but have
relatively high spends on training given
the high employee turnover.
The Varieties of Capitalism Literature …

123. Employee Stock Ownership
• There are two contrasting arguments about the
consequences of employee equity ownership.
• Peter Drucker and Masahiko Aoki support the view
that employee stock ownership should be
encouraged as it aligns the interests of the workers
with those of the shareholders.
• This will not only improve corporate performance,
but also increase the monitoring of the
management.
• Employee-shareholders have both the incentives
and inside information to monitor the
managers.

124. Employee Stock Ownership (Continued)
• Conversely, Michael Jensen and William
Meckling argue that employee equity
ownership entrenches employees.
• This will not only make it more difficult to
remove employees, but it will also push
employees to increase their wages beyond
current market rates.
• Hence, employee ownership will reduce rather
than increase corporate performance.

125. • Both of the above arguments
assume that employee stock
ownership comes hand in hand
with employee voting
power.
• However, this is not necessarily
the case as executives frequently
exercise the votes from the
employee shares.
Employee Stock Ownership (Continued)

126. • The empirical evidence as to the effect of
employee ownership on firm performance is as
yet inconclusive.
• Event studies on the adoption of US employee
stock option plans (ESOPs) either find a positive
market reaction or an insignificant reaction.
• The lack of conclusive results may be due to the
fact that
– ESOPs generate tax benefits to the firm,
– they may also be used to fend off a hostile bidder
and/or increase shareholder returns in a takeover
contest.
Employee Stock Ownership (Continued)

127. • Hence, a priori it is not clear what the stock
market reaction to ESOPs should be.
• However, Joseph Blasi et al. argue that it is
important to consider the whole set of a
company’s employment practices when assessing
the effects of employee ownership.
• They find that employee ownership lowers
employee turnover and increases the willingness
to work hard when combined with low
supervision, high-performance policies and fixed
pay at or above market rates.
Employee Stock Ownership (Continued)

128. Employee Board Representation
• Countries that have a legal requirement of
employee representation on the board of
directly include Austria, Denmark, Finland,
Germany, Luxembourg and Sweden.
• Board representation of employees in Norway
exists in a significant percentage of private-
sector firms.
• In France and the Netherlands, employee
representatives have a consultative capacity.

129. Employee Board Representation (Continued)
• The German Co-determination system is the
most generous one as it grants employee
representatives 50% of the supervisory board
seats in firms with more than 2,000 workers.
• Employee representation on the board
potentially has a dual informational role
1. It provides valuable information to the managers
about work practices, work experiences and
workers’ attitudes towards particular policies
enabling them to run the firm more efficiently

130. 2. It enables employees to gather information that
is valuable to them, such as information on
profitability, which may be used to extract above
market-rate salaries from the firm.
• Hence, a priori it is not clear what the effect of
employee board representation on
performance and productivity will be.
• The existing empirical evidence is as yet
somewhat inconclusive.
Employee Board Representation (Continued)

131. • However overall, the evidence suggests that
– employee representatives that work for the work
increase firm profitability via information sharing
with the management;
– this positive effect is particularly strong in
industries where information sharing and
coordination are important;
– there is no such effect for employee
representatives from trade unions.
Employee Board Representation (Continued)

132. Breaches of Trust and Employee Expropriation
• Andrei Shleifer and Laurence Summers argue
that changes in ownership, in particular
takeovers, may result in breaches of trust.
• These breaches of trust consist of the new
management breaking implicit contracts that
the old management had with the workforce.
• For example, the old management may have
promised lifetime employment in return for
workers investing in skills valuable to the firm.

133. Breaches of Trust and Employee Expropriation (Continued)
• The new management may be tempted to break
this promise by firing workers close to retirement
age that are perceived to be less productive.
• However, the existing empirical research provides
little support for the Shleifer and Summers
hypothesis for friendly and hostile takeovers as
well as management buy-outs.

134. • Nevertheless, there is evidence emerging from
private equity acquisitions of reductions in
employment that cannot be explained by an
equivalent increase in productivity and
profitability.
Breaches of Trust and Employee Expropriation
(Continued)

135. Conclusions
• The contrasting views of the law and finance
literature and literature on improving workers’
rights.
• The limits of the dichotomous version of the
VOC literature.
• The effect of employee ownership on firm
performance.
• The impact of employee board representation
on firm value.
• Breaches of trust and employee expropriation.

136. Next Casestudy 4 : Arthur Andersen
1. Read and prepare the Casestudy on Arthur Andersen
(Monks & Minow (2011)) for discussion next class. Identify
the corporate governance issues faced.
2. You are required to:
– Analyse the scenario’s in the case study and plot
the resulting risk analysis on an appropriate risk
map.
– Map out the stakeholder power/interest issues,
and propose the appropriate corporate actions.

137. Core Readings
• Solomon, Jill (2010) Corporate Governance and
Accountability 3rd Edition, Wiley, UK. Ch.9-10
• Goergen, Marc (2012) International Corporate
Governance, Pearson. Ch.8 & 10
• Monks & Minow (2011) Ch.2 & 3
• Gary, Owen & Adams (1996) Ch.5-10
• CIMA - Performance Strategy: Study Text (2013) BPP
Learning Media Ltd. Part B : 5-6

138. Additional Readings
• Mallin, C. A., Saadouni, B. and Briston, R. J. (1995) ‘The financial performance of ethical
investment funds’, Journal of Business Finance and Accounting, 22, 483–96.
• Gregory, A., Matatko, J. and Luther, R. (1997) ‘Ethical unit trust financial performance: small
company effects and fund size effects’, Journal of Business Finance and Accounting, 24(5), June,
705–725.
• Drexhage, G. (1998) ‘There’s money in ethics’, Global Investor, 109, 56.
• Williams, S. (1999) ‘UK ethical investment: A coming of age’, Journal of Investing, summer, 58–
75.
• Hancock, J. (1999) Making Gains with Values: The Ethical Investor, Financial Times/Prentice Hall,
London.
• Friedman, A. L. and Miles, S. (2001) ‘Socially responsible investment and corporate social and
environmental reporting in the UK: An exploratory study’, British Accounting Review, 33, 523–
548.
• Sparkes, R. (2002) Socially Responsible Investment: A Global Revolution, John Wiley & Sons,
Chichester, UK.
• Solomon, J. F., Solomon, A. and Norton, S. D. (2002) ‘Socially responsible investment in the UK:
Drivers and current issues’, Journal of General Management, November 2001.
• Mercer Investment Consulting (2005) SRI: What Do Investment Managers Think? 12st March,
Mercer Human Resource Consulting LLC and Investment Consulting Inc., New York, USA.
• Cobb, G., Collison, D., Power, D. and L. Stevenson (2005) FTSE4Good: Perceptions and
Performance, ACCA Research Report No.88, Certified Accountants Educational Trust, London,
UK.
• Freshfields Bruckhaus Deringer (2005) A Legal Framework for the Integration of Environmental,
Social and Governance Issues into Institutional Investment, UNEP Finance Initiative, produced
for the Asset Management Working Group of the UNEP Finance Initiative, October.
• Solomon, J. F. and L. Darby (2005) "Is Private Social, Ethical and Environmental Disclosure
Mythicizing or Demythologizing Reality?", Accounting Forum, Vol.29, pp.27-47.
• Mercer Investment Consulting (2006) 2006 Fearless Forecast: What Do Investment Managers
Think About Responsible Investment? March, Mercer Human Resource Consulting LLC and
Investment Consulting Inc., New York, USA.
• Solomon, J. F. and A. Solomon (2006) "Private Social, Ethical and Environmental Disclosure",
Accounting, Auditing and Accountability Journal.
• Solomon J. F. (2008) Preliminary Report on Pension Fund Trustees and Climate Change, ACCA .

139. Next Week’s Ideas for Discussion
• Abernethya, Margaret A. , Bouwensb, Jan
and Laurence van Lent (2010) Leadership
and control system design, Management
Accounting Research No.21: pp. 2–16

140. QUESTIONS?