Socially Responsible Investment, Environmental Social & Governance factors, Enron

1. ASPECTS OF CONTROL :
CORPORATE SOCIAL
RESPONSIBILITY PRACTICES
Stephen Ong, BSc(Hons) Econs (LSE),
MBA International Business(Bradford)
Visiting Fellow, Birmingham City University
Visiting Professor, Shenzhen University
MBA1034 GOVERNANCE, LAW & ETHICS

2. • Discussion: Corporate
Culture & Governance
1
• Institutional Investors and
Environmental, Social &
Governance (ESG) Factors
2
• Case Discussion: The
Collapse of Enron
• Video : Enron
3
Today’s Overview

3. 1. Open Discussion
• Mayer, Colin (2002) “Corporate Cultures and
Governance: Ownership, Control and
Governance of European and US
Corporations”, TRANSATLANTIC
PERSPECTIVES ON US-EU ECONOMIC
RELATIONS:CONVERGENCE, COOPERATION
AND CONFLICT ,Conference paper, JFK School
of Government, Harvard University, April 11-
12

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

5. 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

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

7. 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

8. 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

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

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

11. 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

12. 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

13. 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

14. 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%

15. 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

16. 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

17. • 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

18. 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

19. 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

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

21. 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

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

23. 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

24. 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

25. 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

26. 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.

27. Code (cont.)
• 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

28. 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

29. 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”.

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

31. 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

32. 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?

33. 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?

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

35. Environmental, Social and Governance
(ESG) Factors in Institutional Investment
• Review the increasing importance of
corporate social responsibility as well
as socially responsible investment.
• Discuss the role of institutional
investors and governance.
• Discuss the principles of
Environmental, Social and Governance
(ESG) factors in institutional investment
criteria.

36. Learning Outcomes
• By the end of this lecture, you should be able
to:
1. Discuss the definitions of CSR and socially
responsible investment (SRI) and how these may
change with an investor’s set of values
2. Assess the evidence on whether investors pay a
price for SRI.
3. Describe some of the ESG issues faced by
institutional investors.

37. 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

38. • Also look at the investor side by reviewing
socially responsible investment
(SRI).
• SRI is “an investment process that considers the
social and environmental
consequences of investments, both
positive and negative, within the context of
rigorous financial analysis”.
Introduction (Continued)

39. Socially Responsible Investment
• SRI funds apply a set of exclusionary and/or
inclusionary screens to select their investments.
• However, the definition of SRI and the choice of
exclusionary and/or inclusionary screens may
change depending on the values of the investor
or index.
• E.g., the FTSE KLD Catholic Values 400 Index
excludes companies that are involved in or
support
– abortion,
– contraceptive products, and
– the use of embryonic stem cells and foetal tissue.

40. Socially Responsible Investment
(Continued)
• SRI has ancient roots
– The teachings of Judaism had strict rules on how
to invest money
– Until the middle ages, there were restrictions on
loans and investments for Christians
– In the 17th century, Quakers (“Society of Friends”)
who settled in America refused to benefit from
the weapons and slave trade.
• The Pioneer Fund, which was set up in 1928,
refused to invest in alcohol and tobacco.

41. • The Pax Fund was created in 1971 in the USA
by two Methodists who were opposed to the
Vietnam war and militarism in general
– It refused to invest in weapons contracting.
• The 1980s saw increased awareness by the
general public of racism (apartheid regime in
South Africa) and environmental issues
(Chernobyl and Exxon Valdez).
Socially Responsible Investment (Continued)

42. So is there a price for socially responsible
investment or do SRI funds outperform
other funds?
•Luc Renneboog, Jenke Ter Horst and Chendi
Zhang find that SRI funds from Europe, North
America and the Asia-Pacific region
–underperform compared to the market by
between -2.2% and -6.5% (risk-adjusted returns),
but
–they do not generally perform worse than
conventional funds from the same country.
Socially Responsible Investment (Continued)

43. CSR 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 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
CSR for Institutional Investors?

45. Investors & Environment
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
• 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. • 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. Fiduciary Risk
• 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. Financial interests
• 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. Impact on Investment
• 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 screening
• 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. SRI & ESG
• 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 & Financial Returns
• 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 Benchmark
• 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. Investors and SEE Issues
• Friedman and Miles (2001) found the City of
London was taking SEE issues far more
seriously
• Interviews with institutional investors found
they are dissatisfied with the level of social
and environmental reporting (Solomon 2007)
• Public disclosure is inadequate and therefore
private disclosure channels are developing

73. Private social and
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. Legal perspective : ESG reporting
• 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:
Mythisising 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. The 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. Trustees Responsibility
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. Duty of Trustees
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. Purpose of Trust
• 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. Profit Maximisation?
• 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. Why not profit maximisation?
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. Pension Funds & 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

86. Climate Change Predictions
• The Intergovernmental Panel on Climate Change
(IPCC) state by end of C21st 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 Impact
• 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. CASE DISCUSSION :
THE COLLAPSE OF
ENRON

96. Cases - The Collapse of Enron:
Governance and Responsibility
• Enron was a great business success soaring to a
market capitalization in excess of $60 billion and
ranking seventh on the Fortune 500 list
• Enron was creative in its financial arrangements,
entering into numerous partnerships with a variety of
entities
– The partnerships allowed Enron to keep substantial losses
off its financial statements
• Under increasing pressure from its own failed
investments, facing difficulty in obtaining financing,
and under scrutiny from Wall Street, on October 16
Enron reported:
– A third-quarter pre-tax loss of $710 million and
subtracted $1.2 billion from shareholders’ equity

97. Cases - The Collapse of Enron:
Governance and Responsibility
• A central component of Enron’s strategy was to
utilize subsidiaries and special purpose entities
• In 1993 Enron established a partnership named
JEDI (Joint Energy Development Investments)
with the California Public Employees’ Retirement
System (CalPERS) as the limited partner
• In 1999 Fastow proposed establishing a
partnership LJM Cayman LP (LJM1) for the:
– Ostensible purpose of hedging Enron’s investment in
Rhythms NetConnections by obtaining investments
from outside investors

98. Cases - The Collapse of Enron:
Governance and Responsibility
• Raptor was Enron’s name for a partnership
used to hedge its merchant investments
portfolio in projects and companies
• Enron employees participated in 401(k)
retirement plans, and most of them held
Enron shares
• The Board of Directors was responsible for
the performance of the company and had a
fiduciary duty to shareholders

99. Further Reading
• Solomon, Jill (2010) Corporate Governance and
Accountability 3rd Edition, Wiley, UK. Ch.9-11
• Goergen, Marc (2012) International Corporate
Governance, Pearson. Ch.8
• Gary, Owen & Adams (1996) Ch.2-4
• CIMA - Performance Strategy: Study Text (2012)
BPP Learning Media Ltd. Part B : 4
• Baron, David P.(2013) Business and its
environment, 7th Edition, Pearson

100. Additional Readings (1)
• 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.

101. Additional Readings (2)
• 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 (on blackboard).

102. NEXT Ideas for Discussion
• Morck, Randall and Yeung, Bernard
(2003) Agency problems in large
Family Business Groups,
Entrepreneurship: Theory and
Practice, Summer 2003. Vol. 27, No.
4: pp. 367 – 382

103. QUESTIONS?