International trade, climate change and the 2007-2008 financial crisis are forever changing the landscape of investing. As advocated by free market economists such as Milton Friedman, the notion that the purpose of the firm is to maximize profit – its bottom line, irrespective of any negative impacts of the firm’s activities on the environment and society – has come under severe scrutiny over the past decade.
Negative externalities in the operation of a firm, which are many, have not thus far been factored into the cost of production of goods and services and hence into their prices. Impacts such as pollution, climate change, exploitation of labor in the global supply chain, and adverse consequences of a firm’s operations to employee and people’s health and safety have largely been dealt with in the judicial system, with the cost of such litigation eventually finding its way into prices.
There have been no attempts until the turn of the century to prevent the harmful consequences of the activities of the firm, to deal with them ex ante rather than ex post through the legal process, because the financial markets did not punish such behavior. In fact, risky financial market behavior in investing was encouraged by the government in the name of not interfering with financial innovation leading to the housing crisis in the United States and the consequent Great Recession that is still reverberating around the world. The financial crisis has put the spotlight on corporate governance and on the ability of financial institutions to weather economic downturns and any crises caused by their actions so that tax payers do not foot the bill of rescuing systemically important financial institutions and real sector corporations while also enduring loss of livelihoods, homes and jobs as a result of such crises.
The systemic negative consequences of the activities of the firm have spurred change to take the approach of strengthening the triple bottom line rather than merely the single bottom line of profit: corporate sustainability is now beginning to mean operating at the intersection of the economy, environment and society. Now more corporations are publishing annual corporate citizenship or sustainability reports along with their annual financial reports. The movement is toward publishing integrated annual reports of corporate finance and sustainability because the ability of public corporations to raise capital in the financial markets is increasingly becoming dependent on the triple bottom line. Moreover, the triple bottom line will determine the market capitalization of firms.
Investing in firms, public and private, is beginning to incorporate the medium and long term sustainability (or Environment, Society, Governance – ESG) performance of corporations along with the short term because of the financial materiality of ESG issues in strategic planning. Some examples are the financial impacts of the Deep Water Horizon Spill on BP and the Libor scandal on Barclays. “Responsible investment,” says the United Nations supported Principles for Responsible Investment (UNPRI), “requires investors and companies to take a wider view, taking into account the full spectrum of risks and opportunities facing them, in order to allocate capital in a manner that is aligned with the short and long-term interests of their clients and beneficiaries. This analysis should inform asset allocation, stock selection, portfolio construction, shareholder engagement and voting.”
The six UNPRI principles for responsible investment that UNPRI signatories adopt are:
Principle 1: We will incorporate ESG issues into investment analysis and decision-making processes.
Principle 2: We will be active owners and incorporate ESG issues into our ownership policies and practices.
Principle 3: We will seek appropriate disclosure on ESG issues by the entities in which we invest.
Principle 4: We will promote acceptance and implementation of the Principles within the investment industry.
Principle 5: We will work together to enhance our effectiveness in implementing the Principles.
Principle 6: We will each report on our activities and progress towards implementing the Principles.
Widespread adoption of responsible investing is a first step toward financial and corporate sustainability to achieve the Quadruple Bottom Line (QBL) of incorporating the future vis-a-vis the environment, social and governance actions in the present.