Does “socially responsible” investing do any good?
May 21, 2011 14 Comments
In this video, I’m discussing “socially responsible” investing with the mathematician from http://askamathematician.com. If you limit your investments to companies that uphold ethical principles you care about — for example, environmental protection, human rights, diversity, etc. — how much of an impact does your investment decision have?
Is the video supposed to start so near the end?
NVM, seems to have been a glitch or have been fixed.
This reminds me of my reaction to the controversy about divesting shares in South African companies as a way to fight apartheid years ago. I eventually decided that I’d left some factors out of my analysis, and Spencer might have as well. First, the CEOs of companies really care about their stock prices whether or not their companies directly benefit from higher prices, because the value of the compensation packages depend in part on those prices. So, if you want to influence them to act on the side of the angels, you act so as put upward pressure on their share prices when their companies do good, and vice versa. Second, if it’s well known that good companies tend to have higher stock prices than bad companies (because of all the “socially responsible investment funds”), Angel Food Inc. will have an easier time going public than Devil’s Food Inc., and over time more fewer and fewer chocolate cakes will be seen in the market. Of course, there’s still the problem that I, as a socially responsible investor have only a few million bucks to throw into the market (in my dreams, anyway), and there’s every expectation that no one would notice my decisions at all — but that’s going to be a problem with almost any question about the effects of one individual out of millions. One more thing to point out is that the question of whether the actions of the socially irresponsible investors completely cancel out the intentions of us good guys really comes down to relative demand elasticities — as long at the investors with no moral compass (the un-compass-ionate?) have an incompletely elastic demand for individual stocks, the good guys can have some effect on market prices.
The argument made in the video is not that socially responsible investing in public equity markets does NO good, just that it is not a very efficient mechanism for doing good (as I said in the video). Yes, CEOs care to a certain extent about their share prices (both for reasons mentioned in the video like being able to issue new shares at higher prices to raise capital, and for the reason Barry mentioned above) but that does not imply that the slight price impact that even a fairly large fund is likely to have does very much good. If you want to do good through investing, there are much, much better ways to do so than investing in public equities.
Somehow this argument seems a little bit like saying: recycling doesn’t do NO good, but throwing away one plastic bag a week doesn’t have *that* much of an impact on the environment, so if you care about the environment, you should lobby your local utility to switch to solar power, instead of bothering with recycling.
In order to discuss a social strategy like this, we have to compare a society in which nobody does it to a society in which a significant fraction of the population does it (one percent, at least). Obviously, if you want to do good in the environment, there are better ways to do it than recycling. However, just as recycling patches up a systematic problem with waste handling (materials are not reused), socially responsible investing patches up a systematic problem with free-market economics (externalities are not accounted for). If enough people practice socially responsible investing (even if it’s only 1% of investors), then CEOs, executives, and other stakeholders in large firms will notice a downtick in the company’s share price when they announce an action considered to be morally wrong (or when their wrong actions in the past are exposed to the public), and this is probably the best chance we have at influencing their behavior.
Hey Davidad.
If you want to have your investment dollars do good, there are much better ways to do so than through investing in public stock (assuming you have lots of investment options open to you, which is indeed an assumption). For instance, using $100,000 to help fund a startup company that has a promising new helpful technology (and that wouldn’t have found funding otherwise) is much, much better for the world (in an expected value sense) than buying $100,000 of publicly traded shares of a company that owns an equivalent helpful technology.
If you are going to invest in publicly traded stock, the world is very slightly better off if you do so in socially responsible companies. In those cases where you are sacrificing return though in order to choose the socially responsible investing option, that decision needs to be weighed against the choice of going with the higher return and donating the difference in earnings to a charity that has proven effectiveness.
It also can be helpful to consider a thought experiment to see why the effects of social responsible public equity investing can be at least partly self undermining: Let’s suppose that one third of market dollars are controlled by do-gooders. Now some public company Angels & Devils Inc. was good but suddenly starts doing evil practices. About one third of dollars invested now leave the stock as do-gooders race out. But this causes the price to fall for non-economic reasons, giving profit maximizers an incentive to buy more of the stock, since it is now trading at a discount to its economic value (and therefore now represents a better investment from a return on investment standpoint).
Isn’t the stock’s market value determined by supply and demand? Less demand, lower price.
Yes, the price will be lowered with less demand, on average. The point I was making here is that profit maximizers will actually make money off of the actions of the do-gooders in this scenario (since these actions will allow them to grab shares for cheaper than they could otherwise), which has the effect of somewhat lessening the overall impact of the do-gooders selling than one might otherwise think.
Socially responsible investing does have a net effect of pushing the prices of “evil” companies downward. This is because trading a stock generates liquidity, and illiquid assets trade at low prices relative to their expected cash flows.
With that in mind, one could answer the various objections in the video as follows:
1. “Isn’t the upward price pressure from every buy I make canceled by the opposite effect from every sell?” – your trading of the stock makes it a little easier for others to purchase and sell the same stock, and thus make the stock more attractive to them.
2. “Suppose one third of the dollars leave the stock….” – as far as the company is concerned, its suddenly trading in a market which is 2/3 as large. Of course this doesn’t mean the price falls by a third or anything silly like that, but the net effect is that it has become more difficult to buy and sell large quantities of the stock, which in turn reflects itself in the price.
Even if investing in a company has no impact on the company or the world, it’s hypocritical for the investor to profit from something that the investor condemns, like when Michael Moore’s foundation owned Halliburton stocks.
Very interesting information both in the video and the comments (here and over on facebook)!
Spencer, would you have any recommended reading on the subject?
Hi Bytor,
I don’t have any suggestions for reading, unfortunately.
That was a pretty interesting conversation. It would be interesting to hear more about this topic. I think the interest of supporting socially responsible companies is growing and has to grow.