bottom line management

Adding Business Ethics to the Bottom Line - Does Corporate Social Responsibility Pay Off? By Johannes van de Ven Advisor, Swiss Consulting Group SCG Occasional Paper # 14 Adrianópolis – Rio de Janeiro, September 4, 2005 Contents 1. Introduction: Bringing Ethics into Business ........................................................... 1 2. Religious Roots: Shareholder Activism.................................................................. 2 3. Reporting Renaissance: Integrated Accounting ...................................................... 4 4. Financial Accountability: Social Responsible Investments..................................... 6 4.1. Cutting Global Warming............................................................................... 7 4.2. Dutch-Brazilian Carbon Trading ................................................................. 10 4.3. Microfinance............................................................................................... 13 5. Sustainable Banking: Equator Principles.............................................................. 14 5.1. Financing Soybeans in Brazil...................................................................... 15 5.2. Financing Timber in Indonesia.................................................................... 18 5.3. Financing Warfare in Belgium .................................................................... 19 6. Conclusion: The Road Ahead .............................................................................. 21 6.1. Beyond Reputational Damage Control ........................................................ 21 6.2. Reversing Money Flows ............................................................................. 22 6.3. Increasing Public-Private Partnerships ........................................................ 23 References............................................................................................................... 25 1. Introduction: Bringing Ethics into Business Since the turn of the millennium, the corporate social responsibility (CSR) debate has taken decisive new dimensions. Triple bottom line management initiatives, which focus simultaneously on people, profit and planet, have grown exponentially and are reshaping global corporate conduct. The idea that corporations have societal responsibilities has become commonplace. The two top countries are Japan and the United Kingdom, where eighty and seventy percent of all corporations are conducting separate CSR reporting respectively. Following the earlier lead of electronics & computers, oil & gas companies, now also the financial sector is catching up in ADDING BUSINESS ETHICS TO THE BOTTOM LINE - DOES CORPORATE SOCIAL RESPONSIBILITY PAY OFF? SCG Occasional Paper # 14 – Johannes van de Ven – Rio de Janeiro – September 2005 sustainability reporting. Between 2002 and 2005, financial institutions showed more than a two-fold increase in CSR reporting.1 The vogue of business ethics, however, does not mean that there is a consensus on theoretical models and professional implementation. Corporations are inundated with requests from politicians, non-governmental organizations and stakeholders alike to implement CSR policies without a clear consensus on what should or ought to be achieved. Harvard Business School’s Michael Porter correctly warns that CSR often looks like an “all a defensive effort, a PR game in which companies primarily react to deal with the critics and the pressure from activists.”2 His primary concern is that companies are reacting to pressure rather than having their own affirmative strategies. Others have argued that CSR should be regarded as politically a fairly moderate endeavor aimed at adjusting certain market imbalances. 3 It is time to revisit the debate. In my first paper on this issue, published as Occasional Paper #12 in August 2003, I outlined the rise of business ethics and highlighted two promising new initiatives: Michael Porter’s Context-Focused Strategic Philanthropy and Thomas Dunfee’s Direct Corporate Humanitarian Investment models.4 Since then, the business ethics discourse has significantly evolved. In this paper, I will therefore turn the spotlight on several promising new applications of business ethics: shareholder activism, integrated accounting, social responsible investments and the Equator Principles. All these initiatives are examples of how business ethics is leaping outside the box of outdated management thinking and narrow business models. Before turning to contemporary CSR strategies, I will briefly highlight key initiatives which first raised awareness in civil society. 2. Religious Roots: Shareholder Activism Modern day shareholder activism started in the United States in the late 1960s. Religious orders tried to invest in their ideals of non-violence and stewardship. Congregations often inspired their actions on Quakers and Mennonites whose commitment to non-violence and peace actively led to avoiding investments in institutions involved in weaponry and slavery. The great leap forward for proactive religious engagement came during the Vietnam War when churches boycotted and pressured companies like Honeywell for manufacturing napalm. KPMG & University of Amsterdam (2005), “Fifth International Survey of Corporate Responsibility Reporting,” June. 2 European Business Forum (2003), “CSR – a Religion With Too Many Priests? Interview with Michael Porter,” Copenhagen Business School, September. 3 For the theoretical debate, see: Dubbink, Wim (2004), “The Fragile Structure of Free-Market Society. The Radical Implications of Corporate Social Responsibility,” Business Ethics Quarterly, January. 4 For an in-depth analysis on corporate philanthropy, see Hess, David; Nikolai Rogovsky, & Thomas W. Dunfee (2002), “The Next Wave of Corporate Community Involvement: Corporate Social Initiatives,” Harvard Business Online, January. 1 2 ADDING BUSINESS ETHICS TO THE BOTTOM LINE - DOES CORPORATE SOCIAL RESPONSIBILITY PAY OFF? SCG Occasional Paper # 14 – Johannes van de Ven – Rio de Janeiro – September 2005 In 1971, several religious denominations established the Interfaith Center on Corporate Responsibility (ICCR).5 It is still the leader in the area of shareholder activism, which describes investor efforts to submit and vote corporate proxy resolutions as a means of influencing corporate behavior. Concrete actions include letter writing, engaging in direct management dialogue, public filing of shareholder resolutions, speaking at annual meetings. Proxy education also includes community hearings, public education, product boycotts and radio interviews. One of its first actions focused on IBM in 1975 for selling and leasing computers in South Africa. In Europe, the first major action was launched by churches in England at the annual meeting of Royal Dutch Shell for breaking the oil sanctions against Rhodesia in 1979. Religious communities were also the first to raise awareness against multinational involvement in the South African system of Apartheid. As early as 1972, the World Council of Churches sold its stock holdings in firms directly involved in South Africa and Rhodesia. In 1977, the US General Board of the National Council of Churches withdrew all funds from banks that invested in South Africa. The South African Divesture Movement was the first successful shareholder activism victory in modern day. There are no doubts that the eventual demise of the apartheid regime in the 1990s can be traced back to outspoken shareholder activism. One of the latest ICCR campaigns involves microfinancing. In a proxy presented at a JPMorgan Chase shareholder meeting, the ICCR urged the company to follow the lead of Citigroup, Deutsche and HSBC, which have already implemented microfinance schemes. According to the proxy sponsored by the ICCR, “we believe not only that our corporation will find this financing profitable but also that the long term financial interests of our corporation will be enhanced. Therefore be it resolved that the shareholders request the Board to develop policies that will enable JPMorgan Chase to participate in the funding of microfinance groups through its use of capital markets and to report to the shareholders by the time of the 2006 annual meeting on its plans and achievements in this area.”6 The proxy however did not make much of an impact among the majority of shareholders and was withdrawn for further dialogue. Other proxies have been more successful. A case in point is a proxy directed at Abbott Laboratories to raise awareness of the AIDS pandemic. After a successful proxy campaign, Abbott committed itself to donate up to 20 million of its so-called rapid (15 minutes) tests which determines HIV. Its donations enabled pregnant women to get tested in 68 countries.7 In partnership with Boehringer-Ingelheim, whose drug helps reduce the transmission of the virus to newborns, Abbott directed treatment to women who are HIV-positive. By the year 2007, the company expects to invest $100 million in AIDS-related humanitarian programs. 8 5 At the turn of the millennium, the Interfaith Center on Corporate Responsibility has $110 billion at its disposal. Its membership numbers 275 Catholic, Protestant and Jewish denominations. 6 For an overview of ICCR proxies, see www.iccr.org/shareholder. 7 For more details, see www.accesstohivcare.org and www.abbott-pmtct-testing.org. 8 On the back of the ICCR campaign, several US Jesuit provinces have co-filed resolutions with Bristol Meyers Squibb, Merck, Eli Lilly and Pfizer. The Bill and Melinda Gates Foundation also recently got engaged in a public-private partnership with Botswana to address the country’s infrastructure and handling of AIDS. 3 ADDING BUSINESS ETHICS TO THE BOTTOM LINE - DOES CORPORATE SOCIAL RESPONSIBILITY PAY OFF? SCG Occasional Paper # 14 – Johannes van de Ven – Rio de Janeiro – September 2005 Proxy voting is clearly gaining momentum on multiple fronts. The latest significant victory includes a new rule implemented by the United States Securities and Exchange Commission (SEC) requiring mutual funds to disclose their proxy votes and successful shareholder resolutions and dialogues on matters related to global warming, sexual orientation nondiscrimination, and AIDS. Yet another contemporary example of faith-based shareholder activism which deserves special attention is one concentrating on Halliburton, a US company providing engineering and construction services. In May 2005, the Bush Administration awarded $4.972 billion to its subsidiary Kellogg, Brown and Root (KBR) for its logistical support to the US military occupation of Iraq, including camp maintenance, new construction and the serving of four meals a day for 120,000 troops at 62 primary camps and a dozen satellite camps. The Texas-based company also holds contracts to assist in restoring Iraq’s oil industry and import needed fuel (known as Restore Iraqi Oil) at a total cost of $3.7 billion.9 Faith-based groups are calling to boycott corporations who are profiting from the war on Iraq, the biblical location of the Garden of Eden. Shareholder activism against Halliburton has become even more outspoken since a report released by Democratic members of Congress, showing that Halliburton contracts represent 52 percent of the total value of all Iraq contracts managed by the Defense Department.10 The report also accuses Halliburton of possibly billing the Pentagon for more than $1.4 billion in questionable and unsupported costs based on audits by the Defense Contract Auditing Agency. In the same line of thought, fund-manager Domini has recently announced that it will exclude companies that are major nuclear weapons contractors or that fuel international trade in conventional weapons, such as Lockheed Martin, Northrop Grumman, and Raytheon. Conflict Securities Advisory Group is currently the world’s only firm dedicated to informing institutional and individual investors of terrorismand proliferation-related risk factors that can negatively affect the share values and reputations of publicly traded companies. 11 3. Reporting Renaissance: Integrated Accounting One of the most heavily publicized developments in business ethics is the recent spate of accountability failures. In the early 2000s, it became clear that the line between legitimate and inappropriate accounting techniques has been too hazy. The fuzzy math often applied led to the now infamous cooking of the books with disastrous results for companies like Enron and WorldCom in the United States and Parmalat and Ahold in Europe. Faced with pressure to meet or beat quarterly earnings estimates from investment bankers and shareholders, companies too often used a variety of tricky 9 Briody, Dan (2004), “The Halliburton Agenda: The Politics of Oil and Money,” Weinheim, Germany: Wiley. 10 The report was conducted by Representative Henry Waxman of California and Senator Byron Dorgan of North Dakota. 11 For more details, see www.conflictsecurities.com. 4 ADDING BUSINESS ETHICS TO THE BOTTOM LINE - DOES CORPORATE SOCIAL RESPONSIBILITY PAY OFF? SCG Occasional Paper # 14 – Johannes van de Ven – Rio de Janeiro – September 2005 accounting measures and tax loopholes, therefore deliberately manipulating company revenues. In return, audit companies failed to use their good faith judgment or hardly questioned dubious practices due to conflict of interest. Audit companies sometimes even served as management consulting firms which had a key interest in presenting strong or weak financial numbers, thereby obscuring the true financial position. In most corporate scandals, dubious practices often included one of the following: • • • • • • • • • • • • • deferring expenditures; not replenishing inventories; over- or understating one-time restructuring charges; selling stock option schemes; introducing excess volatility on balance sheet or income statement; creating special purpose vehicles; elaborating unregulated derivatives; buying or selling illiquid securities at a fictitious loss or gain; under- or overstating the fair value of forwards, futures, swaps or options; under- or overstating intangible assets; under- or overstating future earnings prospects; under- or overinvoicing to dodge taxes; prematurely recognizing revenues.12 Although financial accounting by nature runs behind the curve, it is clear that the international accounting bodies should try to overcome these rather huge deficiencies. Tackling or seriously dealing with deficiencies is also difficult because financial markets know how to steer clear of burdensome compliance. The collapse of Enron and other high profile implosions have made clear that auditing is not only about numbers. Reporting is in the end a question of transparency and accountability. The new frontier in accounting is therefore non-financial reporting. Social auditing is slowly moving from the fringe to the center, from the extraordinary to the expected. Although non-financial accounting is still in an embryonic phase, over 2,000 companies worldwide are already publishing stand-alone citizenship, sustainability, environmental and social reports. The main challenge going forward also includes a process of standardization. A growing percentage is using the general framework of the Global Reporting Initiative (GRI), the emerging international standard for non-financial disclosure. Institutions like the SustainAbility, the Governance Metrics International (GMI), Institutional Shareholder Services (ISS) and the Corporate Library (TCL) are trying to build a consensus on how to implement such standards.13 The International Standard for Assurance Engagements (ISAE) 3000 and AccountAbility 1000 Assurance Standard are trying to introduce assurance standards worldwide. Markets also are starting to For more details on this issue, see: Millstein, Ira (2005), “When Earnings Management Become Cooking the Books,” Financial Times, May 27. 13 Larcker, David; Scott Richardson & Irem Tuna (2005), “Ratings Add Fire to the Governance Debate,” Financial Times, May 27. 12 5 ADDING BUSINESS ETHICS TO THE BOTTOM LINE - DOES CORPORATE SOCIAL RESPONSIBILITY PAY OFF? SCG Occasional Paper # 14 – Johannes van de Ven – Rio de Janeiro – September 2005 reward companies that reach beyond the narrow confines of conventional financial reporting by voluntary or mandatory action. No consensus however has been reached on the causal relationships between transparency and financial performance. What has become clear, nonetheless, is the fact that markets are using reporting practices as a proxy for quality of management. According to a 2002 Standard & Poor’s analysis of disclosure practices of 1,500 companies, the amount of information companies provide in their annual reports is correlated to market risk and their respective valuations, especially to higher price-to-book ratios and the ability to lower the cost of capital.14 The cost of opacity or deficient disclosure remains huge. Corporations are warning that higher auditing compliance should not result in higher costs. As proven by the US Sarbanes & Oxley Act, regulatory demand for certified financial statements and other materially accurate periodic disclosures about corporate condition can be onerous. At the same time, a positive development is the adoption of the US Securities and Exchange Commission in July 2005 of so-called fair-value accounting, a system which is supposed to update items regularly in order to capture their current value. In sum, a healthy balance to close the accountability deficit is urgently needed. Governmental regulations should stimulate a company to excel in its wealth-creating potential, without imposing burdensome compliance. Establishing a consensus about eligibility criteria and regaining credibility are the biggest challenges in the medium term. 4. Financial Accountability: Social Responsible Investments CSR has also caught the eye of the asset management universe. In the last couple of years, social responsible investments (SRI) have sharply risen. As of 2005, some $2.5 trillion are managed under the SRI banner. The yearly growth rate is around 15 percent. In the 1990s, SRI was mostly defined as negative investing or avoiding socalled sin-stocks, such as tobacco, alcohol, gaming industry, and weaponry companies. Since 2000, SRI has increasingly become proactive, which means that companies are screened for its positive record on human rights, environmental policies and accounting transparency. The most widely publicized indices are the Calvert Social Balanced Fund and the Domini Social Equity Fund in the United States, and the FTSE4Good Index in the United Kingdom. Due to their culture heritage, Europeans and Americans seem to adopt remarkably different social investment strategies. What is interpreted as “good corporate conduct” differs from culture to culture. Americans are more interested in issues related to sexual harassment, discrimination, practices of gifts, genetic engineering, contraceptives, whistle-blowing policies, sensitive payments or bribery. Philanthropic contributions and entrepreneurship is more stimulated in Anglo-Saxon cultures, notably the United States, the United Kingdom and Australia. The hallmark of corporate social behavior in Northern Europe is job security and a clean environment, 14 Patel, Sandeep (2002), “Transparency and Disclosure: Overview of Methodology and Study ResultsUnited States,” New York: Standard & Poor’s. 6 ADDING BUSINESS ETHICS TO THE BOTTOM LINE - DOES CORPORATE SOCIAL RESPONSIBILITY PAY OFF? SCG Occasional Paper # 14 – Johannes van de Ven – Rio de Janeiro – September 2005 whereas the benchmark in emerging economies is basic healthcare and educational opportunities. European investors, in return, are more sensible to issues related to a broader range of human rights, environmental protection, arms trade and nuclear energy. Whereas the average American favors the individual, legalistic, compliance approach, the average European is more driven by a collective, universal, idealistic approach. Cultural perceptions and preferences are behind the fact that global brands such as McDonald’s, Coca-Cola, Pepsi and Nestle are considered as the most socially responsible by some and most irresponsible by others. Countries like France and Brazil, for example, have a cultural inclination towards governmental regulation, whereas countries like the United States and the United Kingdom try to minimize bureaucratic intervention. Despite the impressive rise of SRI, reviews have been mixed, with critics ranging from those who believe that any kind of SRI is the antithesis of sound business practice to those who believe that all corporations are evil and that to participate in the capital markets is to enable the evil-doers. Some SRI funds might have outperformed the market by a huge margin, but the opposite might also be true. Whereas the Ave Maria Catholic Values Fund, a fund based on the teachings of the Catholic Church set up in 2001, outperformed the broader market with an average annual return of 18 percent between 2002 and 2005, the same holds true for the Vice Fund, which invests primarily in alcohol, tobacco, firearms and gambling. 15 Controversial is the fact that both funds owe their outperformance to huge investments in US Homeland Security companies. Moral or immoral investing is therefore not always correlated to heavenly rewards or divine intervention.16 As of 2005, less than one percent of all assets under institutional management fall under the SRI category. The vast majority of investors is just chasing the highest yield or return available. Governmental incentives should be created to stimulate SRI and bring more mainstream investors on board. 4.1. Cutting Global Warming One of the latest developments in the SRI arena, which deserves special attention, is related to carbon trading. It is no secret that oil companies are among the largest contributors of carbon dioxide emission.17 For decades, SRI portfolio managers have criticized oil companies for the obvious link between profitability and environmental liabilities. 18 Although it has been difficult to harness political momentum toward 15 For more details, see: Waxler, Caroline (2004), “Stocking up on Sin: How to Crush the Market with Vice-Based Investing,” John Wiley & Sons. 16 In November 2003, the United States Conference of Catholic Bishops (USCCB) released an updated statement of its guidelines for Catholic socially responsible investing 17 Carbon dioxide and other greenhouse gasses trap infrared heat around the globe that would otherwise dissipate into space, and therefore causing climate change. The Kyoto Protocol covers a basket of six greenhouse gases, including carbon dioxide. 18 For legally viable ways to litigate against companies linked to climate change, see: Grossman, David A. (2003), “Warming Up to a Not-So-Radical Idea: Tort-Based Climate Change Litigation,” Columbia Journal of Environmental Law, February. 7 ADDING BUSINESS ETHICS TO THE BOTTOM LINE - DOES CORPORATE SOCIAL RESPONSIBILITY PAY OFF? SCG Occasional Paper # 14 – Johannes van de Ven – Rio de Janeiro – September 2005 identifying solutions, some serious progress has been achieved lately. Oil company bashing is being replaced by proactive policy measures. In the United States, the Investor Network on Climate Risk (INCR) and the Coalition for Environmentally Responsible Economies (CERES), which organized a summit on the issue at the United Nations, are lobbying the political arena. This has not been an easy job. The US government currently expects domestic carbon emissions to rise 37 percent by 2025 to nearly 8.1 billion tons a year. Some argue that the answer lies in proactive measures such as curbing demand, imposing a punitive carbon tax and dramatically increasing taxation on gas-guzzling sports utility vehicles (SUVs). The Bush Administration, however, is more interested in allowing oil exploration in Alaska, keeping Chinese companies from buying American oil companies and fostering nuclear power.19 As of July 2005, the main thrust of the US Senate is to provide incentives for nuclear energy generation. 20 The approach of the Bush Administration might be superficially appealing but lacks in a long-term vision. Wishful thinking should not obscure the quest for real solutions. Even the big international oil conglomerates such as ExxonMobil and Chevron have begun an advertising campaign warning that the world is running out of oil and that alternatives to oil for energy generation should be developed. In July 2005, ExxonMobil advertised that “The world faces enormous energy challenges. There are no easy answers.” Chevron also launched a campaign emphasizing that “One thing is clear: The era of easy oil is over. We call upon scientists and educators, politicians and policy-makers, environmentalists, leaders of industry of each one of you to be part of reshaping the next era of energy. Inaction is not an option.”21 From the Orient, yet another example arises to tackle the energy problem. Japanese carmakers, especially Toyota, have been at the cutting edge in their efforts to increase fuel efficiency of automobiles. According to the World Resources Institute (WRI), a Washington, DC-based environmental research and policy organization, and Sustainable Asset Management (SAM), a Zürich-based sustainable investment firm, a promising development is the recent tie-up between Toyota and Nissan around hybrid 19 According to the Economist, “The most worrying aspect of the CNOOC episode, however, is what it says about America. The anti-China hysteria in Washington, DC, the cowardly silence of the pro-China business lobby and the blatant disregard for fair play and open markets is deeply disturbing. A secondrank oil firm such as Unocal is not worth such a sacrifice of principles. Blocking CNOOC has not meaningfully increased America's energy security. But it may have damaged American business interests, in China and elsewhere.” See: “Giving China a bloody nose,” August 4, 2005. 20 It’s worth recalling that the last nuclear power plant in the United Stated was ordered in 1973. The meltdown of the Three Mile Island near Middletown, Pennsylvania, in 1979, however, destroyed public confidence and prompted the cancellation of more than 100 nuclear reactors orders. For more details, see: Walker, J. Samuel (2004), “Three Mile Island: A Nuclear Crisis in Historical Perspective,” Berkeley: University of California Press. A similar approach is advocated by Australia as it started negotiations with China on sale of uranium. Australia’s Foreign Minister, Alexander Downer, defends going nuclear by arguing that “countries using Australian uranium (for power generation) avoid carbon emissions roughly equivalent to Australia's entire annual CO emissions.” For more information, see: Johnston, Tim (2005), “Australia to begin negotiations with China on sale of uranium,” Financial Times, August 10. 21 Hoyos, Carola (2005), “Big Oil warns of coming energy crunch,” Financial Times, August 5. See also ExxonMobil’s report “The Outlook for Energy. A 2030 View” and Chevron’s campaign website www.willyoujoinus.com. 8 ADDING BUSINESS ETHICS TO THE BOTTOM LINE - DOES CORPORATE SOCIAL RESPONSIBILITY PAY OFF? SCG Occasional Paper # 14 – Johannes van de Ven – Rio de Janeiro – September 2005 electric vehicles (HEVs).22 Interestingly, the same institutions predicted several years ago that General Motors and Ford stand to lose more than other automakers in complying with regulations that countries around the world will adopt over the next decade to curb global-warming emissions. The recent downgrade by rating agencies of General Motors debt to junk status is a clear example that capital markets are punishing companies that make the wrong bets or are simply running behind the innovation curve. The old dictum that “what’s good for General Motors is good for America” is no longer true. The American car industry in running on empty. The European Union is the most advanced in addressing the carbon emission problem. As of January 2005, the European Union has put a market price on carbon dioxide.23 Corporations operating within the European Union that emit large amounts of carbon, including energy-intensive industries in the area of electricity generation, oil refineries, iron and steel, cement and lime, pulp and paper producers, are forced to monitor their emissions. The polluters must calculate their emissions of carbon dioxide, based on a certain methodology. Companies that fail to cut emission levels must become buyers of allowances. The philosophy behind these drastic measures is to encourage companies to find ways to reduce pollution. The price of such allowance has tripled in the first six months of existence. The European Climate Exchange is currently the only emissions futures market.24 The new European trading system was inspired on the Chicago Climate Exchange, where America’s voluntary emissions market is located. Between 1995 and 2005, the United States has cut by 50 percent its sulphur emissions, which causes acid rain, by implementing mandatory caps with tradable allocations. European companies face heavy fines if they exceed their emissions caps. This is not the case in the United States, which is the world’s biggest polluter.25 As of June 2005, the Energy Exchange in Austria, Powernext in France and the European Climate Exchange in Amsterdam have started to trade spot and futures contracts side-by-side. The huge trading volumes make the carbon trading scheme a serious part of global financial markets. The higher price reflects investor appetite for innovative solutions and makes polluters aware of the harm they cause. Market makers are increasingly focusing their attention on countries such as China, India and Brazil for the launching of so-called Clean Development Mechanisms (CDMs) and Certified Emissions Reductions (CERs). Another challenge going forward is to incorporate the emission reduction obligation as formulated under the Kyoto Treaty. The benefits to society and the environment are obvious. The trading scheme is so successful that several European cities are now vying to become the center for this highly lucrative commodity market. The United Kingdom is the leader as it already had a voluntary scheme before the mandatory regime was launched. Cutting-edge 22 World Resources Institute (2003), “Changing Drivers: The Impact of Climate Change on Competitiveness and Value Creation in the Automotive Industry,” Washington, DC. 23 For more details, see: Commission of the European Communities (2005), “Winning the Battle against Global Climate Change. A Background Paper,” Brussels, February. 24 For an overview, see: Henderson Global Investors (2005), “The Carbon 100. Quantifying the Carbon Emissions, Intensities and Exposures of the FTSE 100,” London, June. 25 Economist (2005), “First-mover disadvantage,” July 5. 9 ADDING BUSINESS ETHICS TO THE BOTTOM LINE - DOES CORPORATE SOCIAL RESPONSIBILITY PAY OFF? SCG Occasional Paper # 14 – Johannes van de Ven – Rio de Janeiro – September 2005 multinationals such as Rio Tinto and Toyota have called for a global carbon trading system. The trading scheme is the first market-driven approach to address the climate change problem. There are signs within the European Union to apply the same approach to waste dumping. Business sectors which are expected to be incorporated in the scheme soon are aviation, aluminum and chemicals. The carbon trading scheme is a promissory example of how businesses and governments can work together. Diplomats and business leaders should urgently try to convince their American counterparties to adhere to the same mandatory scheme which is proven to be the most effective tool in achieving a cleaner environment. If the United States does not adhere then it runs the risk to be effectively isolated, as only a level global playing field can make the difference. The greater the prospect of significant trading volume, the more liquid the secondary market, which in return can translate in more efficiently-run environment. In sum, SRI is here to stay. The EU carbon trading scheme should be replicated across other industries and continents. The biggest risks associated with ethical portfolios include a lack of diversification, a tendency to go overweight certain sectors, and biases towards growth.26 There is also not yet sufficient evidence that good governance lead to improved returns on investment in the long term. So far there have been too few compelling results to back a correlation. Only if a positive correlation can be proved then SRI can really take off. Global financial markets, which are constantly operating in a state of uncertainty and naturally inclined to discount the future and bet on the unexpected, are poised to play a crucial role in the environmental debate. A recent report by bulge-bracket investment bank Goldman Sachs concluded that companies with the best track record in terms of social responsibility, combined with a long-term vision about a low-carbon future, also dominate the market share of so-called ‘new legacy’ projects, which in return are regarded as key determinants of business success.27 More research in this field is warranted. 4.2. Dutch-Brazilian Carbon Trading Brazil’s approach to tackle problems related to energy problems can serve as an example for other nations. Brazil’s visionary approach started in the early 1970s during the first worldwide oil crisis. Back then, the South American giant still relied for 80 percent on imports to supply its fuel demand. In order to become less dependent on foreign markets, Brazil invested heavily in its homegrown sugar-based ethanol industry. Brazil’s smart move has made it much less dependent on the Middle East and made its economy insulated from the current record oil prices. As of 2005, Brazil is the world’s biggest producer and exporter of sugar. Around fifty percent is used to make ethanol, which is used as an automobile fuel. Brazil’s so-called flexi-fuel vehicles, which allow drivers to vary the amount of gasoline or ethanol, account for half of domestic car sales. 26 Commerzbank (2002), “Green with Envy: SRI Investors Face Additional, More Complex Risks than Their Conventional Counterparts,” Frankfurt am Main. 27 Turner, Mark (2004), “Appealing to money man,” Financial Times, June 24, p. 3. 10 ADDING BUSINESS ETHICS TO THE BOTTOM LINE - DOES CORPORATE SOCIAL RESPONSIBILITY PAY OFF? SCG Occasional Paper # 14 – Johannes van de Ven – Rio de Janeiro – September 2005 Another creative example is how the Brazilian government is adopting the outcome of the 1997 Kyoto Protocol. In an effort to comply with the Clean Development Mechanism, which was created under the protocol, signatory nations have to cut greenhouse-gas emissions 6% below 1990 levels by 2012. One of the most promissory applications is a Dutch-Brazilian enterprise which started in February 2005. The Dutch have agreed to buy methane from Brazil for $4.15 per ton. The methane gas is generated by new landfills, financed by the Dutch, to fuel a thermoelectric plant with the capacity to generate 12 megawatts. The methane is no longer burned, which used to be the case in order to produce electricity, because that would emit carbon dioxide into the atmosphere. The plant will cut emissions of gases that cause the greenhouse effect by the equivalent of 14 million tons of carbon dioxide over the next 21 years. The resulting reduction of greenhouse gas emissions will in return be converted into certificates which will be tradable on a new emissions certificates market. The plant is located in Adrianópolis, a district of Nova Iguaçu, located at the edge of the Baixada Fluminense. This project in Rio de Janeiro’s notorious metropolitan area generates energy from garbage has huge social and environmental benefits. The Wall Street Journal, however, is not impressed with the project. It argues that “the attempt in Nova Iguaçu to help the atmosphere is raising a thorny social issue on the ground: what to do with impoverished scavengers whose only source of income is taken away when a tightly controlled modern landfill replaces an old-style dump that was open to all.”28 A cleaner treatment of garbage, however, eventually will result in better living conditions for the locals. The Wall Street Journal forgets to mention that the Adrianópolis plant is directly replacing the Marambaia rubbish dump, which produced two million tons of waste, contaminating heavily underground water 28 Ball, Jeffrey (2005), “Greenhouse Passes To Cut Pollution, Dutch Pay a Dump In Brazil to Clean Up,” Wall Street Journal, August 11. 11 ADDING BUSINESS ETHICS TO THE BOTTOM LINE - DOES CORPORATE SOCIAL RESPONSIBILITY PAY OFF? SCG Occasional Paper # 14 – Johannes van de Ven – Rio de Janeiro – September 2005 supplies and rivers. The Adrianópolis project moreover offers the waste pickers 150 formal sector jobs involving reforestation of the indicated landfill area. Transforming scavengers, who work in subhuman conditions, into micro entrepreneurs is yet another major contribution. Local entrepreneurs also support the project.29 See below some pictures of the plant: I personally have been working in the Baixada Fluminense region since July 1991. More local color is available upon request. 29 12 ADDING BUSINESS ETHICS TO THE BOTTOM LINE - DOES CORPORATE SOCIAL RESPONSIBILITY PAY OFF? SCG Occasional Paper # 14 – Johannes van de Ven – Rio de Janeiro – September 2005 4.3. Microfinance In the area of financial accountability, microfinance constitutes one of the most effective and popular means of fighting poverty in developing countries. Microfinance is the extension of small loans to entrepreneurs too poor to qualify for traditional bank loans. The year 2005 has therefore been chosen as the United Nations International Year of Microcredit, in an effort to meet demand for basic financial services and remove constraints that exclude people from fully participating in the financial sector in emerging markets.30 The leader in microfinancing is the Grameen Bank, which started in 1976 and as of 2005 serves over 4.4 million borrowers, of which 94 percent are women. Loans are usually made to women as they are considered to be the better poverty fighters. According to Grameen philosophy, women tend to invest their profits in their children, nutrition, and education.31 In 2004, the Grameen Foundation USA announced the offering of the first and largest microfinance bond issued from US capital markets with a 7-year tenor, yielding 25 to 50 basis points over US Treasury bills. The $40 million bond is enabled mostly by a $30 million guarantee from the Overseas Private Investment Corporation (OPIC) and is directed at nine developing nations. The guarantee is provided by two SRI firms, Geneva-based BlueOrchard Finance and Connecticut-based Developing World Markets. The senior notes are backed by the OPIC-guaranteed funds and are therefore considered as safe as investing in 7-year US Treasury Notes. 30 31 For more details, see: www.internationalyearofmicrocredit2005.org or www.microcreditsummit.org. For background information on the Grameen philosophy, see: www.grameen-info.org. 13 ADDING BUSINESS ETHICS TO THE BOTTOM LINE - DOES CORPORATE SOCIAL RESPONSIBILITY PAY OFF? SCG Occasional Paper # 14 – Johannes van de Ven – Rio de Janeiro – September 2005 Also in 2004, Citigroup lead-managed the equivalent of $44 million, pesodenominated bond issued by Financiera Compartamos, a Mexican microfinance institution. With the backing of the International Finance Corporation, the issue received a double-A rating by Standard & Poor’s. These two landmark bond issues mark a shift from a philanthropy-based to a commercial-based model. Microfinance banks are turning to capital markets due to bigger demand but also because funding from traditional sources like the World Bank is becoming inadequate. With high global liquidity, the international capital markets should increasingly be used as a source of funding. Microfinance has proven to be an effective tool to lift the poorest out of the poverty trap. According to a study conducted by Wharton Business School, more than 500 microfinance institutions around the world have loaned $7 billion to about 30 million small-business people.32 The main challenge going forward is to achieve ‘massification’ or obtain sufficient growth of scale to really make a difference. Key for future success is a more sophisticated loan suitability assessment. In concrete terms, this means that loan packages should not be designed to reach a revenue target. First and foremost, microfinance schemes should be designed to reach the borrowers’ repayment capability.33 The biggest problem facing microcredit lenders is the high transaction costs of making miniscule loans. The growing reach of ATMs, mobile phones and internet however are bringing down costs, making the promise of microfinance ever bigger. 5. Sustainable Banking: Equator Principles A fourth and equally important contemporary example of business ethics are the socalled public-private partnerships. One of the most interesting one is an initiative elaborated by the private-sector investment arm of the World Bank, the International Finance Corporation (IFC), in cooperation with the ABN Amro, Citigroup, Barclays and West LB. As mentioned in Occasional Paper #12, the so-called Equator Principles (EPs), are a wide set of voluntary environmental, social-impact and public consultation standards for project financing with a total cost of more than $50 million in emerging markets.34 In its first year of existence, a total of 27 banks signed up, representing more than 75 percent or $55 billion of global project financing funds. The creation of the EPs by ten banks in June 2003 was encouraged by three major controversies between multinational development agencies and private financing firms. In the late 1990s, an oil pipeline project in Ecuador, Oleoducto Crudo Pesado, failed to meet the environmental safeguards and guidelines of the International Finance Corporation (IFC) but some global investment banks were willing to provide financing. At the same time, the World Bank refused to finance China’s controversial Three Gorges Dam. Investment banks were also here willing to commit capital. The public scrutiny that followed eventually led to the creation of the EPs. 32 Wharton Business School (2005), “Microcredit is Becoming Profitable, Which Means New Players and New Problems,” Public Policy and Management, April 20. 33 For an overview of the universe of microfinance, see: www.socialenterprise.net. 34 For complete details, see www.equator-principles.com or www.ifc.org/equatorprinciples. 14 ADDING BUSINESS ETHICS TO THE BOTTOM LINE - DOES CORPORATE SOCIAL RESPONSIBILITY PAY OFF? SCG Occasional Paper # 14 – Johannes van de Ven – Rio de Janeiro – September 2005 The third controversy involved the financing of the Baku-Tbilisi-Ceyhan (BTC) oil pipeline, which runs from the Caspian Sea in Azerbaijan, via Georgia, to the Mediterranean in Turkey.35 The IFC approved lending of $250 million dollars for this project. Over $2.6 billion, which represents over two-thirds of the project’s budget, is financed by the UK’s Export Credits Guarantee Department (ECGD) and nine EPs signatory banks: ABN Amro, Citigroup, Mizhuo, Dexia, HVB, ING, KBC, Royal Bank of Scotland and West LB. Ever since the project was announced, it has made headlines for its supposed disregard for indigenous peoples. The pipeline will pass near seven areas of ethnic conflict.36 Non-governmental organizations (NGOs) moreover suggest that the Turkish government may use the project as an excuse to crack down on ethnic Kurds living along its route. Complaints have led to hearings by a special committee in the UK parliament on the circumstances of the UK ECGD’s involvement. After stakeholder consultation, Italy’s Banca Intesa agreed to sell a third of its $60 million quota in the consortium. The Equator Principles extends to 31 financial institutions located in 14 countries by July 2005. After two years of implementation, it is time to analyze whether the EPs serve their stated purpose of increasing global banks’ social and environmental responsibility. In other words, is the initiative leading to publicly-adopted principles or is it just a smokescreen or public-relations-as-usual? Three brief case studies from opposite corners of the world will shed some light on its efficacy. 5.1. Financing Soybeans in Brazil Other loans which are currently under heavy NGO scrutiny are the ones made to Grupo Maggi, the world’s largest private soybean producer. As of 2004, Maggi planted 170 thousand hectares of soy, mostly in the state of Mato Grosso. In less than a generation, this largely untapped frontier heartland, located at the southern tip of the Amazon, has transformed itself into the world’s breadbasket. Between 1997 and 2005, Brazil’s beef exports jumped more than five-fold, and it now has surpassed the United States as the world’s largest beef exporter.37 Maggi’s harvest yields over 360 thousand tons of soybeans, 175 thousand tons of corn and 20 thousand tons of cotton. It moreover trades 2.5 million tons of soybeans which for 90 percent are exported to Europe and Japan. Total sales of Grupo Maggi reached $600 million in 2004.38 The company has hugely benefited from the increased global demand for meat from cows, which has been fueled in part also by the mad cow disease in Europe and avian flu in Asia. 35 The pipeline is 1000-mile long and has an estimated budget of $3.6 billion. When fully operational, the pipeline will transport up to one million barrels of oil each day. 36 Friends of the Earth (2003), “BP: Beyond Petroleum or Beyond the Pale. A Briefing Paper,” London, April. 37 Shean, M.J. (2004), “The Amazon: Brazil’s final soybean frontier,” Washington, D.C.: United States Department of Agriculture, Foreign Agricultural Service. 38 Fundação Centro Brasileiro de Referência e Apoio Cultural (2004), “Bank Loans and Credits to Grupo André Maggi,” Brasília, June 4. 15 ADDING BUSINESS ETHICS TO THE BOTTOM LINE - DOES CORPORATE SOCIAL RESPONSIBILITY PAY OFF? SCG Occasional Paper # 14 – Johannes van de Ven – Rio de Janeiro – September 2005 Brazil’s explosive growth in agribusiness has not come without a price tag. NGOs are concerned that the soy business damages virgin tropical rainforest in the Amazon. Soy business is therefore being blamed as the most important driver for deforestation. The cultivation of soy is also primarily responsible for establishing transportation infrastructure in the Amazon. The most controversial is the paving of the BR-163, which links Mato Grosso’s capital Cuiabá to the deep-water Amazon River port of Santarém. The asphalting of 1600-kilometer long BR-163 is part of a public-private arrangement between the Brazilian government, Maggi and American agribusiness multinationals ADM, Bunge, and Cargill. Environmental NGOs fear that the new highway will unleash further deforestation as it opens an enormous area for further colonization. Despite these concerns, the Brazilian soy giant has little trouble in arranging funding. The International Finance Corporation granted $30 million loans, both in 2002 and 2004. Funding from private sources has even been bigger. Rabobank, the Netherlands’ based agribusiness cooperation, has led a consortium of 11 banks, including ING (Netherlands), HSBC (UK), BNP Paribas (France), Crédit Suisse (Switzerland), UFJ (Japan), WestLB (Germany), Fortis (Belgium), HSB (Sweden), Bradesco and Itaú (Brazil), to lend $230 million to the soy giant. This issue followed another $100 million loan which was also lead-managed by the Rabobank in 2002. Under pressure from Brazilian NGOs, the World Bank has called for an audit by the IFC Office of the Compliance Advisor Ombudsman of the 2004 loan. The IFC assigned the projects a Category B Procedure for Environmental and Social Review, meaning that “a limited number of specific environmental and/or social impacts may result which, can be avoided or mitigated by adhering to generally recognized performance standards, guidelines or design criteria.” The CAO audit criticized the categorization procedure as “loosely defined and relying heavily on professional discretion.” The IFC in return argued that “Amaggi has in place an Environmental Management System to ensure that its operations and the operations of the third party farmers that receive financing from Amaggi are compliant with the World Bank Group environment and social guidelines.”39 Several environmental non-governmental organizations are not comfortable with this appraisal. According to the Friends of the Earth Amazônia, the loan should have warranted a Category A classification, which is defined as “likely to have significant adverse environmental impacts that are sensitive, diverse, or unprecedented.”40 The International Labor Organization also commissioned a report in May 2005 which revealed that Grupo Maggi bought soybeans from farms where slave labor was detected by Brazil’s federal government. Amaggi has admitted receiving supplies International Finance Corporation (2004), “Amaggi Expansion, Summary of Project Information. Project 22561,” Washington, April 13. 40 For complete details and IFC’s response, see the final report of the Office of the Compliance Advisor/Ombudsman, “CAO Audit of IFC’s Environmental and Social Categorization of the Amaggi Expansion Project,” Washington, May 2005, at www.ifc.org. 39 16 ADDING BUSINESS ETHICS TO THE BOTTOM LINE - DOES CORPORATE SOCIAL RESPONSIBILITY PAY OFF? SCG Occasional Paper # 14 – Johannes van de Ven – Rio de Janeiro – September 2005 from two farms where a total of 84 slaves were freed by federal agents in 2004, though denied being aware of this at the time.41 Besides the already mentioned BR-163 highway, one of the more urgent infrastructure problems related to soy cultivation in the Amazon basin is the construction of a PeruBrazil transcontinental highway, connecting the Atlantic to the Pacific. In order to cross the Andes, a 720-meter bridge, the largest in South America, will be built across the Madre de Dios area. Construction started in July 2005 and the cost is estimated to be around $1 billion. The construction will supposedly cut transportation cost of soy and pulp exports. Environmental lobby-groups fear that the Madre de Dios region in Peru will suffer from the construction as it will transform a jungle outpost into a hub of an international motorway system. There are moreover doubts that the new highway will simply lead to increased illegal logging and clearing of forest for agriculture. History teaches that roads are arteries of deforestation. 42 Soy cultivation should continue to be a force for revenues but not at a high environmental cost. EPs signatory banks, soybean crushing giants such as Bunge, Cargill, ADM and Louis Dreyfus should address these issues in close cooperation with Brazilian and multilateral agencies. The quest to reach sustainable productionconsumption equilibrium is urgent as demand for Brazilian soy is expected to rise dramatically due to reduction of the agricultural subsidies in the United States and European Union, and rising global demand, especially from Asia. In Mato Grosso, it is estimated that soybean cultivated areas could double to 40 million hectares by 2020.43 In sum, what seems clear in these controversies is that huge loans provided by EP signatories should carry robust environmental stipulations, especially in the Amazon which has a notoriously fragile ecosystem. EP signatories should help the Brazilian government to activate public-private investments in infrastructure which yet have to be made public. Bond covenants and conditions of disbursement should constantly be audited for sustainability. Another big question is whether a multilateral stamp of approval (World Bank, IMF or regional development banks) simply justifies private lending. For obvious reasons, multilateral involvement facilitates private lending but that seems not always fully justified. Sometimes it seems that private financials institutions legitimize lending practices based on the fact that multilateral agencies already extended credit lines. Such practices are especially controversial in low-trust regions with threadbare property rights, environmental legislation and law enforcement. 41 According to the non-governmental organization Amazônia, the report focuses on the market links of farms enforced for slavery by Brazil’s Ministry of Labor and was carried out by Reporter Brasil, an investigative journalism NGO, with support from ILO and the Secretariat for Human Rights of the Brazilian Presidency of the Republic. 42 Margulis, Sérgio (2003), “Causes of deforestation of the Brazilian Amazon,” Washington, D.C.: World Bank Working Paper #22. 43 Whyte, Clara; Chloé Cadier, Richard Pasquis & Geert van Vliet (2004), “Soy Expansion in the Brazilian Amazon Region: A Local and Global Social and Environmental Dilemma,” Brasília: Ambassade de France au Brésil (www.ambafrance.org.br). 17 ADDING BUSINESS ETHICS TO THE BOTTOM LINE - DOES CORPORATE SOCIAL RESPONSIBILITY PAY OFF? SCG Occasional Paper # 14 – Johannes van de Ven – Rio de Janeiro – September 2005 5.2. Financing Timber in Indonesia Another interesting case study involves JPMorgan Chase for allegedly financing illegal logging in Indonesia. Non-governmental organization Greenpeace and Rainforest Action Network have argued that JPMorgan Chase should withdraw financing for Atlanta-based BlueLinx, a former division of Georgia Pacific and currently America's largest building products distributor.44 Rainforest Action Network attacked JPMorgan Chase in a November 2004 advertising campaign for failing to set more strict lending practices for environmentally sensitive projects. BlueLinx has been accused of smuggling legally disputed, undocumented timber out of Indonesia and flooding the US marketplace with artificially cheap plywood. According to the US Customs & Border Protection, an agency of the US Department of Homeland Security, BlueLinx acquired timber from eight Indonesian mills that have well-documented histories of illegal trafficking.45 The American Forest & Paper Association estimates that 55 percent of plywood exports from Indonesia are illegal.46 Although such information is publicly available, JPMorgan Chase was still interested in financing BlueLinx. According to a Securities and Exchange Commission registration amendment for an initial public offering of common stock for approximately $120 million, filed on November 26, 2004, BlueLinx documented a credit agreement listing JPMorgan Chase as a documentation agent and a leading lender for a $165 million loan facility. As a EPs signatory, however, JPMorgan should raise serious questions about the sustainability of timber financing. Credit scrutiny becomes even more imperative if we take into consideration a study, conducted by the Indonesian Ministry of Forestry, which claims that 43 million hectares of its rainforests have been severely damaged or destroyed due to illegal logging. Indonesia is home to 10 percent of the world's tropical forests, but it also has the highest rate of deforestation, with on average three million hectares of forest lost between 1998 and 2005. Illegal logging has also been reported in the tsunami-stricken regions of Northern Sumatra. Logging activities in Aceh are currently concentrated in the districts of Aceh Besar, Aceh Tenggara, Aceh Singkil and Aceh Timur, which are areas covered by the Leuser Ecosystem, which covers 2.6 million hectares and is home to the most unique wildlife in the world like endemic species of tigers, elephants and rhinoceros, orangutans, hornbills, cloud leopards and the world's largest flower, the rafflesia. 47 In sum, as financing of illegal projects which causes irreversible ecological degradation is becoming a mounting global problem, the EPs are a tool that should be 44 BlueLinx’s structural products include plywood, oriented strand board and lumber. Its specialty products include roofing, insulation, molding, engineered wood, vinyl, and metal products. 45 The eight mills named by an investigation are: Barito Pacific Timber, Decorindo Inti Alam Wood, Kayu Lapis Indonesia, Melapi Timber, Sangkulirang Bhakti, Sumalindo Lestari Jaya, Tunggal Agathis Indah Wood and Tunggal Yudi Sawmill Plywood. 46 American Forest & Paper Association (2004), “Illegal Logging and Global Wood Markets: The Competitive Impacts on the U.S. Wood Products Industry,” Poolesville, Maryland, November. See also a report produced by the World Resources Institute in 2002 entitled “The State of the Forest: Indonesia.” 47 Panaligan, Riedo (2005), “Another Tragedy in Aceh: Illegal Logging,” Jakarta Post, July 12. 18 ADDING BUSINESS ETHICS TO THE BOTTOM LINE - DOES CORPORATE SOCIAL RESPONSIBILITY PAY OFF? SCG Occasional Paper # 14 – Johannes van de Ven – Rio de Janeiro – September 2005 used to mitigate it.48 The United States should for example follow the example set by the European Union, which already signed agreements with Indonesia boycotting products made from illegal timber.49 EPs signatories should be the vanguard of sustainable banking practices.50 A good example was recently set by Goldman Sachs by purchasing 680,000 acres on Tierra del Fuego, Chile, and donating it to the Wildlife Conservation Society, whose wildlife preservation encompasses Antartica’s old-growth forest. 5.3. Financing Warfare in Belgium Yet another interesting case study involves the Amsterdam-based Internationale Nederlanden Group (ING).51 In November 2003, the Belgium non-governmental organization Netwerk Vlaanderen launched a campaign against the financing of the defense industry.52 It claimed that ING, Axa, Dexia, Fortis, and KBC were together financing eleven defense companies for the total amount of €1.5 billion. Some of these companies were involved in the production of cluster bombs and nuclear weapons.53 In addition, Netwerk Vlaanderen claimed that none of the above mentioned financial institutions had implemented formal policy procedures on defense financing.54 At the same time, Netwerk Vlaanderen interestingly made a link to the Ottawa Treaty, which is also known as the Convention on the Prohibition of the Use, Stockpiling, Production and Transfer of Anti-Personnel Mines and on their Destruction. As this treaty bans the use of anti-personnel mines, Netwerk Vlaanderen argued that financial institutions operating within the jurisdiction of the Kingdom of Belgium should refuse financing those specific companies involved in the financing of banned weapons. After shareholder pressure and internal deliberations, ING decided to no longer invest in companies producing controversial weapons. As of March 2005, the types of weapons excluded by ING are anti-personnel mines, cluster bombs, depleted uranium 48 For more background information, see: Forests and the European Union Resource Network (2004), “Footprints in the Forest: Current Practice and Future Challenges in Forest Certification,” Gloucestershire, United Kingdom. 49 Rainforest Action Network (2005), “Investigation Finds IMD In Indonesia: JP Morgan Chase and BlueLinx Linked to Illegal Logging of Endangered Forests and Resulting Humanitarian Crisis,” February 24. For more details on the campaign, see www.ran.org. 50 For additional info on the topic, see: Rainforest Alliance (2005), “The Global Impact of SmartWood Certification,” June 9, at http://www.rainforest-alliance.org. 51 As of July 2005, this financial services group has over 113,000 employees in more than 50 countries and market cap of over €52bn, making it the 11th largest in the world. 52 Netwerk Vlaanderen (2003), “Mijn geld. Goed Geweten? Een onderzoek naar de financiële banden tussen banken en wapenproducenten,” Brussels. See also: http://www.mijngeldgoedgeweten.be or for full report, see: http://www.netwerk-vlaanderen.be/actie/dossier1.pdf. 53 A cluster bomb is an air-dropped bomb that ejects multiple small submunitions or bomblets, particularly developed to target personnel. The so-called ‘smart’ submunition bombs have been employed in Serbia in 1999, Afghanistan in 2002 and Iraq in 2003. The use is hotly opposed by the Red Cross and the United Nations because about 10 percent do not explode on impact. The small size and bright colors of some of the bomblets make them attractive to especially children, which are still victimized in Laos and Vietnam. 54 Leys, Jos (2005), “Sociaal Verantwoord Beleggen in België 2003-2004,” Forum Financier / Revue Bancaire et Financière. 19 ADDING BUSINESS ETHICS TO THE BOTTOM LINE - DOES CORPORATE SOCIAL RESPONSIBILITY PAY OFF? SCG Occasional Paper # 14 – Johannes van de Ven – Rio de Janeiro – September 2005 weapons, biological, chemical and nuclear weapons.55 In ING’s Defense Policy, it states that “trade finance in military equipment and supplies must comply with NATO regulations and is permitted only when there is an export license from an EU, US or Canadian government as well.”56 Netwerk Vlaanderen’s successful campaign in Belgium should be replicated in other countries where signatory banks are located. These three brief case studies prove that the implementation of certain principles can indeed result in better corporate practices. Other success stories which deserve attention include the financing of a World Bank-backed pipeline running from Chad's oil fields through Cameroon to the Atlantic. Underwriters, including Citigroup, committed themselves to extensive environmental impact assessments studies before disbursements were given. ExxonMobil are providing compensation and health care to locals whose lives have been affected by the pipeline. In sum, the EPs have become the de facto standard for foreign direct investment in emerging markets. Although the initial push for establishing EPs was reputational damage control and avoiding potentially costly litigation that could damage a company’s bottom line, the EPs have proven to be an incentive for global financial institutions to be proactive in sustainability management. Citigroup claims that 800 of its bankers have received EPs training, and that an estimated 400 bankers have completed EPs training programs at the IFC. JPMorgan Chase started to release comprehensive environmental policy reports. It not only adopted the EPs, like the Citigroup and Bank of America, but also extends them beyond project finance to cover all loans, debt and equity underwriting, and financial advisories. The original EPs plan envisions projects over $50 million but JPMorgan Chase promised to apply them starting at $10 million for financing of the extractive industries, such as oil and gas, forestry, and mining. Major flaws in the EPs which should be addressed include increased compliance standards, transparency for credit approvals and the creation of an independent accountability mechanism. These are all crucial as project finance lending requires comprehensive due diligence, due to its long maturities. The EPs momentum is exceeding initial rather skeptical market expectations as financial institutions are slowly realizing and increasingly publicly recognizing that a sound long-term economic strategy relies on embracing environmental sustainability. EPs members should therefore remain committed to recruit new signatories. 55 Credit should be given to the Brussels-based Netwerk Vlaanderen, who’s campaign “My Money. Clear Conscience?” has put pressure on ING to disinvest . For more details, see campaign details at www.netwerk-vlaanderen.be. In its report published in 2004, Netwerk Vlaanderen revealed that AXA, Dexia, Fortis, ING and KBC all invested in producers of controversial weapons. Companies that Netwerk Vlaanderen believes that ING should disinvest from include ATK, Lockheed Martin, Raytheon, Singapore Technologies Engineering and General Dynamics. ATK is the most important ammunition supplier for the US army, and is involved in the production of uranium weapons and cluster bombs. Lockheed Martin is the largest arms producer in the world, and produces nuclear weapons and cluster bombs, amongst other weapon systems. 56 For ING Defense Policy, see www.ing.com. 20 ADDING BUSINESS ETHICS TO THE BOTTOM LINE - DOES CORPORATE SOCIAL RESPONSIBILITY PAY OFF? SCG Occasional Paper # 14 – Johannes van de Ven – Rio de Janeiro – September 2005 6. Conclusion: The Road Ahead The practices discussed in this Occasional Paper have made clear that there is a positive correlation between corporate social and financial performance. A blind pursuit of CSR programs however is no guarantee for sustainability, as laudable initiatives not automatically yield more prosperity. Deep pockets and noble aspirations alone will not make the difference in the end. The CSR doctrine can sometimes be deliberately vague and inherently self-contradictory. Sustainable development is often a rhetorical exercise merely used to bridge the widening gulf between developers and environmentalists. The fact that corporate ethics dilemmas are increasingly bedeviling business leaders is itself a good sign as it will stimulate internal debates. Unregulated or under-regulated by governments, corporations set the terms of engagement often themselves. It is however too cheap to simply dismiss public intervention by means of raising taxes or public spending. Compliance brings business benefits. According to the 2005 KPMG International Survey of Corporate Responsibility Reporting, the five most important business drivers for corporate responsibility for companies are: to have a good brand and reputation; to be an employer of choice; to have and maintain a strong market position; to have the trust of the financial markets and increase shareholder value; to be innovative in developing new products & services and creating new markets.57 6.1. Beyond Reputational Damage Control Social responsible investments however are still too often referred to as “feel-good investments.” The belief that a commitment to CSR requires up-front costs and reduces profitability is flawed. Wall Street consensus is still tilting toward the belief that making social judgments in the investment process has no effect on corporations. The assumption that free markets are efficient by nature is simply flawed. SRI is not about pushing a soft left-leaning hidden agenda, where activists allegedly want to deny businesses their right to a just return on capital. SRI is neither a zero-sum game where profits are sacrificed at the altar of doing good. Instead, SRI portfolio managers should not shy away from making profits. From being considered a fringe movement, SRI should become the leader of portfolio management strategies. The barriers that stop companies from implementing innovative social responsible strategies are still manifold. Managerial skepticism in certain cultures keeps innovators from elaborating projects. If entrepreneurs are stimulated to go ahead with costly initiatives which are not embraced by the competition, then they run the risk to lose market share. In emerging markets, a lack of financial resources, a lack of business models and academic understanding of socioeconomic trends among policymakers keep innovators from delivering. In general, a lack of committing capital to new ideas, particularly at the bottom of the business cycle, is also a major constraint. Sustainability-driven entrepreneurship is best served with examples which KPMG & University of Amsterdam (2005), “Fifth International Survey of Corporate Responsibility Reporting,” June. 57 21 ADDING BUSINESS ETHICS TO THE BOTTOM LINE - DOES CORPORATE SOCIAL RESPONSIBILITY PAY OFF? SCG Occasional Paper # 14 – Johannes van de Ven – Rio de Janeiro – September 2005 have proved to be successful elsewhere. By focusing on best-practices across the globe, local policymakers can more easily be convinced about the tangible long-term benefits. Reputation risk management is often a public relations or media strategy, not a natural outcome of better business practices. The fact that sell-side analysts at the leading global investment banks such as Goldman Sachs, JPMorgan and Morgan Stanley, are increasingly looking at SRI is a strong sign that CSR matters. An increased sense of urgency will build momentum. Sustainable entrepreneurship has to become a core corporate competence. As correctly stressed by Willard, sustainability strategies should be sold as a means to achieving existing corporate ends, rather than as a separate priority to worry about. Sustainability is a solution, a business strategy, and a catalyst for business transformation.58 Greed is out, stewardship is in. Super-size-me is out, slow-food is in. A race-to-the-bottom in terms of price and therefore overall working conditions is simply no longer acceptable. 6.2. Reversing Money Flows Sustainable investment projects in the developing world constitute probably the biggest global challenge, especially in this age of increased global financial liquidity. It is worth remembering that emerging markets had a combined current-account deficit of $93 billion in 1996. As of 2005, the same countries have a combined surplus of $336 billion. Huge current account surpluses in countries like Brazil, where the primary budget surplus is above 4.25 percent of GDP, indicate that a lot of money is either not used in a productive way or just sitting at the sidelines waiting to be invested. The foreign currency reserves of emerging markets rose by $1,556 billion in 1997-2004. Reverse money flows from the developing to the developed countries are one of the most irrational features of international capitalism. At the same time, the United States continues to be the magnet of international capital, using the external funding for its current account and trade deficits. America’s broadest measure of its external shortfall hit an all-time record of 6.3 percent of GDP in the fourth quarter of 2004. According to Stephen Roach, “the Washington spin is that foreigners can’t get enough of dollar-denominated assets and the returns they offer in an otherwise return-starved world.”59 The fact that money is flowing where it is less needed constitutes an urgent challenge to financial markets.60 At the same time, the rise of emerging market corporations constitutes the biggest hope for sustainable development in the developing world. The expansion of Brazilian, Indian and Chinese corporations already poses a bigger threat than American and European companies will admit. According to Citigroup, between 1981 and 1989, the 14 leading emerging market economies together made about $272 58 Willard, Bob (2005), “The Next Sustainability Wave: Building Boardroom Buy-in (Conscientious Commerce),” New Society Publishers. See also: www.sustainabilityadvantage.com. 59 Roach, Stephen (2005), “America Smells the Coffee,” Morgan Stanley, March 18; “The New Macro of Globalization,” Morgan Stanley, June 6. 60 Wolf, Martin (2005), “Capital flow must change course,” Financial Times, June 26. 22 ADDING BUSINESS ETHICS TO THE BOTTOM LINE - DOES CORPORATE SOCIAL RESPONSIBILITY PAY OFF? SCG Occasional Paper # 14 – Johannes van de Ven – Rio de Janeiro – September 2005 million of cross-border acquisitions per year. Between 2000 and 2004, this average has jumped to $19.6 billion. 61 Emerging market corporations are less controlled by protectionist or interventionist governments. Instead, their enterprises are increasingly run by visionary local entrepreneurs. Local companies have learned to survive in financially volatile environments, which were characterized by sky-high local interest rates and expensive capital, and have therefore become better risk managers. Instead of having to deal with corrupt government officials, corporations can now focus on production and innovation. It is therefore no wonder that Samsung in Korea, Cemex in Mexico, Lenovo in China and Embraer in Brazil have not only become global business champions but also local heroes.62 The reduced aggregate cost of capital combined with a growing internal demand for consumption will make corporations and governments in emerging markets even more proactive. Instead of sitting on cash reserves and generating huge current account surpluses, countries like Brazil, South Korea, India and China, are soon poised to seek more profitable investments by means of cross-border takeovers. Digesting the new avalanche of foreign direct investment, capital market, project and venture financing in a sustainable manner represent a huge challenge for the EPs forum. 6.3. Increasing Public-Private Partnerships More attention should be paid to public-private partnerships as the corporations cannot be held solely responsible for all social problems. Commodity or banking conglomerates which have been scrutinized in this paper like Grupo Maggi, ExxonMobil and JPMorgan for example, can contribute significantly to healthcare and education for communities immediately affected by their operations but this should not be their prime concern. A good example was set in August 2005 by the Multilateral Investment Fund by approving a $1,345,000 grant for a technical cooperation project to implement corporate social responsibility practices in 120 small and medium-sized enterprises in Brazil.63 The project is of particular interest as it will develop methodologies and conditions to implement corporate social responsibility among value chains in small and medium-sized companies, and it will disseminate the results to promote a competitive spirit and application of the model by other firms. The case studies in this paper have highlighted the pitfalls of corporations getting involved in what are or should be key governmental competences. According to Bennett Freeman, the former US deputy assistant secretary of State for democracy, human rights and labor, who developed the Voluntary Principles, “we cannot allow ourselves to view multinational corporations and their suppliers and partners as the default key we press to solve every problem in the world.”64 It is however hard to 61 Klein, Michael (2005), “Raids on western companies are more than a fad,” Financial Times, August 10. 62 Sull, Donald (2005), “What Western Managers Can Learn from Trailblazing Chinese Entrepreneurs,” Harvard Business School Press. 63 These enterprises participate in value chains in selected economic sectors, including metallurgy, civil construction, sugar and alcohol, electricity, oil and gas, mining, and retail. 64 Murray, Sarah (2004), “Social issues gain more importance,” Financial Times, November 29. 23 ADDING BUSINESS ETHICS TO THE BOTTOM LINE - DOES CORPORATE SOCIAL RESPONSIBILITY PAY OFF? SCG Occasional Paper # 14 – Johannes van de Ven – Rio de Janeiro – September 2005 define where mandatory regulations should end and voluntary self-regulation should begin.65 The United Nations sponsored recommendations on regulation were rejected at the 1992 Earth Summit in Rio de Janeiro in favor of a manifesto for voluntary selfregulation which was put forward by a coalition of multinationals called the World Business Council for Sustainable Development. In the end, CSR is about corporate social accountability. Voluntarism in itself is inadequate to tackle the endemic problems of developing countries.66 CSR slogans quickly sound empty if corporations cannot be held accountable. By the same token, history teaches that too much regulation impairs progress, whereas the enlargement of economic freedom enhances innovation and advances prosperity. The path between governmental oversight and corporate voluntarism is small. 67 The biggest promise lies in the creation of a proper regulatory environment complemented by voluntary CSR and SRI initiatives of the corporate sector.68 An encouraging example of how corporations can make a significant contribution is Indonesia. In the aftermath of the devastating tsunami that struck Northern Sumatra, global corporations turned out to be much more effective in their efforts than governmental agencies. UPS, the global logistics company, shipped over £1m of emergency relief supplies free of charge, whereas pharmaceutical powerhouses such as Novartis and GlaxoSmithKline contributed with a healthy supply of antibiotics, adult nutritional supplements and infant formula. The tsunami relief effort is the best example that corporations indeed have a crucial role to play in the quest for global prosperity. Corporations are not just instrumental but crucial in their contribution to the public good. Johannes van de Ven Adrianópolis – Rio de Janeiro, September 4, 2005 The author is an advisor of the Swiss Consultant Group and is based in Rio de Janeiro, Brazil. He writes here in a personal capacity.69 65 For the academic debate, see: Cavanagh, Gerald F. (2004), “Global Business Ethics: Regulation, Code, or Self-Restraint?” Business Ethics Quarterly, October. 66 Organization for Economic Cooperation and Development (2003), “Voluntary Approaches for Environmental Policy: Effectiveness, Efficiency and Usage in Policy Mixes,” Paris. 67 For an excellent overview of the current state of global initiatives, see a joint publication by SustainAbility and the United Nations Global Compact Office, entitled: “Gearing Up. From Corporate Responsibility to Good Governance and Scalable Solutions,” New York, 2004. 68 For more details, see the excellent research paper written by the International Council on Human Rights Policy (2001), “Beyond Voluntarism: Human Rights and the Developing International Legal Obligations of Companies,” Geneva, November (www.ichrp.org). 69 Last but not least, I want to thank my colleague Richard Radu for reviewing this paper. 24 ADDING BUSINESS ETHICS TO THE BOTTOM LINE - DOES CORPORATE SOCIAL RESPONSIBILITY PAY OFF? SCG Occasional Paper # 14 – Johannes van de Ven – Rio de Janeiro – September 2005 References American Forest & Paper Association (2004), “Illegal Logging and Global Wood Markets: The Competitive Impacts on the U.S. Wood Products Industry,” Poolesville, Maryland, November. Ball, Jeffrey (2005), “Greenhouse Passes To Cut Pollution, Dutch Pay a Dump In Brazil to Clean Up,” Wall Street Journal, August 11. 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