Pension funds, corporate responsibility and sustainability

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a v a i l a b l e a t w w w. s c i e n c e d i r e c t . c o m

w w w. e l s e v i e r. c o m / l o c a t e / e c o l e c o n

ANALYSIS

Pension funds, corporate responsibility and sustainability Franck Amalric⁎ CCRS Centre for Corporate Responsibility and Sustainability at the University of Zurich, Künstlergasse 15a, 8001 Zurich, Switzerland

AR TIC LE I N FO

ABS TR ACT

Article history:

The paper introduces two approaches to identify corporate behaviours that should attract

Received 1 December 2004

the attention of pension funds in the context of debates over sustainability, while remaining

Received in revised form

within a narrow interpretation of their fiduciary duty. The approaches are based on two

30 October 2005

simple models of how different societal spheres interact with one another and influence

Accepted 2 November 2005

long-term economic performance. These models allow exploring the idea that corporations

Available online 26 January 2006

can influence trajectories of societal change—keeping in mind that pension funds care about these trajectories because they care about the long-term performance of the

Keywords:

economies in which they invest. The model underlying the internalising investor

Sustainability

approach assumes that corporations are the only actors in society. In this model, pension

Pension funds

funds will maximise their expected ability to meet their liabilities if companies internalise

Corporate responsibility

negative externalities and spill-over effects in order to reduce the cost of market failures for

Governance

the economy as a whole. The model underlying the civic investor approach comprises companies and various actors (the state, NGOs, corporate stakeholders) engaged in shaping the governance structure that mediates the interaction between the social, environmental and economic spheres. In this model, pension funds will want companies to facilitate effective responses to societal problems. These approaches allow us to identify a number of corporate behaviours that should be of concern to pension funds. © 2005 Elsevier B.V. All rights reserved.

1.

Introduction

Over the past few years, pension fund members, experts and policy-makers have expressed the view that pension funds have a special role to play in facilitating shifts towards sustainable societies, given their specific investment objectives and their nominal capacity to influence corporate conducts. These expectations have arisen out of the convergence of two societal trends. First, pension funds have become major shareholders in most major corporations—what Drucker (1976) called the “unseen revolution”. Second, the emergence of concerns over sustainability in the 1990s, combined with the perception that states are incapable of meeting the challenge alone, supports the proposition that

private actors–including pension funds–will have to assume new responsibilities. And these expectations have been sufficiently strong to pave the way to the introduction of new legislation in various OECD countries.1 With some rare exceptions, pension fund trustees have generally been sceptical that they can indeed, or should, play this special role. In their view, to do so would violate their fiduciary responsibilities to their members, that is, the principle that their investment and ownership decisions should solely aim to enhance their members' financial interests. Trustees' scepticism thus hinges on the perception that the enhancement of pension fund members' financial interests conflicts with an engagement of pension funds in the pursuit of sustainability.

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The main purpose of this paper is to show that, in some noteworthy circumstances, there is no such conflict and that, in the opposite, the fulfillment of pension funds' fiduciary responsibilities call upon them to exercise their influence on corporations and society in ways that promote sustainability. The thrust of the argument is the following: (1) pension funds' ability to meet their future liabilities is linked to the trajectory of societal change; (2) pension funds influence that trajectory through their investment decisions; (3) pension funds should aim to influence the economy and to promote those trajectories of societal change that will maximise their expected ability to meet their liabilities. Following the logic of this argument, this paper identifies corporate behaviours that pension funds should be concerned about in the perspective of sustainability. We consider pension funds whose investment objective is to finance long-term liabilities (20 years or more) and we assume that they invest in a broadly diversified portfolio. The paper introduces two complementary approaches that pension funds can follow to monitor corporate behaviours. These approaches are based on simple models of how different societal spheres interact with one another and which allow exploring the idea that corporations can influence trajectories of societal change. Section 2 presents the internalising investor approach. The model underlying this approach assumes that corporations are the only actors in society. They influence the long-term return on capital through their impact on the social and environmental spheres (with social and environmental changes bearing back on the economy) and through the economy in the context of market failures. In this model, pension funds will maximise their expected ability to meet their liabilities if companies internalise negative externalities and spill-over effects in order to reduce the cost of market failures for the economy as a whole. Section 3 introduces the civic investor approach. The implicit model underlying this approach comprises companies and various actors (the state, NGOs, corporate stakeholders) engaged in shaping the governance structure that mediates the interaction between the social, environmental

1

Evidence of these expectations is numerous. Among policymakers, see Annan (2003) in relation to global warming, and Short (2000) in relation to international development. Evidence of pension fund member expectations: Canadian Democracy and Corporate Accountability Commission (2002) found that, among the 2006 persons interviewed, 51% want their pension plans to invest in companies with a good record of social responsibility. For academic discussions, see among others: Kasemir et al. (2001), Monks (2001) and Kasemir and Süess (2002). Regarding legislation, the UK government has led the way with the passing in 2000 of an amendment to the pension act requiring pension fund trustees to disclose whether or not they take into account ethical, social and environmental criteria in their investment decisions. Similar legislation was subsequently passed in Germany (2001) and Australia (2001), and is being discussed in Austria, Belgium, Canada, Denmark, Italy and Spain. In its white paper on corporate responsibility, the European Commission (2002) invited occupational schemes to adopt similar practices. For a general review of the role of public policy in promoting CSR, see Aaronson and Reeves (2002).

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and economic spheres. We assume that companies can influence the other actors and that society can reach various equilibriums that are determined by the capacity of society to respond effectively to new societal problems by putting in place the right governance structures. In this model, pension funds will maximise their expected ability to meet their liabilities if companies do not hinder or actively facilitate effective responses to societal problems. Section 4 concludes with some remarks on methodologies to assess the contribution of companies to sustainability.

2.

The internalising investor

2.1.

Structure of the approach

Large institutional investors with a long-term investment horizon, such as pension funds, aim to maximise their expected ability to meet their liabilities. Given this objective, they are concerned about the long-term return on capital and, for this reason, about long-term economic growth. It follows that, assuming no changes in the institutional setting, investors may wish companies to internalise externalities and spill-over effects in order to enhance the performance of the economy as a whole. This is what we call the internalizing investors' approach. In this section, we identify corporate responsibility issues of potential concern to investors according to this approach. To do this, we take long-term economic growth as a proxy for the long-term value of a widely diversified portfolio, consider a list of the main determinants of long-term growth established by gathering the results of the many studies carried out on this topic (see, for instance, Sala-I-Martin, 1997), and look for evidence showing that corporate behaviours bear on these determinants, starting with a comprehensive list of corporate responsibility issues provided by the Global Reporting Initiative (2002). We distinguish between two categories of determinants of growth. First, we focus on determinants that lie in the social and environmental spheres: human capital, social capital, natural capital and political capital. The idea is that companies may have an impact on the long-term return on capital by fostering social and environmental changes, which, in return, affect the economy through interdependencies between the different societal spheres. Second, we consider economic determinants of growth– physical capital, labour and total factor productivity–in relation to situations of market failure. Under conditions of perfect competition, full information and complete markets, corporate behaviours would not affect the long-term return on capital as the opportunities and resources not seized by one company would be picked up by other companies. Thus, companies may have an impact on the long-term return on capital by wasting capital, underutilizing labour and/or undermining total factor productivity, when there exist intraeconomy market failures. Our analysis yields a short list of corporate responsibility issues of potential concern for investors. In a second step not carried out here, the impact on the long-term return of capital of each issue on the list should be assessed carefully.

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Corporate operations and strategies

Non-economic determinants of growth: Human capital Social capital Natural capital Political capital

Economic growth/ long-term return on capital

Fig. 1 – From corporate behaviours to long-term economic performance through non-economic spheres.

2.2. Corporate impacts on social and environmental determinants of long-term economic performance Fig. 1 presents the basic connections between corporate behaviours and the social and environmental determinants of long-term economic performance. Table 1 summarises the evidence. The following paragraphs review this evidence in more detail.

2.2.1.

Yet, most of the corporate responsibility issues that may affect individual welfare and capabilities, such as labour standards and corporate impacts on human rights, are not unambiguously linked to determinants of long-term economic performance. In fact, the only corporate responsibility issue that relates to human capital and for which (1) the responsibility of companies is clearly established and (2) evidence of the impact on long-term economic performance sufficiently solid, is that of on-the-job training.

Human capital

In the early 1960s, Schultz (1961) and Becker (1962) introduced the concept of human capital to underline the importance of the quality of the workforce, in contradistinction to its size, as a key determinant of long-term economic performance. Recent empirical analyses, e.g. Barro (1991) or Mankiw et al. (1992), have confirmed the importance of human capital in explaining past growth. Furthermore, the accumulation of human capital increases the long-term return on physical capital, which, according to Lucas (1990), may explain why returns on investment remain high within developed countries despite high levels of capital stock. Most of these studies take the level of schooling as a proxy for human capital, although more recent ones, e.g. Bloom et al. (2001), have also given attention to health and shown the significance of this factor in explaining economic growth.

2.2.2.

Social capital

Social capital refers to the network of formal and informal institutions that facilitate social interaction and nurture individuals' trust in the legal and economic system. Banuri et al. (1994) use the following image to illustrate the importance of social capital in sustaining the economy. Consider the various elements that are required to build an effective road transport system: one prerequisite is a network of good roads (physical capital); another is the development of people's driving ability (human capital); yet a third is a set of formal and informal rules and norms to regulate drivers' behaviour on the road. This third element is social capital. Some political scientists and economists, e.g. Putnam (1993), Fukuyama (1995), Knack and Keefer (1997), Porta et al. (1997) and Harrison and Huntington (2000), have recently

Table 1 – From corporate behaviours to long-term economic performance through non-economic spheres CR issues affecting non-economic spheres (main issues taken from GRI) Respect and promotion of human rights Decent work Labour rights Product responsibility (e.g. impact on health) Welfare impact of pollution Depletion of natural resources, pollution Corruption and bribery Diversity Freedom of association

Determinants of long-term economic performance, evidence of corporate impacts

Significance for long-term economic performance

Human capital

Strong

–On-the-job training

–Formal education –Health –On-the-job training

Natural capital

Social capital (incl. “social fractionalisation”) Usually seen as being formed through association Political capital: good governance, rule of law, civil liberties Anecdotal evidence of corporate impact on good governance Little evidence that corporations hinder or foster civil liberties

CR issues of relevance for pension funds On-the-job training

Weak and indirect (through other societal spheres) Medium (difficulties in “measuring” social capital)

Strong

Corruption, in particular linked to management of natural resources

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Corporate operations and strategies

Market failures: -

Externalities Information asymetries Transaction costs

Economic determinants of growth: -

Physical capital Employment Total Factor Productivity

Economic growth/ long-term return on capital

Fig. 2 – Impact of corporate behaviours on long-term economic performance in the context of market failures.

drawn attention to the importance of social capital, and beyond it of culture, in sustaining economic activity and longterm development processes. A high degree of trust within society would reduce transaction costs and thus enhance economic activity; social capital would also facilitate the creation and operation of public institutions, with positive long-term effects on economic performance. However, as noted by Solow (1995), social capital is difficult to measure, and so likewise its contribution to economic performance. Even if social capital could be measured, there is a lack of knowledge about the role that large companies play in building-up, nurturing or eroding it. Some corporate behaviours do seem to have an impact on social capital–e.g. corruption and bribery, diversity in the workplace, freedom of association–but these connections have not been thoroughly explored by academics.

2.2.3.

Natural capital

Nature provides products and services that are often deemed important in sustaining the long-term performance of an economy. Products include non-renewable resources such as oil and minerals, as well as renewable resources such as fisheries, forests, land and water. Services include climate regulation, the hydrological cycle, nutrient cycles, the transformation of solar energy into biochemical energy through photosynthesis and the management of soils, to name just a few. Resource economics studies the economic factors that determine the use of exhaustible and renewable resources, and the significance of these resources for long-term economic performance under various conditions.2 It is the latter strand of this subdiscipline that interests us here. While normative approaches to this second issue–i.e. how to use natural resources to sustain long-term economic performance–are plentiful, comparatively few empirical studies investigate how and when the over-use of natural resources has led to economic under-performance. Moreover, the main empirical result that has been established is somewhat paradoxical. Known as the “curse of natural resources”, it holds that countries with abundant natural resources tend to grow slower than resource-poor countries (Sachs and Warner, 2001). Most explanations for the curse have a crowding-out logic: reliance on natural resources would crowd out one or more of the key factors that drive growth and thus undermine it. An important issue, explored by Auty (2001), is how reliance on natural resources can crowd out good government by fostering rent-seeking behaviours and corruption. However, in

this model, the problem is not so much how changes in the environmental sphere undermine economic performance, but rather how the management of natural resources has an effect in other societal spheres–in this case political capital–which in turn affect economic performance negatively. We therefore conclude that there is little evidence to support the view that companies that destroy natural capital undermine long-term economic prospects, simply because the link between natural capital and growth is itself not well established.

2.2.4.

2.3. Long-term economic consequences of corporate behaviours in the context of market failures Fig. 2 presents the connections between corporate behaviours, market failures and economic determinants of long-term economic performance. Table 2 summarises available evidence. The following paragraphs review this evidence in more detail.

2.3.1. 2

For a broad presentation, see Bretschger (1999).

Political capital

Political capital refers here to political stability, respect for the rule of law, political rights and civil liberties, and good governance. Sala-I-Martin (1997) found that these political variables are among the more solidly established determinants of longterm economic performance. Political stability, respect for the rule of law and good governance, i.e. ensuring that the state acts for society and not in private interests, are obviously key to ensuring that resources are used efficiently and effectively. Political rights and civil liberties, on the other hand, are instrumental in preserving the proper and legitimate functioning of the state. There is a degree of evidence that an accumulation of economic power may, in some circumstances, erode political capital, in particular through bribery and corruption in countries with relatively weak political systems. As mentioned above, this phenomenon is proposed as an explanation for the “curse of natural resources”. Furthermore, there is anecdotal evidence that corporations, as holders of significant economic power, may take part in this erosion of political capital—and it could be substantiated that they have an impact on long-term economic performance in this way. Pension funds should therefore closely monitor corporate behaviours, such as corruption and bribery that have an impact on political capital.

Externalities across production units

Corporate-generated externalities that have a direct bearing on other productive activities may lead to a waste of physical

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Table 2 – Impact of corporate behaviours on long-term economic performance in the context of market failures CR issues Pollution (across productive activities) R&D Training Disclosure of information, including product labelling Corporate governance Access to work, products and services M&As Dividend payments

Market failures

Significance of the market failure for long-term economic performance

Negative externalities

No evidence

Positive externalities

Strong (ideas, human capital)

Information asymmetries

Strong for some issues (i.e. finance)

On-the-job training R&D Transparency/reporting

Transaction costs and corporate boundaries

Strong

Dividend payments

capital and thereby undermine long-term returns on capital. This effect may take place either through the ex-ante appropriation of a production input to which access is not regulated (“tragedy of the commons” effect), or through the ex-post emission of pollutants that will affect other production processes. Externalities across production units can also be positive, however, and new growth theories, such as in Lucas (1988), have underlined their significance for long-term growth. These positive external effects are transmitted mainly through human capital and ideas. By contrast, no study assesses the level of physical or natural capital that may be lost owing to negative externalities across production units, and their further impact on long-term economic performance. The role of companies is key in promoting positive externalities through R&D and on-the-job training. These issues should therefore be monitored by investors.

2.3.2.

CR issues of relevance for pension funds

Asymmetries of information

Asymmetrical information, notably between providers and users of capital, can be an important source of market failure. It can lead to a misuse of capital at company level–the risk being, as shown formally by Edlin and Stiglitz (1995) and Shleifer and Vishny (1989), that managers invest in a way that secures their own position, rather than increasing shareholder value–as well as to a distortion of market prices, itself leading to a misallocation of financial resources at the societal level and hence to a waste of capital and economic underperformance. Recent studies, e.g. Greenwood and Jovanovic (1990), Levine (1997) and World Bank (2001), have underlined the long-term significance of a society's ability to acquire and process information on competing investment prospects. Since many firms and entrepreneurs solicit capital, financial intermediaries and markets that are better at selecting the most promising firms and managers will produce a more efficient allocation of capital and faster growth. Corporations play an important role in producing information about themselves. The recent corporate scandals in the US and Europe have shown the damage that distorting information can have, not only for individual companies, but also for the economy as a whole. Investors should thus want companies to achieve high standards of corporate reporting and transparency.

Mergers

2.3.3.

Transaction costs and corporate boundaries

Transaction costs–costs of market search, acquiring information, guaranteeing property rights, negotiating terms of exchange and ensuring that the terms of the exchange will be respected–can be a major hindrance to the fluidity of economic activities and an obstacle to economic performance. North (1990) has argued that a reduction in transaction costs has historically been one of the most important drivers of economic growth in Western countries. Corporations, along with institutions, play an important role in reducing transaction costs according to Coase (1937). They do so when they enter into long-term contractual commitments with their employees, merge with or acquire other companies, develop consumer management practices with specific target groups or retain earnings; in short, when they put in place a control-and-command system to organise transactions, instead of conducting market transactions. The main rationale behind these corporate practices is profit maximisation. Firms will engage in them when controland-command proves to be profitable and less costly than reliance on market transactions that incur (transaction) costs. For instance, Easterbrook (1984) argued that retained earnings are superior to the payment of dividends because they avoid transaction costs penalising investors as well as companies. However, these practices may be counter-productive for society when they undermine the good functioning of the market, in the same way as mergers may undermine competition. This suggests that the socially optimal boundary between corporations and the market cannot be set by corporations motivated by profit. For this reason, investors should give attention to corporate behaviours that shift this boundary, such as dividend payments.

2.4.

Discussion

Tables 1 and 2 list the (few) issues, which there is evidence on that corporations affect long-term economic performance in a static institutional setting. Most of these issues are economic rather than social or environmental. Moreover, one of these issues, corruption in the management of natural resources, would not pass the second test—that of an actual measurement of its significance for pension funds' portfolios. If the “curse of natural resources” is a well-established result in the empirics of economic growth, it affects mainly small developing countries, e.g. Gulf states, Zambia, Liberia, etc. However,

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large pension funds based in OECD countries are very little exposed to the long-term economic performance of these countries—thus undermining the rationale for considering corruption in the management of natural resources an issue of concern to them. These overall results can be given two interpretations: (a) that there are not many corporate responsibility issues that pension funds should be concerned about in the context of sustainability; (b) that the internalising investor approach is too restrictive. There are some grounds for believing that the approach is indeed too restrictive. In the absence of some form of general equilibrium model that would allow to test the relative importance of social and environmental indicators on future economic performance, one is limited to an empirical assessment of the relative importance of such indicators in explaining past economic performance. Yet studies that do so may take for granted the existence of certain background conditions, such as climatic stability, provided by the environmental and social spheres. In other words, we cannot be sure that they have taken into account the full benefits provided by the stability of the background conditions, in part because these benefits are so difficult to measure. The insignificance of these spheres in studies of long-term economic performance may thus reflect the limitation of the (neo-classical) economic models, rather than the true state of things. Furthermore, the past may not be a very good indication of what the future holds in store. After all, one of the basic ideas behind the concept of sustainability is that current trends cannot continue in the future.

3.

Civic investors

Some issues at the core of the debate on sustainability– environmental crisis, growing inequalities between different regions of the world, demographic transition in ageing societies, etc.–will, in all likelihood, have an impact on the long-term return on capital in society. Clearly, these issues should be of concern to pension funds. Most of these issues have not been created by large corporations. Yet corporations may have unique capacities to either hinder or contribute to addressing them. One of the reasons behind the emergence of a corporate responsibility movement is precisely the realisation that states alone are unable–or unwilling–to address some of the major societal problems that the world is currently facing, notably the challenge of sustainability (e.g. Ruggie, 2003). Should pension funds support responsible corporate behaviour under the rationale of addressing societal issues and compensating for state failures? This section addresses this question. It explores the responsibilities of pension funds in the face of threats raised by major societal trends when the state is incapable, or unwilling, to intervene. We call this approach the civic investor approach because it suggests that pension funds might play a more active role in public policy debates than they currently do. Throughout the section, we shall use the issue of climate risk to illustrate the logic at play. This example

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is pertinent because it is a core issue of sustainability and because a number of institutional investors have recently expressed concerns on the matter, through such initiatives as the Carbon Disclosure Project, launched in May 2002, and the Investor Network on Climate Risk (2003), created in November 2003.

3.1.

Overall structure of the approach

Consider society as stemming from the interaction between three societal spheres–the economy, the social sphere and the environment–mediated by a political sphere. We assume that society can follow different trajectories of societal change, which lead to different societal outcomes characterised by mutually compatible social, environmental and economic performances. The reason pension funds should care to know which future is best for them is that there is no perfect hedge, i.e. no way of guaranteeing that liabilities will be financed in all possible future contingencies of the world. We now set out the three steps of the civic investor approach. First, pension funds should assess which of the different futures they face will maximise their capacity to meet their financial objectives. This is done by comparing the expected performance of their investments under different scenarios of societal transformation. Second, if a pension fund is better off if the societal issue is addressed, it will logically want a public response to that end. Such a response can take different forms: the state may step in, or when the state fails, some form of civil regulation may arise. Each case draws attention to specific aspects of corporate conduct that can support or hinder these public responses. Third, it assesses the actual costs and benefits of publicresponse enhancing corporate conduct from the perspective of pension funds. Only those aspects of conduct that generate higher benefits than costs would qualify as pension funds' preferences for responsible corporate conduct.

3.2. Monitoring the potential impact of various societal issues and trends The construction of scenarios provides an appropriate methodology to paint different possible futures, and then assess the more desirable course of action from the point of view of pension funds. These scenarios, as in World Business Council for Sustainable Development (1997), are intended to replicate the different paths of societal transformation and equilibria they lead to in the medium to long run. Consider the issue of climate risk. The starting point of the approach is to assess the stake of broadly diversified investors in climatic change. To simplify the analysis, we distinguish between two different scenarios: in a businessas-usual scenario, increases in greenhouse gas emissions continue unabated and produce widespread climatic changes that affect some businesses and economic activities directly; in a public-response scenario, concerns over current levels of greenhouse gases trigger a public response–either through state regulation or through various forms of civil regulation–to curb emissions, with the consequence that

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climatic disruptions are of limited magnitude but with a cost to businesses exposed to greenhouse gas emissions. In each of the two scenarios, pension funds will assess the potential impact on the value of a market portfolio on the basis of the type of risks that each company faces: risks from the direct impact of climatic changes in the first scenario or risks linked to a reduction in greenhouse gas emissions in the second. The Carbon Disclosure Project 2002 Report (cf. Innovest, 2002) assesses the relative importance of these two kinds of risks for large companies. This information can be used to draw implications for the performance of broadly diversified portfolios. On this basis, pension funds can identify which of the two scenarios is better for them, i.e. under which of the two scenarios they will have the greatest chance of meeting their financial objectives. If the business-as-usual scenario is more favourable, then the assessment of the specific societal issue will stop there.

3.3.

Promoting a public-response scenario

We now assume that pension funds prefer the publicresponse scenario over the business-as-usual scenario. The likelihood of such a public response will depend on the capacity of societies to organise themselves and undertake collective action. This is the challenge of governance. This challenge can be met in a number of ways. Standard economic and political theory posit that it is the role of the state to address existing societal problems and prevent the emergence of new ones. Yet, in practice, the state may not be able–or willing–to play the role that theorists assign to it. Cases of state failure are particularly significant in relation to sustainability, as Speth (2003) points out. One cause is jurisdictional gaps, i.e. mismatches between the level at which an issue arises and the existence of state institutions, coupled with mechanisms of accountability at the appropriate level (e.g. Kaul et al., 1999). Another cause is a sheer lack of human, financial or administrative capacity at the service of state action—an important limitation in many countries of the South. A third is the diversion of the state from its core mission of promoting the public goods and its capture by private interests. Innovative forms of governance have emerged over the past few years in response to these failures. Many of them– multi-stakeholder initiatives, civil regulation, public–private partnerships–are characterised by the active involvement of non-state actors, including large corporations and nongovernmental organisations, and thus break away from the simple model of state regulation according to which the state sets the rules and companies abide by them. Large corporations exercise a strong influence on these various forms of governance, old and new. This influence is a significant channel through which they have an impact on societal outcomes and thus an important component of their overall corporate responsibility.

3.3.1.

Facilitating and promoting state intervention

Pension funds can perform a number of tasks to facilitate and promote state intervention. For instance, they can share their concerns with their members and, in this way, influence

public debate. Alternatively or in addition, they can express these concerns directly to the public at large and to the state. The involvement of national associations of pension funds and institutional investors seems a logical way to do the latter.3 Pension funds can also facilitate state intervention by monitoring the political influence of the corporations in which they invest. Public policy and the design of institutions is a controversial area, and corporations have often participated in the process of policy-making to such an extent that, ever since Adam Smith's denunciation of the merchants' political influence in the late 18th century, their political power has regularly been criticised (e.g. Korten, 1995; Rajan and Zingales, 2003, among many others). The point is that the interests of managers and owners often diverge regarding public policy-making. Broadly diversified long-term investors will seek public policies that enhance the value of their portfolio and, usually, this will be achieved by policies that support a performing economy. Corporate executives, by contrast, aim to increase shareholder value and will promote public policies that favour their industry or, even better, their own companies. Pension funds should thus be concerned about the political influence exercised by companies. Indeed, they may find themselves in the strange position of being owners of companies that lobby policy-makers to hinder the state intervention that they themselves call for.

3.3.2.

Supporting the emergence of new forms of governance

State intervention is not the only form of public response available. In fact, in the context of state failures, new nonstate-centred forms of governance are emerging, in particular to deal with issues of sustainability. Revealingly, the speech of Kofi Annan (2003) at the Institutional Investors' Summit on Climate Risk is a barely concealed call on investors to act in response to the lack of political will shown by some governments. There is a wide diversity of these forms and, to focus our attention, we shall take the example of just one of them here. The governance system known as civil regulation relies on the demand for corporate responsibility expressed by the key stakeholders of a company—its investors, clients, employees and the communities wherein it operates (cf. Zadek, 2001). These stakeholders, in on-going contact with public debate, form their own opinion as to what constitutes appropriate corporate conduct. Such opinion coalesces into expectations

3 Consider the National Association of Pension Funds (NAPF) in the UK. NAPF represents pension funds covering some 10 million employees, who account for 75% of occupational scheme assets in the UK and control 20% of the shares of the London Stock Market. In its own words, “NAPF concentrates the power of its membership into an influential voice to government, parliament, regulators and the media. It also provides its members with valuable information and other services to assist them in the effective running of their schemes”. Given its mission, it seems reasonable to expect the NAPF to take a position on key policy issues, which may have a strong bearing on their members' capacity to meet their future liabilities, such as climatic change or international development. Similar organisations exist in other countries that base their retirement systems on pension funds.

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and ethical demands addressed at companies. From these then emerge business opportunities as well as reputation and other risks—thence business decisions reflective of stakeholders' new ethical preferences. Higher ethical standards and greater engagement on the part of stakeholders can thus contribute to aligning corporate operations with the societal objectives of sustainability.4 Civil regulation thus requires (i) high levels of corporate alertness and responsiveness to stakeholder expectations and to the risks and opportunities stemming from issues of sustainability; and (ii) high levels of stakeholder commitment to reward the more progressive companies and punish others. Large companies can derail civil regulation by not fulfilling the role that other actors expect them to play. Pension funds should monitor these corporate behaviours when a state-led response is unlikely to address a particular societal issue. Assessing corporate conduct in this perspective will involve assessing the extent to which corporate behaviours (i) are alert and responsive to stakeholder expectations and (ii) support (or hinder) the emergence of a counter-corporate power, notably in the form of enhanced stakeholder engagement. In the case of climatic risk, the 10-point action plan of the INCR provides some concrete examples of such countercorporate power measures. Point 1 calls upon the SEC “to enforce corporate disclosure on requirements under regulation S-K on material risks such as climate change (…)”; point 2 calls upon the “SEC to re-interpret or change its proxy rules”; points 4 and 5 call for companies to be more transparent about how they may be affected by climate change itself and the introduction of new regulations (INCR, 2003). Whether companies hinder or facilitate such proposals should be considered a corporate responsibility issue— and this is one to which pension funds may be particularly sensitive.

3.3.3. Costs and benefits of public-response enhancing corporate conduct We have identified above a number of specific corporate conducts that may provide benefits to pension funds in the context of serious societal issues: ▪ Restraint from exercising political influence that may hinder state intervention in addressing the societal issues. ▪ Raising corporate alertness and responsiveness to stakeholder expectations, and encouraging stakeholder engagement, in order to facilitate the emergence of civil regulation. We now assess whether it makes financial sense for pension funds to want companies to undertake such action, given that this may have a cost. The costs and benefits expected from corporate action comprise two elements: impact on the expected performance of a portfolio within a specific scenario and impact on the likelihood of occurrence of

4 For statistics on stakeholders' demands for corporate responsibility, see Environics International (2002). For the business case based on stakeholder expectations, see Willard (2002), among others.

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the three different scenarios—business-as-usual, public response through state intervention and public response through civil regulation. Furthermore, we assume that the expected long-term return on a pension fund's portfolio, for a given level of risk, is inferior in the business-as-usual scenario to what can be earned in the two public-response scenarios (otherwise pension funds would prefer the business-as-usual scenario). In this framework, restraining corporations from carrying out political lobbying aimed at hindering state intervention has a doubly positive effect for pension funds. First, it reduces corporate costs (i.e. the costs of political lobbying) and thus increases corporate profits and returns for investors. Second, it increases the probability of state intervention, and thus a public-response scenario, as preferred by pension funds. We can therefore conclude that this is indeed a preference that pension funds should rationally hold. Things are more complex for other aspects of corporate conduct. Raising alertness and responsiveness to stakeholder expectations may carry a hidden cost that will not automatically be covered by increased earnings or reduced costs at the company level. To reach some preliminary conclusions, assume that stakeholder engagement will not be strong enough for the company to recover these costs in the business-as-usual or the public-response-through-state-intervention scenarios, and that, by contrast, costs will be recovered in the public-response-through-civil-regulation scenario, because in this scenario stakeholder engagement is assumed to be high. From these simple assumptions, we derive the following points: ▪ Pension funds, among other stakeholders, will not take the lead in promoting corporate responsibility to address a specific societal issue through civil regulation. Indeed, if the level of stakeholder engagement in a specific societal issue is low, the cost of corporate engagement will not be recovered and the increased likelihood of the civil regulation scenario will not be sufficient to compensate for this loss. ▪ As stakeholder engagement rises, pension funds will want to raise corporate alertness and responsiveness before management does. The reason is that they have more to gain, i.e. the increased likelihood that the societal issue will be addressed.

3.3.4.

Discussion

The civic investor approach defines the responsibilities of pension funds in the face of threats raised by deep societal trends in a context of the restricted capacity or willingness of the state to intervene. Our analysis suggests that pension funds have a number of tasks to perform: ▪ Monitor how societal changes and emerging societal problems put their investments at risk ▪ Facilitate and promote state intervention by – raising members' awareness about the issue at hand – engaging in political lobbying – monitoring corporations' political influence and lobbying work

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▪ Support the emergence of new forms of governance by – raising corporate alertness and responsiveness to stakeholder expectations – encouraging stakeholder engagement. These tasks have a cost and, in many instances, issues of free-riding will arise (some pension funds may incur the costs of action from which all pension funds will benefit). These are valid concerns that require appropriate responses beyond the scope of this paper—although we did allude that some could be addressed through associations of pension funds. The tasks listed above go well beyond the tasks currently performed by pension funds and, for this reason, may seem strange. Yet, upon reflection, what should seem strange is that pension funds do not perform such tasks: individuals invest huge sums of money for their retirement, and yet there exists no seriously organised lobbying group to defend these investments against the encroachment of present policies and practices. The reason for this gap lies perhaps in people's confidence in the future. The concept of sustainability was formulated precisely to challenge this confidence and draw attention to the distribution of economic and social opportunities across time. Pension funds have still to draw the full implications of this challenge.

4.

Conclusion

Over the past few years, a consensus has emerged that sustainable development should be seen to have three main dimensions: economic, social and environmental. Consequently, and following John Elkington's Triple Bottom Line idea, companies are increasingly evaluated according to their impact on the economic, environmental and social spheres (Elkington, 1998). However, this is not sufficient to relate corporate behaviours to trajectories of societal change and to the long-term performance of the economy. In addition, it needs to be specified how the three spheres interact with one another, since it is this interaction that shapes societal development. This paper has proposed two approaches to identify corporate behaviours that may have a bearing on societal trajectories and, in particular, on long-term economic performance, and for this reason that are of potential concern for pension funds. The two approaches are complementary: the first one identifies corporate practices within a given institutional setting and the second one corporate practices that directly bears on this setting. It should be clear that there is a certain degree of overlap between the two approaches: indeed, in some cases, it is by adopting new practices such as in environmental management that companies will be able to bear on political processes. The combination of these two approaches has led us to narrow down substantially the number of corporate behaviours of relevance to pension funds (in the sole perspective of fulfilling their fiduciary responsibility) as compared, for instance, to the number of indicators developed by the Global Reporting Initiative (2002). Attention to how companies can impact trajectories of societal change through the interaction between different societal spheres has other important consequences. One of

them is to draw attention away from the relation between corporate responsibility and financial performance at the level of one company, and onto the link between corporate responsibility and the financial performance of broadly diversified portfolios.5 When broadly diversified investors look at a company's behaviour in relation to the other assets they own–as they should do–they will support the pursuit of shareholder value maximisation only to the extent that it is compatible with the maximisation of the performance of their entire portfolio.6 This paper has provided many examples of instances in which the two may diverge, such as in the case of political lobbying. This point, surprisingly rarely made in the literature apart from Hansen and Lott (1996), challenges current wisdom that all shareowners would agree with and promote the corporate objective of maximizing shareholder value.7 Another consequence stemming from looking at the impact of companies on societal trajectories is the need to precise the society under consideration, thereby drawing attention to the (mathematical) fact that the societal performance of companies will generally differ across societal systems. Since pension funds depend only upon the performance of those economies in which they invest, they will be concerned about corporate conducts that are responsible towards a specific territory or economy. This is the reason that, as discussed earlier, OECD pension funds will not be concerned about the “curse of natural resources” phenomenon. For pension funds, the concept of a corporate societal performance without reference to any specific societal system is of little interest. Finally, we may note that this spatial dimension raises more than an aggregation issue. It is also about the kind of information that is to be aggregated. Consider, for instance, the amount of water a company uses globally. Corporate responsibility analysts who use this criterion implicitly assume that it is meaningful to aggregate the amounts of water, measured in litres, that a company uses in different places to assess the sustainability impact of corporations. However, pension funds concerned about the long-term performance of specific economies will care about the opportunity cost of using water, and this cost will widely

5

More than 100 studies have explored the relationship between corporate social performance and financial performance. For references, see Forum for the Future (2002). For substantive critiques of these exercises, see Wood (1991), Rowley and Berman (2000) and Margolis and Walsh (2001). 6 In general, the set of corporate strategies that maximizes the value of a portfolio is logically different from the set constituted by the corporate strategies that maximize the shareholder value of each company considered in isolation. They will differ substantially as soon as interdependencies begin to exist across companies outside of the market and open to the influence of corporate behaviours. 7 Note that the current consensus on shareholder value maximization is rather new. In the 1970s, economists debated whether shareowners could unanimously agree on a firm's objectives. Disagreement, rather than agreement, was considered more likely, owing to differences in shareholders' investment horizons and risk/return preferences, e.g., Grossman and Stiglitz (1977).

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differ between different places. In this sense, a litre of water in water-rich Canada is not the same thing as a litre of water in water-poor Egypt. Here our analysis underlines the practical relevance of recent attempts (e.g. Figge and Hahn, 2004) to measure corporate contributions to sustainability in terms of opportunity costs.

Acknowledgements I would like to thank André Burgstaller for his support in writing this paper, as well as for inputs by Peter Buomberger, Jason Hauser, Alexander Seidler and two anonymous referees. Thank you also to Lucas Bretschger, Bettina Furrer and Bernd Schanzenbächer for useful comments. Financial support by Ecoscientia Foundation is gratefully acknowledged.

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