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Sustainable Returns--Investor Impact

Sustainable Returns--Investor Impact

Author: Kate Eskra

This lesson will explain Sustainable Returns--Investor Impact

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Hi. Welcome to Economics. This is Kate. This tutorial is called Sustainable Returns-- Investor Impact. As always, my key terms are in red and my examples are in green. So in this tutorial, we'll talk about what a CEO's fiduciary responsibilities are to its shareholders. We'll discuss whether these responsibilities should actually extend beyond just financial returns and include social responsibility. And then we'll outline the ways that economists are currently looking at the issue of sustainability and talk about some of the challenges.

So think like an investor for a second. If you were thinking about investing in a company, what is it that's your top priority? Well, you want to make a decent return on your money, right? Otherwise there's no point in investing. But is there anything else that you might consider? Would you care what the company's producing? Would you care how the company is producing? Think about that as we go through this tutorial.

So what is fiduciary duty? It's the idea that any company has certain duties or responsibilities to its investors. And first of all, that duty is to get them the highest return possible, but also do so with care, loyalty, and disclosure. So generally, the focus here has been on generating strong investment returns. And those are reported in quarterly earnings performance.

So could this, though, also imply that companies have social responsibilities? So what is it that investors consider when they are seeking companies? Well, a lot of investors look for companies to have successful management teams. They're looking to leaders of the company to drive profits and to make wise decisions for the company. But some investors, especially more so today, are starting to be concerned with investing in what we call socially responsible firms, or SRI, Socially Responsible Investing.

And there are actually some funds that contain an index for only companies who follow high environmental or social and governance standards. And that's where I already said, Socially Responsible Investing, or SRI combines the goals of financial return and social good. So the idea that people are out there who want to make money, but they want to do it where they feel that those companies are doing something that's good, or at least not harming the environment, for example.

So what Socially Responsible Investing does is it encourages practices that promote environmental protection, consumer protection, human rights, and diversity. Some even go as far as to avoid any companies in their index or in their fund that involves any companies at all dealing with alcohol, tobacco, gambling, pornography, maybe weapons, or military. It just depends. It really varies from index to index.

So some surveys recently have been pointing to increasing concern for companies to either disclose their climate risk, and/or take on sustainability initiatives. But really, right now, the evidence on this is inconsistent as to how much people really do want companies to do those two things. All right. So let's think about an example of a CEO of a company.

Let's say that this CEO is an environmentally concerned one. He wants to adopt practices that take into consideration climate change for his company. Certainly this is going to cost of the company money. And unfortunately, it might initially bring profit levels down. Not to say that long-run those profit levels won't come right back up, but initially it could certainly bring those levels down.

In order to do this, he's going to need support from his investors, the Board of Directors, and any other corporate stakeholders. Without that support, his role as CEO-- he could be very easily replaced. So then this presents a dilemma. You can kind of see why, maybe, leaders of companies are not taking these initiatives, because, again, back to this idea of fiduciary responsibility, what is that responsibility?

Now that we're seeing perhaps more investors concerned with sustainability and climate change risk, does this now become an actual priority? Obviously, returns are still the top priority for most investors. And so it's almost as if there are these two different ideas here, where they could focus mainly on returns, which is the top priority, but how much is this becoming a top priority with climate change and sustainability?

Unfortunately, because returns are still the top priority, that can really keep leaders from implementing policies that might adversely impact earnings performance, especially in the short-term. So what executives are forced to do is really think short-term, in terms of quarterly performance, more than long-run, with things like sustainability and climate change.

So just an example, here, to kind of show the impact that investors have had, let's look at the impact that they've had on CEO compensation. So recently, the public, especially shareholders, people have really had something to say about CEOs and how much they're paid. And that was all because of a really weak economy. And then couple that with companies not performing very well, that led to a lot of people saying, wait! Hold on!

Most people are doing very poorly in their jobs right now. The economy is tanking. These companies are not doing well. They risking people's money. And wait! The leaders of the companies are making how much money?

And so the outcome of the public outcry was something called "Say on Pay." And that's been where executive pay needed to be disclosed. So we want to know how much these leaders are making. And a cry for their pay to be tied to the company's performance and their ability to manage risk.

So evidence suggests now that investors have really had a very significant impact in this regard. In fact, among 51 major CEOs, by the end of fiscal year 2012, half of their compensation has been tied to companies performance. And this just highlights the role that investors really can play in public companies decisions.

So could they, potentially, have this kind of impact on sustainable returns? If investors can have that kind of influence on the CEO salaries, isn't that evidence enough to show maybe they can put pressure on companies to address the environment and climate change? So awareness hasn't increased enough for the SEC to address it as an issue, but unfortunately short-run concerns right now, like I was talking about before, have kept the focus mainly just on that quarterly performance and returns.

So how are economists viewing this? Because after all, this is an economics course. Well, environmental groups such as Nature Conservancy and many others, are currently working on climate advocacy programs. And they're working with economists, because they want to incorporate the ideas of profitability into it.

They know that no one's going to go along with this if it's just at the idea of sustainable. So if we incorporate profitability with sustainability, then maybe we can get somewhere. So some believe that a long-term solution might be adopted, but only if it's universally adopted-- so by everybody, all countries. And it includes a list of what risks need to be addressed and mitigated. So mitigated means changing how we do things. Also that the risk management really needs to be specifically developed and implemented sector by sector. So it's going to be different for each industry and each company.

Most people are now recognizing the importance of involving investors, seeing the impact that they've had, like we said, on CEO compensation. And so if anything is going to happen, companies realize that they need to get their investors involved in developing and implementing changes in the way that executives make decisions for the company.

So economists right now are looking to the government to get involved, because without the government, there won't be standards set, and there won't be any universal mandates. And that's what needs to happen. So right now, there really are no universal regulations in place in the United States when it comes to climate change. There was the treaty, the Kyoto Protocol, but the United States has not signed it. And that was a treaty to reduce greenhouse gas emissions.

It turns out that investors in the United States are much less interested in climate change than investors in European countries. So that's really why economists right now are looking to the government get involved here.

So in this tutorial, we talked about the fiduciary responsibility that CEOs have to their investors. We talked about how some people believe this responsibility should, in fact, extend beyond just high returns, and consider socially responsibility, like climate change and sustainable returns. But there are really obstacles preventing CEOs from committing to ideas like sustainability. But if we can get investors and environmental groups and the government, we might be able to have an influence in the future. Thanks so much for listening. Have a great day.