A Rose by Any Other Name : Models of Social Responsibility as Predictors of Financial Performance J.C. Thompson *, Professor of Finance Northern Kentucky University Allen D. Engle, Sr., Professor of Management Eastern Kentucky University Judith Winters Spain, Professor of Management Eastern Kentucky University ABSTRACT Corporate social responsibility: Does it have to be at the expense of long term financial performance? As client seek the best return on investments, can an investment firm ethically promote a socially responsible investment fund rather than a more established traditional investment in an index fund that does not explicitly account for social responsibility? The authors predict that returns of socially responsible investment funds of varying market capitalizations and investment philosophies do perform as well as funds where managers are not required to choose from a limited universe of investment options. Results from a comparative analysis of traditional funds vis a vis funds made up of firms with various practices associated with social responsibility over six years (2001 2006) indicate no significant differences in economic performance captured by stock price movement. There is also no significant difference in the risk profiles as measured by the standard deviations of the returns. The paper concludes with a discussion of the potential advantages of further research focusing on enhancing the operationalization of firm practices related to social responsibility and replicating the research over a wider time horizon. Key Words: Business ethics, Corporate social responsibility, Investments, Socially responsible investing What's in a name? That which we call a rose, by any other name would smell as sweet. William Shakespeare Romeo and Juliet, Act II, Scene II INTRODUCTION Social responsible investment. Conventional investment. The terms vary, but do the results? Can we combine the traditional management practices associated with intermediate term economic returns with practices associated with long term social returns, or is there some inevitable tension or tradeoff between the two (Engle, Spain and Thompson, 2002). How do potential investors and brokers measure firm practices related to social responsibility and how do we measure and create metrics to measure the nature of these potential tradeoffs? An average investor seeks the highest yield given tolerable risk levels on his limited investment monies. Investment firms provide advice as to what would be the best investment option for the investor. The investor trades based upon this advice. It is a never ending circle. For the average investor seeking return on his limited investment, can or should the client/investor afford to put their ethics first and their investment second? Shank et. al. (2005, 82) would contend, few if any investors are willing to place their core beliefs ahead of a fair return on their * Contact author is J.C. Thompson and his email is Thompsonj2@nku.edu.
money. However, if social responsible investment returns the same or similar yield with similar risk, then a client could be encouraged to vote his conscience and invest in social responsible funds. The authors ask if the best fund for this average investor can also be the one that practiced socially responsible investment. Schueth (2003, 190) defines socially responsible investing as the process of integrating personal values and societal concerns into investment decision making. Hayes (2005, 59) further defines the concept by stating, the objective of SRI is to combine an investor s traditional financial goals with a commitment to social concerns. A problem with the term social concerns is that it appears to run the gamut across a variety of issues and priorities resulting from the personal value systems of owners, the agendas of various interest groups, or national or international fads or fashions. Among the topic areas covered are chemical greenness, child labor, animal rights, global warming, economic justice, and national sovereignty, to name just a few of the more common issues screened for by companies espousing corporate social responsibility. The authors have concluded that there is no consistent definition of social concerns. However, the authors further conclude that however SRI is defined; the firms that espouse utilizing social responsibility screens do reduce their investment universe. Socially responsible investment (SRI) is neither a new term nor a new concept. (Owen, 1990; Sauer, 1997). Indeed, a quick search of the Internet using the search term "socially responsible investment netted 1,178,000 hits (Accessed October 28, 2007). SRI now encompasses an estimated $2.3 trillion out of $24 trillion in the United States investment marketplace today. (SIF, 2007). Various research studies have compared different SRI funds to traditional funds, typically with similar net assets. Bello (2005) utilized Morningstar s Principia Pro database versus S&P 500 and threemonth Treasury Bills. Bello (2005) concluded that SRI funds are more volatile than conventional mutual funds. Statman (2000) compared the performance of the Domini 400 Social Index to S&P 500 and that while the S&P 500 did outperform the Domini 400 Social Index, the results were not significant. Sauer (1997) also utilized the Domini 400 Social Index and compared it to Domini Equity Mutual Funds, and found that the application of socially responsible screens did not significantly adversely affect performance. Schroder (2007) compared SRI indices rather than SRI funds and found that SRI indices had risk adjusted returns similar to those of their benchmarks. Indeed, investment firms have been using socially responsible screens to determine attractive investment opportunities. Interestingly, a review of this research nets contradictory results. Rudd (1981) contends that whenever a fund is constrained, its performance suffers. Hamilton et. al. (1993) and Statman (2000) all argue that using social screens does not have a significant effect upon investment performance. Sauer (1997) conjectured that diversification within the funds may be affected since the screens eliminate certain entire industries. Ahrens (2004) contends that the screening process itself is flawed since companies could be eliminated based upon incomplete information, or a flawed articulation of the firm s real social position on social responsibility, and not due to some actual set of objective management practices related to social responsibility. RESEARCH DESIGN There is significant literature comparing the risks and returns to various types of conventional mutual funds. For instance, comparisons are routinely made between growth and value funds. These funds, however, face few restrictions on the investments they are allowed to pursue. With the exception of certain restricted countries where investment is not allowed, the fund managers typically have a virtually unlimited choice of investment options. In the SRI sector, however, the choices are limited by the restrictions that various funds place on the investments they consider appropriate. The appropriate restrictions are by no means consistent among fund management companies. For example, some funds screen for only environmental issues while others screen for such things as animal welfare and gambling or defense related stocks, yet, both types of funds are in the SRI realm. This paper examines the returns of SRI s of varying market capitalization and investment philosophies compared to similar funds whose managers are not required to choose from a limited
universe of investment possibilities. Because the risk profiles are similar between the SRI funds and similar sized non SRI funds, the focus of this paper is primarily on the returns generated. The analysis covers the period 2001 through 2006. For several of the comparisons, individual yearly returns were analyzed as well as those for the entire six year period. The authors conducted three separate analyses. One analysis utilized the Social Investment Forum 1 (SIF) which provided a list of small/mid cap SRI funds and large cap SRI funds. The SIF was chosen since it is a national membership association dedicated to advancing the concept, practice, and growth of socially responsible investing. SIF s membership includes over 500 investment practitioners and institutions and its website identifies all socially responsible mutual funds offered by the SIF member firms. The list is public and is provided by SIF as a means for the individual investor to compare funds. Additionally, SIF members invest in companies of different market capitalization, as do most conventional mutual funds. For the first analysis, utilizing the SIF identified funds, the authors compared the returns of both small/mid cap SRI funds and large cap SRI funds to size appropriate indices of performance for ordinary mutual funds that face no restrictions on their investment universe. The indices chosen for the initial comparisons were the Russell 2000 Index for the small/mid cap funds and the Russell 3000 Index for the large cap funds. These indices were chosen because they are broader and more inclusive that others such as the S&P 500. In addition, the authors also conducted a second analysis. In this comparison, the authors continued to utilize the SIF identified funds. However, in this analysis, the authors compared the SIF funds to Best Corporate Citizens 2000 (BCC), an index based on a compilation of socially involved companies published listed as the 100 Best Corporate Citizens in 2000, published in Business Ethics (2000). The 2000 BBC index was the last one compiled before our comparisons were made. The list, which originally contained one hundred names of both large cap and small/mid cap companies, was reduced to sixty five as a result primarily of mergers that occurred involving companies on the list during the period under study. In conjunction with the second analysis, the authors also compared the monthly returns of the BCC to the Russell 3000 Index for large cap funds, the Russell 2000 Index for the small/mid cap SRI funds and to both groups of funds (small/mid cap and large cap) individually. The third analysis is a further comparison of the SIF identified funds, based upon specific investment attributes/screens, to the Russell 3000 Index. DATA Data for the first analysis were the monthly returns for fifty SRI mutual funds, as identified through SIF. The returns were computed using month end prices for the funds from Yahoo Finance. (http://finance.yahoo.com) The SIF funds were first segregated by market capitalization regardless of investment philosophy and analyzed separately. There were 39 large cap funds and 11 small/mid cap funds analyzed. The average returns to the SIF funds were compared to the returns of an appropriate index of conventional mutual funds. The indices chosen by the authors were the Russell 2000 Index for the small/mid cap SRI funds and the Russell 3000 Index for comparison to the large cap SRI funds. Data for the second analysis were the monthly returns for all fifty SIF mutual funds compared to the BCC. The BCC index was created for this study and had a mix of both large cap and small/mid cap companies. The third analysis also utilized the monthly returns for the fifty SIF mutual funds. The SIF funds were segregated by investment philosophy. Investment philosophies varied significantly. Some funds have negative screens meaning that they would not invest in certain sectors of the universe of investments. Other funds had positive screens, meaning they sought investments in only certain sectors of the investment universe. 1 http://www.socialinvest.org/about/index.cfm
In this third analysis, the SIF funds were segregated by investment philosophy. The following categories were chosen because these were the only clearly delineated screens for which a reasonable sample size could be obtained: Screen A: Those that only excluded firms with tobacco interests with no positive screens Screen B: Those whose only positive screen is human rights Screen C: Those whose only positive screen is equal employment opportunity Screen D: Those whose positive screens concern the environment, human rights, labor relations employment equality and community investment (the largest grouping of multiple screened funds) In all three analyses, the returns for the SIF funds, BCC, Russell 2000 Index, and Russell 3000 Index were computed over a six year period (2001 through 2006). The period was chosen because it encompassed a variety of economic conditions from the recessionary environment in 2001 to a relatively robust economy in 2005 and 2006. METHODOLOGY SIF Small/Mid Cap and SIF Large Cap v. Russell Indexes For the first analysis, the monthly returns were averaged across the funds in both the SIF identified SRI small/mid cap and SRI large cap and groups. This produced 72 data points for each study, one for each of the 72 months of data. This vector of average SRI returns was tested for differences from the matched monthly returns of each respective index (Russell 2000 Index and Russell 3000 Index) using a paired t test. The paired t test was chosen because of the temporal match between the returns tested. Table 1 shows the results for the sample of SIF small/mid cap compared to Russell 2000 Index for the entire 6 year period, 2001 through 2006. Tables 1.1 through 1.6 show the results of the tests on the same sample for each of the individual years. Because N in the case of the individual years was a relatively small 12, the non parametric Wilcoxon Matched Pairs Signed Rank Test value was also computed for each instance of this sample size. The statistical significance of the results did not change so the more familiar t test results are shown in the tables. Table 2 shows the results for the sample of SIF large cap compared to Russell 3000 Index for the entire 6 year period 2001 through 2006. Tables 2.1 through 2.6 show the results of the tests on the same sample for each of the individual years. SIF Small/Mid Cap and SIF Large Cap v. BCC For the second analysis, Table 3 shows the results for the combined sample of both SIF small/mid cap and SIF large cap fund as compared to the BCC for the entire six year period under study. Tables 3.1 through 3.6 show the results of the tests on the same sample for each of the individual years. As stated above, the index created by the authors contained both small/mid cap and large cap firms, hence, the combined analysis. Tables 4 through 7 show the results of a comparison of the BCC s index to the sample of small/mid cap funds, the large cap funds, the Russell 2000 Index and Russell 3000 Index respectively. This was done in the case of Tables 4 and 5 to be certain that our combined analysis (small/mid cap and large cap funds) relative to the BCC was appropriate. Tables 6 and 7 show the comparison of the BCC to the well recognized Russell Indexes. SIF Screened v. Non screened For the third analysis, additional testing was done on funds that screen for specific investment attributes. This involved the comparison of the various screened funds, as identified by the SIF, to the appropriate index of non screened funds, as identified by the Russell 3000 Index. The results of these tests are shown in Tables 8 through 11.
SUMMARY AND INTERPRETATION SIF Small/Mid Cap and SIF Large Cap v. Russell Indexes For the first analysis, the results (Tables 1 1.6 and Tables 2 2.6), if evaluated at the normal significance level of.05, show only one significant difference between the returns to a SRI portfolio and one to which it is compared. This situation occurs in 2006 in the large cap sample (p=0.0092). (Table 2.6) The Russell 3000 Index outperformed the large cap SRI s during this year. The most logical reason for this appears to be the significant increase in oil prices that occurred during 2006. Prices for crude rose from about $40/bbl to above $70/bbl during 2006. This led to significant returns for companies involved in the oil industry and included in the Russell 3000 Index. The oil industry is avoided by a significant number of SRI funds, which, as a result, would not have benefited at all from the increase. Because the results for only this one circumstance are statistically significantly different, it appears that those investors, who are attracted to SRI s, rather than more traditional investments, are not generally suffering lower returns as a result. However, should the results be evaluated at a 0.075 level, other relationships become statistically significant that have greater bearing on investors choices. The returns to the Russell 2000 Index are statistically significantly different at this level from those of the small/mid cap SRI sample (p=0.0685). (Table 1) The higher returns to the Russell 2000 Index are driven primarily by the returns in 2003 (p=0.0614). (Table 1.3) The average monthly return in 2003 of the SRI funds was 1.9% while the average returns of the Russell 2000 Index was 3.4%. The authors posit that one reason the SRI s may have failed to achieve the overall performance of the Russell 2000 Index is the fact that the Russell 2000 Index contains many companies whose operations are technical and biological in nature. SRI funds generally shy away from including companies that do the type of experimentation, e.g., animal studies, done by many of these firms. For the first analysis, these data seem to indicate that for socially responsible investors, SRI large cap funds may be a better option than small/mid cap funds. SIF Small/Mid Cap and SIF Large Cap v. BCC For the second analysis, the results (Table 3), if evaluated at the normal significance level of.05, show no significant difference. Table 3 compares the SIF small/mid cap and large cap funds to the BCC. In addition, Tables 4 through 7 show the results of a comparison of the BCC s index to the sample of small/mid cap funds, the large cap funds, the Russell 2000 Index and Russell 3000 Index respectively. The lack of statistical significance in Tables 4 and 5 support the authors use of the combined (both small/mid cap and large cap) analysis shown in Table 3. The lack of statistical significance in Tables 6 and 7 shows that the BCC Index performed as well financially as the Russell 2000 and 3000 Indexes. SIF Screened v. Non screened For the third analysis, the results (Tables 8 through 11), if evaluated at the normal significance level of.05, show no significance. Thus, since SIF funds that screen, using the criteria set forth in Screens A, B, C, and D show no significant difference in return on investment as compared to funds in the Russell 3000 Index, an investor could invest in the SRI funds without concern for loss of investment. FUTURE RESEARCH This study was limited to the extent that only two lists that identified social responsible invested funds were compared to conventional funds. Further research could develop additional lists to further test the theory espoused in this paper. Additionally, the present study only covered a six year window. Additional analysis over wider time horizons would add to our understanding of the issues related to this topic area. Indeed, one could expand this research and delve into the arena of establishing the criteria for determining corporate social responsibility. Judging from the plethora of lists ranking firms on the basis of their commitment to social responsibility, numerous definitions of the terms exist. The authors believe
that the criteria for placement on these lists varies to such an extent that one would wonder if there is a right definition of corporate social responsibility in terms of a predictor of financial performance. Perhaps with utilizing multiple lists with multiple firms, future research could develop the best criteria for defining social responsibility as a predictor of financial performance. More work towards a more sophisticated operationalization of that set of management practices related to firm social responsibility in the SIF beyond the four screens we employed would speed our collective analysis of this topic as well as bear practical benefits for investors and brokers. Traditional financial performance metrics are sophisticated and widely accepted (Boudreau and Ramstad, 2007, 16 19). If social responsibility is as the authors believe a critical conceptualization of firm effectiveness in an increasingly interdependent and complex world, then efforts to develop and promulgate a more complete and accurate set of metrics for corporate social responsibility will move us all beyond the existing sad situation in which we appear paralyzed by the vague, long held assumption of a zero sum game between social stewardship and professional financial stewardship. We trust this paper is a positive step toward reconciling these warring parties and we may go hence, to have more talk of these sad things. (Romeo and Juliet, Act V, Scene, III)
TABLES Table 1 All Years 2001 2006 SIF Small/Mid Cap v. Russell 2000 Index Group Small/Mid Cap Russell 2000 Mean 0.0030 0.0092 SD 0.0320 0.0528 SEM 0.0038 0.0062 The two tailed P value equals 0.0685 t= 1.8499 Table 1.1 Year 2001 SIF Small/Mid Cap v. Russell 2000 Index Group Small/Mid Cap Russell 2000 Mean 0.0069 0.0043 SD 0.0464 0.0690 SEM 0.0134 0.0199 The two tailed P value equals 0.2576 t= 1.1939 Table 1.2 Year 2002 SIF Small/Mid Cap v. Russell 2000 Index Group Small/Mid Cap Russell 2000 Mean 0.0130 0.0168 SD 0.0439 0.0664 SEM 0.0127 0.0192 The two tailed P value equals 0.7281 t= 0.3566 Table 1.3 Year 2003 SIF Small/Mid Cap v. Russell 2000 Index Group Small/Mid Cap Russell 2000 Mean 0.0187 0.0337 SD 0.0277 0.04681 SEM 0.0079 0.0135 The two tailed P value equals 0.0614 t= 2.0824
Table 1.4 Year 2004 SIF Small/Mid Cap v. Russell 2000 Index Group Small/Mid Cap Russell 2000 Mean 0.0069 0.0149 SD 0.0195 0.0421 SEM 0.0056 0.0122 The two tailed P value equals 0.2977 t= 1.0931 Table 1.5 Year 2005 SIF Small/Mid Cap v. Russell 2000 Index Group Small/Mid Cap Russell 2000 Mean 0.0041 0.0045 SD 0.0207 0.0419 SEM 0.0060 0.0121 The two tailed P value equals 0.9568 t= 0.0555 Table 1.6 Year 2006 SIF Small/Mid Cap v. Russell 2000 Index Group Small/Mid Cap Russell 2000 Mean 0.0083 0.0148 SD 0.0165 0.0393 SEM 0.0048 0.0113 The two tailed P value equals 0.4128 t= 0.8513
Table 2 All Years 2001 2006 SIF Large Cap v. Russell 3000 Index Group Large Cap Russell 3000 Mean 0.0028 0.0039 SD 0.0368 0.0406 SEM 0.0043 0.0048 The two tailed P value equals 0.1891 t= 1.3261 Table 2.1 Year 2001 SIF Large Cap v. Russell 3000 Index Group Large Cap Russell 3000 Mean 0.0075 0.0185 SD 0.0571 0.0587 SEM 0.0165 0.0017 The two tailed P value equals 0.5923 t= 0.5515 Table 2.2 Year 2002 SIF Large Cap v. Russell 3000 Index Group Large Cap Russell 3000 Mean 0.0165 0.0185 SD 0.0479 0.0580 SEM 0.0138 0.0068 The two tailed P value equals 0.6371 t= 0.4851 Table 2.3 Year 2003 SIF Large Cap v. Russell 3000 Index Group Large Cap Russell 3000 Mean 0.0195 0.0233 SD 0.0274 0.0331 SEM 0.0079 0.0096 The two tailed P value equals 0.1145 t= 1.7143
Table 2.4 Year 2004 SIF Large Cap v. Russell 3000 Index Group Large Cap Russell 3000 Mean 0.0080 0.0097 SD 0.0237 0.0234 SEM 0.0068 0.0068 The two tailed P value equals 0.1578 t= 1.5158 Table 2.5 Year 2005 SIF Large Cap v. Russell 3000 Index Group Large Cap Russell 3000 Mean 0.0046 0.0053 SD 0.0238 0.0249 SEM 0.0069 0.0072 The two tailed P value equals 0.5296 t= 0.6491 Table 2.6 Year 2006 SIF Large Cap v. Russell 3000 Index Group Large Cap Russell 3000 Mean 0.0085 0.0124 SD 0.0205 0.0184 SEM 0.0059 0.0053 The two tailed P value equals 0.0092 t= 3.1496
Table 3 All Years 2001 2006 SIF Large & Small/Mid Cap v. BCC Group Large & Small/Mid Cap BCC Mean 0.0028 0.0055 SD 0.0356 0.0471 SEM 0.0042 0.0055 The two tailed P value equals 0.6774 t= 0.4177 Table 3.1 Year 2001 SIF Large & Small/Mid Cap v. BCC Group Large & Small/Mid Cap BCC Mean 0.0074 0.0055 SD 0.0545 0.0471 SEM 0.0157 0.0055 The two tailed P value equals 0.9154 t= 0.1088 Table 3.2 Year 2002 SIF Large & Small/Mid Cap v. BCC Group Large & Small/Mid Cap BCC Mean 0.0156 0.0055 SD 0.0469 0.0761 SEM 0.0135 0.0220 The two tailed P value equals 0.9954 t= 0.0059 Table 3.3 Year 2003 SIF Large & Small/Mid Cap v. BCC Group Large & Small/Mid Cap BCC Mean 0.0193 0.0302 SD 0.0273 0.0362 SEM 0.0079 0.0105 The two tailed P value equals 0.3825 t= 0.9097
Table 3.4 Year 2004 SIF Large & Small/Mid Cap v. BCC Group Large & Small/Mid Cap BCC Mean 0.0772 0.0032 SD 0.0226 0.0284 SEM 0.0065 0.0082 The two tailed P value equals 0.6585 t= 0.4542 Table 3.5 Year 2005 SIF Large & Small/Mid Cap v. BCC Group Large & Small/Mid Cap BCC Mean 0.0045 0.0076 SD 0.0230 0.0234 SEM 0.0066 0.0068 The two tailed P value equals 0.7913 t= 0.2712 Table 3.6 Year 2006 SIF Large & Small/Mid Cap v. BCC Group Large & Small/Mid Cap BCC Mean 0.0085 0.0129 SD 0.0195 0.0203 SEM 0.0056 0.0059 The two tailed P value equals 0.5646 t= 0.5938
Table 4 BCC v. SIF Small/Mid Cap Group BCC Small/Mid Cap Mean 0.0055 0.0030 SD 0.0471 0.3201 SEM 0.0055 0.0038 The two tailed P value equals 0.7164 t= 0.3672 Table 5 BCC v. SIF Large Cap Group BCC Large Cap Mean 0.0055 0.0028 SD 0.0471 0.0368 SEM 0.0055 0.0043 The two tailed P value equals 0.6999 t= 0.3870 Table 6 BCC v. Russell 2000 Index Group BCC Russell 2000 Mean 0.0055 0.0092 SD 0.0471 0.0528 SEM 0.0055 0.0062 The two tailed P value equals 0.6607 t= 0.4408 Table 7 BCC v. Russell 3000 Index Group BCC Russell 3000 Mean 0.0055 0.0039 SD 0.0471 0.0406 SEM 0.0055 0.0048 The two tailed P value equals 0.8327 t= 0.2120
Table 8 SIF Screened Funds (Screen A ) v. Russell 3000 Index Group Screen A Russell 3000 Mean 0.0039 0.0039 SD 0.0276 0.0406 SEM 0.0033 0.0048 The two tailed P value equals 0.9732 t= 0.0337 Table 9 SIF Screened Funds (Screen B ) v. Russell 3000 Index Group Screen B Russell 3000 Mean 0.0049 0.0039 SD 0.0148 0.0406 SEM 0.0017 0.0048 The two tailed P value equals 0.7853 t= 0.2735 Table 10 SIF Screened Funds (Screen C ) v. Russell 3000 Index Group Screen C Russell 3000 Mean 0.0038 0.0039 SD 0.0331 0.0406 SEM 0.0039 0.0048 The two tailed P value equals 0.9113 t= 0.1118 Table 11 SIF Screened Funds (Screen D ) v. Russell 3000 Index Group Screen D Russell 3000 Mean 0.0024 0.0039 SD 0.0368 0.0406 SEM 0.0043 0.0048 The two tailed P value equals 0.0901 t= 1.7184
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