How a company manages its labor force, including how diverse it is and how a firm treats the environment, can help it avoid regulatory fines and prevent lawsuits, he adds. Such practices lead to all sorts of efficiencies. Socially conscious screens also help identify management teams that are on the ball, ones that can handle many complex issues and come up with effective ways of dealing with them, he says.
Many socially conscious fund managers were considering corporate governance in their investment decisions before the recent wave of corporate scandals. Socially conscious funds have been considering board independence, executive compensation and other issues for years in choosing investments, although many did not have specific screens for them.
In the last couple of years, more socially conscious fund managers have started voting against independent auditors whose compensation for non-audit work exceeded various benchmarks. At Pax World Funds, for example, Green says, early in 2001 the firm began voting against them if 75% or more of compensation came from non-audit activities. "We found in that first year, we voted against auditors 37% of the time. And by the end of the year, we all heard about Enron (Corp.)" This year, Pax World instituted tougher standards and lowered its benchmark to 25%. Green didn't have figures available yet on how the change affected the number of votes against auditors.
Concerns about corporate governance and social issues did help these funds stay away from companies that later became scandal-ridden. But it didn't help them avoid all the bad apples. With so much fraud and mismanagement surfacing, some managers have beefed up or added screens to identify potential management and financial problems. And many have been vocal supporters of regulatory changes that would require more openness and transparency in financial reporting.
Joan Bavaria, president of Boston-based Trillium Asset Management, an independent socially conscious investment manager, says the firm avoided many companies plagued with serious problems, such as WorldCom, primarily because of social concerns. "The only one we got hit with was Enron, but we weren't hit as badly as others. Most of us depend on a system that's honest. No one can anticipate theft," she says.
Other socially conscioius managers agree that corporate fraud and theft is difficult, if not impossible, to detect. Some of the worst offenders ended up in their portfolios until problems were revealed. For example, the Domini Social Equity Fund included Enron. Green says the Pax World High-Yield Fund owned some Adelphia Communications Corp. investments.
Julie Gorte, director of social research at the Bethesda, Md.-based Calvert Group Ltd., says the firm's various screens helped its passively managed social index avoid about half the problem companies-including Qwest Communications International Inc., Tyco International Ltd. and WorldCom. But others made it into the fund, including Enron, Global Crossing Ltd. and Adelphia.
Calvert, the category giant with 29 funds and about $8.5 billion under management, had already considered corporate governance issues when reviewing investments. But because of the magnitude of problems that have surfaced recently, it did a review and in August announced it was adding a new set of corporate governance and business ethics guidelines to its criteria. Among the 51 corporate governance issues Calvert now looks at are board diversity, compensation, securities fraud and the quality and independence of auditors.
Gorte notes the company is using Corporate Governance Quotient (CGQ) ratings, introduced in June by Institutional Shareholder Services of Rockville, Md. CGQ ratings are supposed to help institutional investors evaluate the quality of corporate boards and the impact their governance practices have on company performance.
"We have sharpened our filters, but whether it will add financial value in the long run, it's too soon to tell," Gorte says.