Financial Resource

Financial markets are the driving force behind the world; they determine the actions of companies and the wealth of billions. Each day they go up and down dependant on numerous factors, however, whether social, environmental or sustainability issues (hereafter all will be referred to generically as social issues) are included in those factors is still unclear. This paper looks to examine whether financial markets are concerned with these issues and why we should care if they do or not. “If certain actions (classified as socially responsible) tend to be negatively correlated with financial performance of firms, then managers might be advised to be cautious in this area. If, on the other hand, a positive relationship can be shown to exist, then management might be encouraged to pursue such activities with increased vigour or to investigate the underlying cause of the relationship” (Cochran & Wood, 1984). Firstly we will look at some evidence concerning the link between the markets and these issues and from it we come to the conclusion that markets in fact do not care, or respond, to social issues. We will then discuss why we may be concerned with these results; why should we care the markets do not react to these issues? Finally we will look at how we might get the markets to respond to these issues, one such way may be Elkington’s Triple Bottom Line.

There have been several different arguments concerning whether financial markets are affected by social issues. Some claim a negative relationship; their arguments state that the added costs of being responsible put them at a disadvantage to other comparable firms who have not been as socially responsible as them (Bragdon & Marlin, 1972; Vance, 1975). Contrasting this are those arguing a positive relationship (Anderson & Frankle, 1980; Bowman & Haire, 1975); Soloman & Hansen (1985) state that it can result in increased employee and customer goodwill. Others state that it can aid relationships with key institutions and people (banks, investors and the government for example) bringing with it economic benefits (Moussavi & Evans, 1986). One other argument for a positive relationship is that of Cornell & Shapiro (1987); their discussions on stakeholder theory lead to a conclusion that firms with an image of higher social responsibility have a better financial performance. Some simply conclude that it doesn’t matter either way; “economic performance is not directly linked, in either a positive or negative fashion, to social responsiveness” (Arlow & Gannon, 1982).

With so many conflicting arguments and varying methods of research done, it can be hard to find the real truth to discuss. Primarily for simplicity we have selected the conclusions of Murray et al. (2006) as the basis of this discussion. Their methods take into account and build upon the research done before them; this gives them a greater degree of accuracy in their results. They also undertake a longitudinal examination of the trend as a result of the arguments by Gray et al. (2001) that a relationship is more likely to be seen over time rather than at one point in time. The specific link this study focussed on was that between the behaviour of the stock market (the share price returns for the company) and social disclosure (the data reported by that company). The data sets used were subjected to several statistical tests and the Pearson Correlation (used to test for a linear association) and the Chi-Squared test (used to test for a non-linear association) resulted in the conclusion “no relationship, either linear or non-linear, however, emerges from an analysis of the findings” (Murray et al., 2006). It would appear from their findings that markets do not appear to care about social issues; of the many different factors that change the market they are not one of them. So why is it a concern to us whether the markets care about these issues? Well, if it could be shown that these disclosures can start to affect the markets then a viable case can be included with the moral case that “substantive social and environmental disclosure needs to become a regular, significant and regulated part of corporate disclosure” (Murray et al., 2006). From this we can consider, like Schmidheiny & Zorraquin (1996), that financial markets may be a key driver for global sustainability.

Considering some evidence, this conclusion may not seem too unexpected. Traditionally, investors are still assumed to be concerned with nothing but maximising their risk-adjusted returns (Benston (1982); Skogsvik (1998); Rivoli (1995)). “Under such an assumption, there is no immediate or obvious reason for shareholders to have any interest in the social and/or environmental aspects of their investment – except insofar as those aspects represent a potential risk to the investment or whose disclosure can be taken as signals about the competence of management (Neu et al., 1998; Hufsted, 2000; Orlitzky and Benjamin, 2001; Milne and Patten, 2002)” (Murray et al., 2006).

Considering that the markets, in fact, do not care about these social issues, why is it that companies dedicate so much to producing these social disclosures. As Murray et al. (2006) suggests; it appears simply wasteful of the management to produce these reports considering that they do not affect the share price (the financial markets). They comment that this wastefulness “would fly directly in the face of ‘conventional’ market wisdom” (see, Friedman’s (1962, 1970) comments concerning this) without it being proven that these reports can affect share price and the markets. They put forth some musings on how these reports may be deemed useful; “Could such data represent signals to the investor? Could the signal suggest that, for example, the company is aware of potential social or environmental costs and has taken steps to manage them? Could it be that it is aware of the actions of pressure groups and has responded to avoid potential problems? Perhaps it signals awareness of growing liabilities on which the company is acting accordingly or suggests that the company is managing and exploiting its high level of reputation with niche consumer groups” (Murray et al., 2006). The market needs to be changed to take into account these factors.

One way we may affect change of market behaviour is by educating the financial markets. Through various methods (new law, change of regulation etc.) the markets can be taught to take into account these social issues. “Corporate social responsibility (CSR) can only take root when it is rewarded by the financial markets” (Frankental, 2001).

One possible way of doing this is through a change in the accounting system. As the current system stands companies are mainly evaluated on financial indicators (profits etc.) and, as we have seen, not on any social indicators. Were they to be audited on these social indicators as well as the financial then the market would take notice of this and respond to it. John Elkington (1997) proposed that companies be judged on what he called the Triple Bottom Line. The bottom line is normally known simply as a company’s net profit or loss. What Elkington suggested was that as well as this financial bottom line there should also be an environmental and social bottom line. “The idea behind the [triple bottom line] paradigm is that a corporation’s ultimate success or health can and should be measured not just by the traditional financial bottom line, but also by its social/ethical and environmental performance” (Norman & MacDonald, 2003). Through these additional bottom lines the markets take into account more than the financials of a company. “The significance of the triple bottom line is that if companies are audited according to their environmental and social impact, and penalised if they do not perform, along the principle of ‘the polluter pays’, then financial markets will begin to judge companies according to their wider impact on society. Share prices will then positively reflect the ethical dimensions of a company’s operations” (Frankental, 2001).

Elkington discusses 7 revolutions in his book, the first of these concerns the markets. He states “Revolution I has been building for many years. It focuses on the use of market mechanisms, rather than traditional command-and-control measures, to deliver improved performance against environmental and broader sustainability targets” (Elkington, 1997). According to him we now recognize that to get to a sustainable economy we need to depend on the “motivation, ambitions, and performance of corporations —and on the restructuring of the markets which they serve” (Elkington, 1997).

Elkingtons way is just one of several that could be considered to make markets pay attention to social issues. It is not necessarily the best option, just the example chosen, and has, as does most things, its criticisms. One being how exactly these additional bottom lines are to be measured. How can the various factors that are said to contribute to these bottom lines be given a number. The traditional bottom line is found by subtracting the costs from the earnings; the bad from the good. Who is to determine which parts of the social and environmental accounts are bad and good? Losing the life of an employee in simple terms is bad. When compared with others in the same sector, however, it may in fact be good; every other firm in the sector may be have lost 50 lives in which case one seems almost good. One other issue of the triple bottom line is that of a common unit of currency. The financial bottom line has a common unit of currency; monetary. What common unit of currency could be used to compare each of the different aspects involved in the other two bottom lines? What unit can be

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