Data Intervention

Lately I've been thinking about how developments in data technology have helped responsible investing ideas and practices become more mainstream. Improving the collection and flow of information could be considered the essence of responsible investing.  More information makes it possible for investors to calculate risks and opportunities more accurately and on longer time-scales.  Then the financial markets can reward more responsible business practices and facilitate the spread of better practices.  Making ESG data more easily available could be considered a kind of policy intervention as opposed to command and control regulation or market incentives.  I wrote a blog post about this on my company blog.

I also did a short talk about it at Phage's fundraiser for Brainlove!  I made a simple website with the key points.

Defending the Establishment

When this primary season started, I was dead-set against voting for Hillary Clinton because I believed that she was corrupt.  I thought that even if she was effective, all the progress would be for naught if a scandal erupted.  It could discredit the progressive cause for at least two election cycles and possibly more.  I wasn't quite feeling the Bern, but he seemed promising.  I have now done a pretty dramatic 180 on Hillary, and I guess a less dramatic -90 on Bernie Sanders.

After looking into the past scandals involving the Clintons, I found that they were all pretty much engineered by Republicans.  Given how much Republicans hate them and how much they've been investigated, I now really doubt that the Clintons are really corrupt or that there is a scandal waiting to be exposed.

With that out of the way, I am more supportive of Hillary for president.  She is a believer and practitioner of incremental change.  Sanders is a proponent of a "political revolution."  I certainly ascribe more to her theory change, particularly for the presidency while Congress is still dominated by Republicans and the Tea Party.  I expand on this train of thought in an essay, where I use examples from my professional field of responsible investing.

Dreaming of Incremental Change




The one thing that really still bothers me about Hillary is that she is too much of an interventionist on foreign policy.  This is where I often diverge with liberals because they usually want to go in to every conflict and support every rebel and of course posture at China!  I don't really think she's a neocon, though, but rather she is in line with the foreign policy elite in the US.  She seems like the classic bleeding heart liberal, actually.  I hope that after working with Obama and Biden that her views have moderated.  With that said, maybe it's more important that the foreign policy elite's views moderate.

Plea for Long Term Thinking in Business and Finance

Public companies in the US are required by law to report their quarterly earnings.  As a result, they are often under a lot of pressure from investors to maximize earnings and reduce costs on a quarterly basis in a dynamic referred to as "short-termism."  This can often hurt long-term performance for example by laying-off employees to reduce costs.  It also often results in irresponsible environmental or human rights practices.  At the same time it's really difficult to address these issues since they almost certainly require a multi-year commitment.

Larry Fink, the CEO of BlackRock, periodically sends letters to investors and companies imploring both groups to get beyond short-termism.  Last week he sent his latest letter to S&P500 companies.  Fink has been a prominent figure in advocating for good corporate governance, which typically refers to having board members that are not related to each other and subjecting the executive leadership to board oversight.  He says,

Generating sustainable returns over time requires a sharper focus not only on governance, but also on environmental and social factors facing companies today. These issues offer both risks and opportunities, but for too long, companies have not considered them core to their business – even when the world’s political leaders are increasingly focused on them, as demonstrated by the Paris Climate Accord. Over the long-term, environmental, social and governance (ESG) issues – ranging from climate change to diversity to board effectiveness – have real and quantifiable financial impacts.

At companies where ESG issues are handled well, they are often a signal of operational excellence. BlackRock has been undertaking a multi-year effort to integrate ESG considerations into our investment processes, and we expect companies to have strategies to manage these issues. Recent action from the U.S. Department of Labor makes clear that pension fund fiduciaries can include ESG factors in their decision making as well. We recognize that the culture of short-term results is not something that can be solved by CEOs and their boards alone. Investors, the media and public officials all have a role to play. In Washington (and other capitals), long-term is often defined as simply the next election cycle, an attitude that is eroding the economic foundations of our country.

Public officials must adopt policies that will support long-term value creation. Companies, for their part, must recognize that while advocating for more infrastructure or comprehensive tax reform may not bear fruit in the next quarter or two, the absence of effective long-term policies in these areas undermines the economic ecosystem in which companies function – and with it, their chances for long-term growth.

A particularly interesting and bold recommendation was to reform the capital gains tax.

...tax policy too often lacks proper incentives for long-term behavior. With capital gains, for example, one year shouldn’t qualify as a long-term holding period. As I wrote last year, we need a capital gains regime that rewards long-term investment – with long-term treatment only after three years, and a decreasing tax rate for each year of ownership beyond that (potentially dropping to zero after 10 years).

*clap clap clap*

Who manages your 401k, and what are their positions on corporate governance, short-termism, and ESG?

Ethical Mice

My interest in corporate social responsibility and climate change has led me to reflect on the role of ethics in industry.  Reading "Flash Boys" by Michael Lewis, "Moral Mazes" by Robert Jackall, and a collection of books and articles has given me a better idea about decision-making inside corporations and the challenges of regulating businesses.  Many of these challenges seem to be outside the standard microeconomic framework that currently dominates policy analysis.  In that framework, ethics seems quaint, but perhaps there really is no replacement.

There are many reasons to regulate the private sector: minimize pollution, improve worker safety, ensure fair prices, combat fraud, etc.  If everyone's incentives were aligned then there would be no reason for rules to be enforced.  In the standard economic analysis framework, the misalignment of incentives cause "market failures."  This means that harms, known as negative externalities, are not being accounted for in the markets of the offending products.  (They might lead to more spending in the markets such as the market for medicine).  The market failures are caused by things like transactional frictions, principal-agent problems, and asymmetric information.  Solutions to market failures involve regulating the private sector one way or another.  The objective is to align the incentives of producers with the interests of society by increasing the cost of causing externalities through fines or taxes.

In applying this framework, welfare is typically equated with monetary value.  Then businesses and individuals in them respond exclusively to monetary incentives, their decisions driven by exacting cost-benefit analysis.  The cost of regulating then, is proportional to the amount the business stands to gain from the activity.

Is this the whole story?  Does this mean ethics is irrelevant?

First I want to point out that the motivation to avoid regulation is proportional to how much "individuals" have to gain.  This is not always the the same thing as the amount the business has to gain overall because the individual is primarily concerned with his/her own career.  This is generally true for decisions in an organization.  In other words, if an initiative has the potential to cause one manager to gain recognition and a bonus rather than sharing credit with other managers, that initiative is more likely to be championed and thus implemented.  For example, according to Nassim Taleb in "Black Swan," a contributing cause to the subprime mortgage crisis was the misalignment of individuals and the business.  The analysis of risk management divisions in banks were often ignored because individuals in the trading divisions stood to gain fantastically from increasingly risky activities.

Next, let us inspect the costs of regulation more carefully.  At first glance, the cost is simply the size of the fine, subsidy, or tax.  Most analysts also take into consideration the likelihood that the fine or analogous costs will be incurred.  The cost to the regulating body of administering these programs and auditing activities is often left out of economic analyses.  Both the regulators and the businesses participate in auditing and accounting activities, although for different purposes.  The higher the tax, the more resources businesses will allocate towards evading it by either by masking its activities in its own accounting system or lobbying to cut the budget of the regulator.  It is possible to make information arbitrarily difficult and time-consuming to assess, which greatly increases the cost to regulators.  In Flash Boys, the exchanges created complicated order types.  In addition, the documentation to the SEC about these order types seemed purposefully more complicated than they needed to be.

Complicity among individuals in the industry is another driving factor for the cost of regulating behavior.  If all the businesses participate in obfuscating their activities, then they can all maintain the illusion that the level of complexity is necessary.  Idolizing neoclassical economics and the free market at the expense of ethics then is very convenient for those who stand to gain.  Believing in the wisdom of the invisible hand means that the value of one's work is evidenced by the amount one is paid.  Those who feel no need to question the purpose of their activities can be counted on to be complicit.

Even if regulators manage to administrate a program, they still may not have enough resources or information to assess the effectiveness of the program.  Measuring effectiveness often requires some additional information.  For example, the Reg NMS rule sought to make markets more fair by mandating that financial intermediaries must trade public equities at the best price.  However, financial intermediaries found other ways to scalp investors.  Regulators neglected to collect the information needed to assess the prevalence of other kinds of unfair practices.

By now it should be clear that regulating private sector activities is often an elaborate cat and mouse game.  A few fat mice are more strongly motivated and can more easily collaborate than millions of mice.  The smartest cat must be at least as smart as the smartest mice or else the mice can easily confuse the cat.

Many conclude that regulating is indeed hopeless in many situations.  Brad and his team gave up on the SEC, who had no ability to compete with Wall Street for the talent required to regulate.  In order to sell his idea, Brad had to adopt rhetoric about being "long-term greedy."  But in fact he was personally very compelled to take on the system because it is not "right."  It is significant to me that only those who with an ideal about fairness even dared to pursue a market solution.  Only ethics can provide enough drive to an individual to overcome the risk, the likelihood of a lower payoff, and the stress from causing extreme conflict among peers.

The culture around ethics and the purpose of one's job perhaps should be considered as another tool in policy-making.  The structure of incentives in an organization governs the behavior of individuals.  Moral Mazes describes the incentive structure of a hierarchical bureaucracy typical of large public corporations.  There are many similarities with the environment and culture of these corporations with that of Wall Street exchanges and investment banks as described in "Flash Boys."

It may be possible to modify the standard framework of policy analysis to include this kind of ethical motivation as a part of individuals' welfare functions.  It's not clear to me whether that is the most helpful approach.  Instead, the study of polycentric systems an cooperation could potentially be applied to such environments in order to increase the value of transparency and ethical behavior.  There may also be analytic tools from complexity theory and behavioral economics.

My theory now is that for any given industry, a minimum number of individuals with resources and talent who commit to acting ethically is needed to stunt the efforts of those who are amoral.  On the flip side, a minimum number of talented amoral individuals is needed in order to implement an injustice.  Complicity with an amoral system ultimately perpetuate the injustice systemically.  It follows then that conviction matters.  Resolve matters.  Ethics matter.

My Little Poster: Improving Metrics for Corporate Emissions Initiatives

I presented a poster on Thursday night for the BERC Innovation Expo, which is an event at the annual Energy Conference at UC Berkeley!

Here it is!  I had many stimulating conversations with people about it, which was pretty exciting.

Corporate Lawyers Might Know What's Up

I asked Jamie O'Connell, a law professor at UC Berkeley, whether it is well known that in the US it is extremely difficult for shareholders to successfully sue a corporate board in the US for violating fiduciary duty.  Basically, a corporate board that is accused of violating their fiduciary duty to maximize shareholder value can always rely on the "business judgment rule" in court.  Shlensky v. Wrigley seems to be the case that is cited most often to demonstrates this principle.  Professor O'Connell said that among corporate lawyers and among lawyers generally, it's very well-known.  This surprises me because this does not seem to be well-known among MBA's or undergraduate business majors.  Professor O'Connell himself is a human rights lawyer, though, so he may be particularly familiar with this.

At the same time, corporate managers that don't maximize profit are likely to lose their bonuses and even their jobs.  Shareholders can and do campaign to fire board members they don't like.  Usually the imperative to maximize shareholder value is enforced this way.

Job Pitch

I'm going on the job market!

I wrote up a pitch about what I want to do.  I will probably want to keep editing it a bit.

Investors as well as environmental activists could be more effective if they better understood the pressures corporate boards face from the finance industry. For example, perverse incentives in the financial system may make long term planning difficult.
Corporations should sometimes be insulated from these pressures. I want to analyze how financial incentives influences corporate governance regarding climate change. Then I can help environmental organizations and long-term investors develop ways to respond.  Ways that corporations benefit from managing their emissions may also need to be identified and better publicized to the financial industry.
I'm also interested in improving corporate data management for GHG emissions. These software systems help corporations manage emissions reduction as well as report results to stakeholders such as investors or consumers. These systems always need to be customized for each organization because the operations of different organizations vary so much. As a result, experimentation and iteration is always needed. However, in order for the information to be useful for external stakeholders, these systems also need to be compatible with each other to some extent. For example, managing and reporting the emissions of a supply chain where suppliers have many other customers, can be challenging.

Public Corporations and Investors: Theory vs. Reality

It's conventional knowledge, in the business world at least, that a corporation's primary purpose is to maximize shareholder value.  A corporation can only hope to maximize benefits to everyone through maximizing shareholder value. This idea is often presented as a law of the universe as immutable as the laws of physics.  In The Shareholder Value Myth by Lynn Stout makes a persuasive case that maximizing shareholder value is not always the best for the corporation, the market, or society.  Stout is a law professor at Cornell specializing in corporate governance law.  She argues that corporations are not legally required to maximize shareholder value at the exclusion of other goals.  Furthermore, the focus on stock price leads corporations to destroy fundamental value in favor of short-term gains, which is against the long-term interests of many shareholders as well.  Instead, corporations should invest in their employees and their communities to maximize long-term benefits.

I recommend anyone who is interested in corporate governance, business management, economics, finance, or social entrepreneurship to read this.  It is a fairly short and quick read, but since many people still won't read it, I will summarize the main points here.




        Shareholder primacy is the principle that the corporation's sole purpose is to increase shareholder value because this maximizes the welfare of the corporation as well as society at the same time.  This means that a corporation's performance is based completely on one number, and that is the stock price.  Yes, it is very conceptually elegant, not to mention convenient, if this were true.  This idea became popular in the 1980's coinciding with the rise of neoclassical economic theory.  (Although there is nothing wrong with neoclassical theory itself, it is often misapplied.  More on this later).  Since then, conviction in shareholder primacy became so strong that everyone believes that corporations have a fiduciary duty to maximize shareholder primacy and that this duty is enforced legally.

It's Not Legally Required
        Lynn Stout's first point is that shareholder primacy is actually not a legal requirement.  The case that is typically cited to demonstrate legal fiduciary duty to shareholders is Dodge v. Ford 1916 where Dodge was a minority shareholder in Ford Motor Company.  The court ruled that Henry Ford could not reduce the dividends to shareholders such as the Dodge brothers to build more plants and pay his employees more while profit was increasing.  Stout argues that the ruling is outdated as well as irrelevant because

1. Ford was not a public corporation.  It was a closely held corporation where the majority shareholder (Henry Ford) had a duty to look out for the interests of minority shareholders (Dodge).  
2. The comment that supports shareholder primacy, "a business corporation is organized and carried on primarily for the profit of the stockholders" was a "dicta."  In other words, it was not part of the legal rationale for the decision and therefore does not set legal precedent.
3. It is an old ruling. 
4. It was a ruling from the Michigan Supreme Court, which is not considered an authoritative source for corporate law compared to Delaware, where many more companies are incorporated.

        Instead, directors of public corporations have protection under the "business judgment rule," where corporations can do anything as long as it is lawful and directors do not have personal conflicts of interest.

The Theory is Flawed
        Stout's second and perhaps more interesting point is that economic theory is being misapplied to corporate governance.  The theory behind shareholder primacy is that shareholders are the owners and thus residual claimants of a corporation's profits.  They are the principals while directors are the agents and therefore if the agents maximize the welfare of the principals, welfare should be maximized overall.  This idea was popularized by Milton Friedman, a prominent neoclassical economist.  However, Stout argues that the principal-agent relationship isn't really descriptive of the relationship between the shareholder and corporation because

1. Shareholders do not legally or practically own corporations.  In fact corporations own themselves.  Shareholders own a share, which is a contract with some limited rights.
2. Shareholders are not the residual claimants.  The idea that they are comes from bankruptcy law, where the shareholders get whatever is left over after other contractual obligations are fulfilled as a company is being liquidated.  However, a company being liquidated is completely different from a living company, which has to plan for the future.
3. Shareholders are not principals.  Corporations are created before there are shareholders, but principals should exist before agents.  
4. The share price alone (probably) cannot be used to measure the worth of a company.  First of all, it doesn't really make sense to use something that fluctuates constantly.  Second of all, because of frictions that come with doing business in real life, a corporation can cause many externalities (public harm) while privatizing the benefits.  These externalities ultimately lower the quality of life of the public, including shareholders.  Stout claims that externalities can and do harm the private sector as well, stunting the growth of the market overall.

Justifying Myopic Behavior in the Finance Industry
        Another very rich topic that Stout digs into is how the realities of the finance industry interact with shareholder primacy to encourage myopic behavior in corporations and investors.  Short-term investing has been increasing.  By 2010, public stock is held for four months on average compared to eight years in 1960.  Therefore, even though investors should theoretically be primarily interested in long-term corporate performance, clearly many are profiting from short term gains.  An investor who only plans on holding a stock for a short time can and do lobby for actions that increase the stock price in the short term, after which the investor sells, thus relinquishing her interest in the long-term success of the corporation.  In fact, it would be good for these investors if the stock price subsequently went down so that she can invest again and start the cycle over.  Myopic behaviors include cutting back on R&D or marketing or laying off employees to boost quarterly earnings reports.  They also include splitting up the company, selling off assets, and getting acquired.
       These things happen because shareholders (and thus investors) are heterogeneous in their expertise as well as incentives.  Also, information is expensive and time consuming, especially more qualitative information as opposed to prices.  Long-term investors profit from the overall performance of the market.  They will hold diversified assets in order to reduce risk.  As a result, they "suffer" from rational apathy.  There is too much information and their stake in each company is so small that it is not worth it to investigate whether a company's earnings went up because of myopic behavior or because of a particularly successful new product or operational improvements.  In contrast, shareholders who are more involved in corporate governance are usually short-term investors who profit from buying and selling.  They will hold relatively large stakes in a small number of companies, and it is in their interest to create "news" that will change expectations one way or another.  Yes, the market eventually "corrects itself," but the profits and losses from the error and subsequent correction are real.  Misallocation of financial capital, hurting employee morale, losing talent, slower innovation, lower quality products, reduced customer loyalty are sometimes also tangible and lasting effects.  Another dynamic that exacerbates the prevalence of these behaviors is that long-term investors such as institutional investors, who invest on behalf of pensioners for example, hire active managers to manage large portions of their assets.  These active managers are judged by their quarterly performance.  As a result, they are often short-term investors because those strategies are more reliable as well as profitable.


Recommendations
        Ok, that sounds like a hairy mess.  Stout's recommendations aren't as crisp as her analysis of the situation.  Even so, there are four potential solutions that stood out to me.

1. Stop promoting shareholder democracy and giving shareholders more power.  This is one of Stout's main recommendations.  Shareholders do not act like responsible principals and cannot be counted on for effective corporate governance.  For example, even after the Great Recession and subsequent bailout, shareholders opted not to diffuse the power of the CEO and chairman of JPMorgan Jamie Dimon, much less fire him. 
2. Her second recommendation is to encourage companies to maximize stakeholder value.  She introduces the concept of team production, which expands on maximizing stakeholder value as a more descriptive theory of how corporations create value.  Basically, value is created as corporations build trust and commitment among employees, creditors, managers, consumers, and the community.
3. Institutional investors should change how they evaluate active managers.  Stout did not focus on this probably because she does not think that institutional investors have enough incentive to reform this.
4. Make information cheaper for long-term investors.  Stout also does not focus on this possibly because it is unclear if it is technically feasible.  However, I am personally very interested in this kind of solution.

GHG Intensities of Companies

I made this table today for my report.  The total GHG is the combined Scope 1, 2, and 3 for each company.  All of them reported the Scope 1 and 2 for 2013, but I had to estimate the Scope 3 for Exxon Mobil, Target, and TJX.  Which carbon metric should be used?  Well, if we are comparing between companies in the same sector, it doesn't seem to matter.  Exxon Mobil is always worse than Chevron, Target is always worse than TJX, and Google is always better than Microsoft.  So what does this mean?  Well, I'm not exactly sure.  

GHG/revenue (lbs/$)	GHG/marketcap	GHG/enterprise value	GHG/profit
Exxon Mobil	Exxon Mobil	Exxon Mobil	Exxon Mobil
Dow Chemical	Dow Chemical	Chevron	Dow Chemical Company
Chevron	Chevron	Dow Chemical Company	Chevron
Target	Target	Target	Target
Microsoft	TJX Companies Inc.	TJX Companies Inc.	TJX Companies Inc.
TJX Companies	Microsoft	Microsoft	Microsoft
Google	Google	Google	Google

Carbon Commoditization

I am reading a paper that describes my perspective on carbon disclosure and accounting.  Usually I struggle with articulating the implications and difficulties of measuring and reporting corporate emissions so I'm pretty excited to have found something that will help me communicate my interests.  In other words, I found some relevant google key words and jargon!  

Crucially, the institutionalization of carbon reporting as a form of governance relies on a successful project of ‘commensuration’, defined by Levin and Espeland (2002, p. 121) as ‘the transformation of qualitative relations into quantities on a common metric.’

The carbon market is not a naturally existing entity; the commodification of carbon is a political and institutional project, requiring an extensive legal and bureaucratic infrastructure to define and measure carbon units for various activities and gases, allocate and adjudicate property rights, and to establish rules for trading across national boundaries and different carbon jurisdictions.

Kolk, Ans, David Levy, and Jonatan Pinkse. 2008. “Corporate Responses in an Emerging Climate Regime: The Institutionalization and Commensuration of Carbon Disclosure.” European Accounting Review 17 (4): 719–45. doi:10.1080/09638180802489121.

Outrage on the Internet

Recent high profile events show that a type of political consumerism can be effective.  For example, the Clipper's owner Donald Sterling has come under fire for some racist comments he made.  Many basketball players and coaches have spoken out against it and are calling for action such as boycotting of Clippers games.  The CEO of RadiumOne, a large online advertising company, recently had to step down after being found guilty of domestic abuse.  The Mozilla CEO also had to step down after furor over his donation to Proposition 8, the campaign against legalizing gay marriage.  What's interesting about these controversies are that many of the people who objected aren't end consumers but rather employees (like basketball players) or other companies.  It seemed that the leadership of other companies were motivated to speak out because of the attitudes of their employees.  Is political consumerism more effective when the employees are more powerful?  The employees in these cases were basketball players or software developers.  Many of Mozilla and RadiumOne's downstream consumers are also in the tech industry.  Both of these groups happen to be in extremely high demand.  Large public forums (eg. Twitter) seemed to facilitate these events.

Corporate Social Responsibility

I'm taking a class this semester called Governance of Global Production with professor Dara O'Rourke.  He is a cofounder of Good Guide.  http://www.goodguide.com/about

It just occurred to me that he kinda looks like nerdier version of the lead singer of Tool, James Maynard Keenan.

They could be brothers!  or maybe just cousins?

Anyway, I was going to riff on the readings I did this week about corporate social responsibility.

In the past decade or so, the idea that a business should be more concerned with creating "shared value" has been gaining momentum.  This means that businesses have a responsibility to stakeholders beyond their shareholders such as their employees, their local community, and the global environment.  

So far, the prevailing attitude among most business leaders and investors is still that the most important thing to do is to maximize shareholder value.  I think it's safe to say that for the most part, corporations are only interested in sustainability as a way to increase the stock price through improving reputation and thus increasing the value of the brand.  

Even so, within a corporation there are likely to be champions of corporate social responsibility for its own sake.  And there are notable leaders in the corporate world who seem to be truly committed to CSR and sustainability in particular.  O'Rourke specifically singles out Unilever as one of them.  http://www.sustainable-living.unilever.com/

Those committed to CSR wouldn't say (admit) that CSR may sometimes reduce profits.  Instead, they would point out two concepts that change the perspective.  The first is that every corporation exists as part of an economy, where it depends on the well-being of the citizens.  So it may be true that their CSR initiatives actually benefit all companies in their industry not just themselves.  The second concept is that the corporation is planning on sticking around for many years to come.  In terms of game theory, it's a repeated game which can make it beneficial in the very long run to internalize more costs and take others' interests into account.  This is only slightly different from increasing brand value in that it is a more future-oriented perspective.  The brand value motivation would only justify CSR initiatives that would help the corporation get recognition in the near term.

Social Governance Securities Exchange

My friend and I wrote up a submission to the Industrial Efficiency contest on the Climate CoLab.

http://climatecolab.org/web/guest/plans/-/plans/contestId/16/planId/1300012/tab/DESCRIPTION

We recommended creating a new securities exchange for companies who want to be leaders in corporate social responsibility and investors who are interested in such companies.

Check it out and support our proposal!

I even made a little logo.

Book on Corporate Social Responsibility

I just started reading the Market for Virtue, which is a book on corporate social responsbility (CSR) by David Vogel, a prominent professor at the UC Berkeley business school (Haas).

It basically is an overview of CSR and an analysis of its strengths as well as shortcomings.

...an important shortcoming of CSR is its failure to appreciate the critical role of public policy in promoting more responsible corporate behavior

In contrast, it cites examples of several prominent companies who have supported public policies that would apply to all firms so that the large companies wouldn't be at a competitive disadvantage or always be bearing the brunt of activism.

1. Starbucks supporting national health care
2. Wal-Mart backing raising minimum wage
3. Nike supporting internationally binding labor standards