Wednesday, 18 September 2013

Active ownership pushing Corporate Social Responsibility pays off

When companies are pushed by institutional investors to improve their governance practices and to do something about climate change, they tend to actually do something. And shareholders benefit with better operating performance by the company and stock price gains. So conclude Elroy Dimson, Oğuzhan Karakaş, and Xi Li in Active Ownership.

There is now quite a lot of research showing a positive association between Corporate Social Responsibility action and better accounting performance and stock gains (see literature reviews within the paper) but Dimson et al making a convincing claim that the link is causal i.e. action can produce results. They accessed the records of a big activist institutional investor and linked specific interventions or engagements with subsequent acceptance or refusal by the target corporations and then with the accounting/stock data. Accounting measures they used included return on assets, gross profit margin, asset turnover and sales per employee.

A few types of action matter most ...
There is a whole slew of CSR actions they list but only a few seem to have the most beneficial impact for shareholders.
  1. Successful engagements, where the company ends up making a change, garner 4.4% cumulative abnormal positive returns, vs no returns for unsuccessful engagements
  2. Corporate governance (+7.1% abnormal return) and climate change (+10.6%!!) successful engagements have the most impact
  3. Large, mature, poorly performing firms with poor existing governance who are image sensitive are the best targets
  4. Direct engagement like telephone calls and letters do the job. In contrast, traditional shareholder activism like voting on resolutions at annual meetings doesn't.
Today's news in the Globe that Barrick Gold (TSX: ABX) will be making changes to board composition and executive compensation after a group of pension funds complained seems to be a perfect example of what the Dimson study found. There hasn't been a big turnaround in Barrick's stock price yet, so maybe this is the time to buy into ABX. Tangible accounting improvements happen typically within 12 months or so according to the study. Probably the pension funds will be adding to their stakes since the study found that an effect of successful engagements was an increase in activist institutional ownership.

The causal mechanism ... evidence though not proof
How does company performance and share price improve, the authors ask? As they cautiously note, their findings are "consistent" with:
  • increased customer loyalty, which gives the company pricing power
  • virtuous companies attract a clientele amongst CSR-activist investors
  • increased employee satisfaction / loyalty, which helps efficiency 
A challenge to passive index ETF investing and traditional active funds too
Correct me if I'm wrong but passive index ETFs are, um, passive. They don't do this kind of active intervention. Note who approached Barrick - Canada Pension Plan Investment Board, the Ontario Teachers’ Pension Plan and Caisse de dépôt et placement du Québec, as well as Alberta Investment Management Corp; British Columbia Investment Management Corp; Hermes Equity Ownership Services; Ontario Municipal Employees Retirement System; and Public Sector Pension Investment Board (from Toronto Star April 19, 2013). ETFs just vote their shares following the recommendations of an advisory service or its own policy, such as BlackRock's (provider of iShares) in its Prospectus. But voting is all BlackRock does. And though it voted against (link through to voting records here) Barrick's excessive executive compensation package, it was not part of the group that publicly engaged Barrick. As Dimson et al note, mere voting doesn't work for shareholders.

Actively managed mutual funds seem to follow the same tack, of voting and resolutions only (proxy voting policies here). They vote, but when unhappy they sell instead of engaging the company. Update: This Gilson & Gordon paper on SSRN says this: "The business model of key investment intermediaries like mutual funds, which focus on increasing assets under management through superior relative performance, undermines their incentive and competence to engage in active monitoring of portfolio company performance."

Hedge funds are a different animal, whose high-profile activism most often aims at mergers, acquisitions and divestitures. Hedge fund Hershing Square is the one who took on Canadian Pacific, with CPPIB's support. Individual retail investors don't have access to hedge funds anyway.

Pension reform implications?
I think I'd rather have my money in CPPIB than iShares' XIU. It's better for the companies and for me.

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