pension funds, corporate responsibility and sustainability

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ANALYSIS

Pension funds, corporate responsibility and sustainability

Franck Amalric⁎

CCRS Centre for Corporate Responsibility and Sustainability at the University of Zurich, Künstlergasse 15a, 8001 Zurich, Switzerland

A R T I C L E I N F O

⁎ 22, rue d'Alboni, 75 016, Paris, France. Tel.: +E-mail address: [email protected].

0921-8009/$ - see front matter © 2005 Elsevdoi:10.1016/j.ecolecon.2005.11.009

A B S T R A C T

Article history:Received 1 December 2004Received in revised form30 October 2005Accepted 2 November 2005Available online 26 January 2006

The paper introduces two approaches to identify corporate behaviours that should attractthe attention of pension funds in the context of debates over sustainability, while remainingwithin a narrow interpretation of their fiduciary duty. The approaches are based on twosimple models of how different societal spheres interact with one another and influencelong-term economic performance. These models allow exploring the idea that corporationscan influence trajectories of societal change—keeping in mind that pension funds careabout these trajectories because they care about the long-term performance of theeconomies in which they invest. The model underlying the internalising investorapproach assumes that corporations are the only actors in society. In this model, pensionfunds will maximise their expected ability to meet their liabilities if companies internalisenegative externalities and spill-over effects in order to reduce the cost of market failures forthe economy as a whole. The model underlying the civic investor approach comprisescompanies and various actors (the state, NGOs, corporate stakeholders) engaged in shapingthe governance structure that mediates the interaction between the social, environmentaland economic spheres. In this model, pension funds will want companies to facilitateeffective responses to societal problems. These approaches allow us to identify a number ofcorporate behaviours that should be of concern to pension funds.

© 2005 Elsevier B.V. All rights reserved.

Keywords:SustainabilityPension fundsCorporate responsibilityGovernance

1. Introduction

Over the past few years, pension fund members, experts andpolicy-makers have expressed the view that pension fundshave a special role to play in facilitating shifts towardssustainable societies, given their specific investment objec-tives and their nominal capacity to influence corporateconducts. These expectations have arisen out of the conver-gence of two societal trends. First, pension funds have becomemajor shareholders in most major corporations—whatDrucker (1976) called the “unseen revolution”. Second, theemergence of concerns over sustainability in the 1990s,combined with the perception that states are incapable ofmeeting the challenge alone, supports the proposition that

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private actors–including pension funds–will have to assumenew responsibilities. And these expectations have beensufficiently strong to pave the way to the introduction ofnew legislation in various OECD countries.1

With some rare exceptions, pension fund trustees havegenerally been sceptical that they can indeed, or should, playthis special role. In their view, to do so would violate theirfiduciary responsibilities to their members, that is, theprinciple that their investment and ownership decisionsshould solely aim to enhance their members' financialinterests. Trustees' scepticism thus hinges on the perceptionthat the enhancement of pension fund members' financialinterests conflicts with an engagement of pension funds in thepursuit of sustainability.

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The main purpose of this paper is to show that, in somenoteworthy circumstances, there is no such conflict and that,in the opposite, the fulfillment of pension funds' fiduciaryresponsibilities call upon them to exercise their influence oncorporations and society in ways that promote sustainability.The thrust of the argument is the following: (1) pension funds'ability to meet their future liabilities is linked to the trajectoryof societal change; (2) pension funds influence that trajectorythrough their investment decisions; (3) pension funds shouldaim to influence the economy and to promote those trajecto-ries of societal change that will maximise their expectedability to meet their liabilities.

Following the logic of this argument, this paper identifiescorporate behaviours that pension funds should be concernedabout in the perspective of sustainability. We considerpension funds whose investment objective is to financelong-term liabilities (20 years or more) and we assume thatthey invest in a broadly diversified portfolio.

The paper introduces two complementary approaches thatpension funds can follow to monitor corporate behaviours.These approaches are based on simple models of howdifferent societal spheres interact with one another andwhich allow exploring the idea that corporations can influ-ence trajectories of societal change.

Section 2 presents the internalising investor approach. Themodel underlying this approach assumes that corporationsare the only actors in society. They influence the long-termreturn on capital through their impact on the social andenvironmental spheres (with social and environmentalchanges bearing back on the economy) and through theeconomy in the context of market failures. In this model,pension funds will maximise their expected ability to meettheir liabilities if companies internalise negative externalitiesand spill-over effects in order to reduce the cost of marketfailures for the economy as a whole.

Section 3 introduces the civic investor approach. Theimplicit model underlying this approach comprises compa-nies and various actors (the state, NGOs, corporate stake-holders) engaged in shaping the governance structure thatmediates the interaction between the social, environmental

1 Evidence of these expectations is numerous. Among policy-makers, see Annan (2003) in relation to global warming, and Shor(2000) in relation to international development. Evidence opension fund member expectations: Canadian Democracy andCorporate Accountability Commission (2002) found that, amongthe 2006 persons interviewed, 51% want their pension plans toinvest in companies with a good record of social responsibilityFor academic discussions, see among others: Kasemir et al. (2001)Monks (2001) and Kasemir and Süess (2002). Regarding legislationthe UK government has led the way with the passing in 2000 of anamendment to the pension act requiring pension fund trustees todisclose whether or not they take into account ethical, social andenvironmental criteria in their investment decisions. Similarlegislation was subsequently passed in Germany (2001) andAustralia (2001), and is being discussed in Austria, BelgiumCanada, Denmark, Italy and Spain. In its white paper on corporateresponsibility, the European Commission (2002) invited occupa-tional schemes to adopt similar practices. For a general review othe role of public policy in promoting CSR, see Aaronson andReeves (2002).

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and economic spheres. We assume that companies caninfluence the other actors and that society can reach variousequilibriums that are determined by the capacity of society torespond effectively to new societal problems by putting inplace the right governance structures. In this model, pensionfunds will maximise their expected ability to meet theirliabilities if companies do not hinder or actively facilitateeffective responses to societal problems.

Section 4 concludes with some remarks on methodologiesto assess the contribution of companies to sustainability.

2. The internalising investor

2.1. Structure of the approach

Large institutional investors with a long-term investmenthorizon, such as pension funds, aim to maximise theirexpected ability to meet their liabilities. Given this objective,they are concerned about the long-term return on capital and,for this reason, about long-term economic growth. It followsthat, assuming no changes in the institutional setting,investors may wish companies to internalise externalitiesand spill-over effects in order to enhance the performance ofthe economy as a whole. This is what we call the internalizinginvestors' approach.

In this section, we identify corporate responsibility issuesof potential concern to investors according to this approach.To do this, we take long-term economic growth as a proxy forthe long-term value of a widely diversified portfolio, considera list of the main determinants of long-term growth estab-lished by gathering the results of the many studies carried outon this topic (see, for instance, Sala-I-Martin, 1997), and lookfor evidence showing that corporate behaviours bear on thesedeterminants, starting with a comprehensive list of corporateresponsibility issues provided by the Global Reporting Initia-tive (2002).

We distinguish between two categories of determinants ofgrowth. First, we focus on determinants that lie in the socialand environmental spheres: human capital, social capital,natural capital and political capital. The idea is that compa-niesmay have an impact on the long-term return on capital byfostering social and environmental changes, which, in return,affect the economy through interdependencies between thedifferent societal spheres.

Second, we consider economic determinants of growth–physical capital, labour and total factor productivity–inrelation to situations of market failure. Under conditions ofperfect competition, full information and complete markets,corporate behaviours would not affect the long-term return oncapital as the opportunities and resources not seized by onecompany would be picked up by other companies. Thus,companies may have an impact on the long-term return oncapital by wasting capital, underutilizing labour and/or under-mining total factor productivity, when there exist intra-economy market failures.

Our analysis yields a short list of corporate responsibilityissues of potential concern for investors. In a second step notcarried out here, the impact on the long-term return of capitalof each issue on the list should be assessed carefully.

Corporate opera- Non-economic determinants ofgrowth:- Human capital- Social capital- Natural capital- Political capital

Economic growth/long-term return oncapital

tions and strate-

gies

Fig. 1 –From corporate behaviours to long-term economic performance through non-economic spheres.

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2.2. Corporate impacts on social and environmentaldeterminants of long-term economic performance

Fig. 1 presents the basic connections between corporatebehaviours and the social and environmental determinantsof long-term economic performance. Table 1 summarises theevidence. The following paragraphs review this evidence inmore detail.

2.2.1. Human capitalIn the early 1960s, Schultz (1961) and Becker (1962) introducedthe concept of human capital to underline the importance ofthe quality of theworkforce, in contradistinction to its size, as akey determinant of long-term economic performance.

Recent empirical analyses, e.g. Barro (1991) or Mankiw et al.(1992), have confirmed the importance of human capital inexplaining past growth. Furthermore, the accumulation ofhuman capital increases the long-term return on physicalcapital, which, according to Lucas (1990), may explain whyreturns on investment remain high within developedcountries despite high levels of capital stock. Most of thesestudies take the level of schooling as a proxy for humancapital, although more recent ones, e.g. Bloom et al. (2001),have also given attention to health and shown the significanceof this factor in explaining economic growth.

Table 1 – From corporate behaviours to long-term economic pe

CR issues affectingnon-economic spheres(main issues taken from GRI)

Determinants of long-termeconomic performance,

evidence of corporate impacts

Respect and promotion ofhuman rights

Human capital

Decent work –On-the-job trainingLabour rightsProduct responsibility(e.g. impact on health)Welfare impact of pollution

Depletion of naturalresources, pollution

Natural capital

Corruption and bribery Social capital (incl. “socialfractionalisation”)

Diversity Usually seen as being formed througassociation

Freedom of association Political capital: good governancerule of law, civil libertiesAnecdotal evidence of corporateimpact on good governanceLittle evidence that corporationshinder or foster civil liberties

Yet, most of the corporate responsibility issues that mayaffect individual welfare and capabilities, such as labourstandards and corporate impacts on human rights, are notunambiguously linked to determinants of long-term economicperformance. In fact, the only corporate responsibility issuethat relates to human capital and for which (1) the responsi-bility of companies is clearly established and (2) evidence ofthe impact on long-term economic performance sufficientlysolid, is that of on-the-job training.

2.2.2. Social capitalSocial capital refers to the network of formal and informalinstitutions that facilitate social interaction and nurtureindividuals' trust in the legal and economic system. Banuriet al. (1994) use the following image to illustrate theimportance of social capital in sustaining the economy.Consider the various elements that are required to build aneffective road transport system: one prerequisite is a networkof good roads (physical capital); another is the development ofpeople's driving ability (human capital); yet a third is a set offormal and informal rules and norms to regulate drivers'behaviour on the road. This third element is social capital.

Some political scientists and economists, e.g. Putnam(1993), Fukuyama (1995), Knack and Keefer (1997), Porta et al.(1997) and Harrison and Huntington (2000), have recently

rformance through non-economic spheres

Significance forlong-term economic

performance

CR issues of relevancefor pension funds

Strong On-the-job training

–Formal education–Health–On-the-job training

Weak and indirect (throughother societal spheres)

Medium (difficulties in“measuring” social capital)

h

, Strong Corruption, in particularlinked to management ofnatural resources

Corporateoperations andstrategies

Economic determinants ofgrowth:

- Physical capital

- Employment - Total Factor Productivity

Economic growth/long-term return oncapital

Market failures:

- Externalities- Information asymetries- Transaction costs

Fig. 2 – Impact of corporate behaviours on long-term economic performance in the context of market failures.


drawn attention to the importance of social capital, andbeyond it of culture, in sustaining economic activity and long-term development processes. A high degree of trust withinsociety would reduce transaction costs and thus enhanceeconomic activity; social capital would also facilitate thecreation and operation of public institutions, with positivelong-term effects on economic performance. However, asnoted by Solow (1995), social capital is difficult to measure,and so likewise its contribution to economic performance.

Even if social capital could be measured, there is a lack ofknowledge about the role that large companies play inbuilding-up, nurturing or eroding it. Some corporate beha-viours do seem to have an impact on social capital–e.g.corruption and bribery, diversity in the workplace, freedomof association–but these connections have not been thorough-ly explored by academics.

2.2.3. Natural capitalNature provides products and services that are often deemedimportant in sustaining the long-term performance of aneconomy. Products include non-renewable resources such asoil and minerals, as well as renewable resources such asfisheries, forests, land and water. Services include climateregulation, the hydrological cycle, nutrient cycles, the trans-formation of solar energy into biochemical energy throughphotosynthesis and the management of soils, to name just afew.

Resource economics studies the economic factors thatdetermine the use of exhaustible and renewable resources,and the significance of these resources for long-term eco-nomic performance under various conditions.2 It is the latterstrand of this subdiscipline that interests us here. Whilenormative approaches to this second issue–i.e. how to usenatural resources to sustain long-term economic perfor-mance–are plentiful, comparatively few empirical studiesinvestigate how and when the over-use of natural resourceshas led to economic under-performance. Moreover, the mainempirical result that has been established is somewhatparadoxical. Known as the “curse of natural resources”, itholds that countries with abundant natural resources tend togrow slower than resource-poor countries (Sachs andWarner,2001). Most explanations for the curse have a crowding-outlogic: reliance on natural resources would crowd out one ormore of the key factors that drive growth and thus undermineit. An important issue, explored by Auty (2001), is how relianceon natural resources can crowd out good government byfostering rent-seeking behaviours and corruption. However, in

2 For a broad presentation, see Bretschger (1999).

this model, the problem is not so much how changes in theenvironmental sphere undermine economic performance, butrather how themanagement of natural resources has an effectin other societal spheres–in this case political capital–which inturn affect economic performance negatively.

We therefore conclude that there is little evidence tosupport the view that companies that destroy natural capitalundermine long-term economic prospects, simply becausethe link between natural capital and growth is itself not wellestablished.

2.2.4. Political capitalPolitical capital refers here to political stability, respect for therule of law, political rights and civil liberties, and goodgovernance.

Sala-I-Martin (1997) found that these political variables areamong the more solidly established determinants of long-term economic performance. Political stability, respect for therule of law and good governance, i.e. ensuring that the stateacts for society and not in private interests, are obviously keyto ensuring that resources are used efficiently and effectively.Political rights and civil liberties, on the other hand, areinstrumental in preserving the proper and legitimate func-tioning of the state.

There is a degree of evidence that an accumulation ofeconomic power may, in some circumstances, erode politicalcapital, in particular through bribery and corruption incountries with relatively weak political systems. As men-tioned above, this phenomenon is proposed as an explanationfor the “curse of natural resources”. Furthermore, there isanecdotal evidence that corporations, as holders of significanteconomic power, may take part in this erosion of politicalcapital—and it could be substantiated that they have animpact on long-term economic performance in this way.Pension funds should therefore closely monitor corporatebehaviours, such as corruption and bribery that have animpact on political capital.

2.3. Long-term economic consequences of corporate beha-viours in the context of market failures

Fig. 2 presents the connections between corporate behaviours,market failures and economic determinants of long-termeconomic performance. Table 2 summarises available evi-dence. The following paragraphs review this evidence in moredetail.

2.3.1. Externalities across production unitsCorporate-generated externalities that have a direct bearingon other productive activities may lead to a waste of physical

Table 2 – Impact of corporate behaviours on long-term economic performance in the context of market failures

CR issues Market failures Significance of the market failurefor long-term economic performance

CR issues of relevance forpension funds

Pollution (acrossproductive activities)

Negative externalities No evidence

R&D Positive externalities Strong (ideas, human capital) On-the-job trainingTraining R&DDisclosure of information,including product labelling

Information asymmetries Strong for some issues (i.e. finance) Transparency/reporting

Corporate governanceAccess to work, productsand services

Transaction costs and corporateboundaries

Strong Dividend payments

M&As MergersDividend payments


capital and thereby undermine long-term returns on capital.This effect may take place either through the ex-anteappropriation of a production input to which access is notregulated (“tragedy of the commons” effect), or through theex-post emission of pollutants that will affect other produc-tion processes.

Externalities across production units can also be positive,however, and new growth theories, such as in Lucas (1988),have underlined their significance for long-term growth.These positive external effects are transmitted mainlythrough human capital and ideas. By contrast, no studyassesses the level of physical or natural capital that may belost owing to negative externalities across production units,and their further impact on long-term economicperformance.

The role of companies is key in promoting positiveexternalities through R&D and on-the-job training. Theseissues should therefore be monitored by investors.

2.3.2. Asymmetries of informationAsymmetrical information, notably between providers andusers of capital, can be an important source of market failure.It can lead to a misuse of capital at company level–the riskbeing, as shown formally by Edlin and Stiglitz (1995) andShleifer and Vishny (1989), that managers invest in a way thatsecures their own position, rather than increasing shareholdervalue–as well as to a distortion of market prices, itself leadingto a misallocation of financial resources at the societal leveland hence to a waste of capital and economic under-performance.

Recent studies, e.g. Greenwood and Jovanovic (1990),Levine (1997) and World Bank (2001), have underlined thelong-term significance of a society's ability to acquire andprocess information on competing investment prospects.Since many firms and entrepreneurs solicit capital, financialintermediaries and markets that are better at selecting themost promising firms and managers will produce a moreefficient allocation of capital and faster growth.

Corporations play an important role in producing informa-tion about themselves. The recent corporate scandals in theUS and Europe have shown the damage that distortinginformation can have, not only for individual companies, butalso for the economy as a whole. Investors should thus wantcompanies to achieve high standards of corporate reportingand transparency.

2.3.3. Transaction costs and corporate boundariesTransaction costs–costs of market search, acquiring informa-tion, guaranteeing property rights, negotiating terms ofexchange and ensuring that the terms of the exchange willbe respected–can be a major hindrance to the fluidity ofeconomic activities and an obstacle to economic performance.North (1990) has argued that a reduction in transaction costshas historically been one of the most important drivers ofeconomic growth in Western countries.

Corporations, along with institutions, play an importantrole in reducing transaction costs according to Coase (1937).They do so when they enter into long-term contractualcommitments with their employees, merge with or acquireother companies, develop consumer management practiceswith specific target groups or retain earnings; in short, whenthey put in place a control-and-command system to organisetransactions, instead of conducting market transactions.

The main rationale behind these corporate practices isprofit maximisation. Firms will engage in them when control-and-command proves to be profitable and less costly thanreliance on market transactions that incur (transaction) costs.For instance, Easterbrook (1984) argued that retained earningsare superior to the payment of dividends because they avoidtransaction costs penalising investors as well as companies.

However, these practices may be counter-productive forsociety when they undermine the good functioning of themarket, in the same way as mergers may underminecompetition. This suggests that the socially optimal boundarybetween corporations and the market cannot be set bycorporations motivated by profit. For this reason, investorsshould give attention to corporate behaviours that shift thisboundary, such as dividend payments.

2.4. Discussion

Tables 1 and 2 list the (few) issues, which there is evidence onthat corporations affect long-term economic performance in astatic institutional setting. Most of these issues are economicrather than social or environmental. Moreover, one of theseissues, corruption in the management of natural resources,would not pass the second test—that of an actual measure-ment of its significance for pension funds' portfolios. If the“curse of natural resources” is a well-established result in theempirics of economic growth, it affects mainly small devel-oping countries, e.g. Gulf states, Zambia, Liberia, etc. However,


large pension funds based in OECD countries are very littleexposed to the long-term economic performance of thesecountries—thus undermining the rationale for consideringcorruption in themanagement of natural resources an issue ofconcern to them.

These overall results can be given two interpretations: (a)that there are not many corporate responsibility issues thatpension funds should be concerned about in the context ofsustainability; (b) that the internalising investor approach istoo restrictive.

There are some grounds for believing that the approach isindeed too restrictive. In the absence of some form of generalequilibrium model that would allow to test the relativeimportance of social and environmental indicators on futureeconomic performance, one is limited to an empiricalassessment of the relative importance of such indicators inexplaining past economic performance. Yet studies that do somay take for granted the existence of certain backgroundconditions, such as climatic stability, provided by the envi-ronmental and social spheres. In other words, we cannot besure that they have taken into account the full benefitsprovided by the stability of the background conditions, in partbecause these benefits are so difficult to measure. Theinsignificance of these spheres in studies of long-termeconomic performance may thus reflect the limitation of the(neo-classical) economic models, rather than the true state ofthings.

Furthermore, the past may not be a very good indication ofwhat the future holds in store. After all, one of the basic ideasbehind the concept of sustainability is that current trendscannot continue in the future.

3. Civic investors

Some issues at the core of the debate on sustainability–environmental crisis, growing inequalities between differentregions of the world, demographic transition in ageingsocieties, etc.–will, in all likelihood, have an impact on thelong-term return on capital in society. Clearly, these issuesshould be of concern to pension funds.

Most of these issues have not been created by largecorporations. Yet corporations may have unique capacitiesto either hinder or contribute to addressing them. One of thereasons behind the emergence of a corporate responsibilitymovement is precisely the realisation that states alone areunable–or unwilling–to address some of the major societalproblems that the world is currently facing, notably thechallenge of sustainability (e.g. Ruggie, 2003). Should pensionfunds support responsible corporate behaviour under therationale of addressing societal issues and compensating forstate failures?

This section addresses this question. It explores theresponsibilities of pension funds in the face of threats raisedby major societal trends when the state is incapable, orunwilling, to intervene. We call this approach the civicinvestor approach because it suggests that pension fundsmight play a more active role in public policy debates thanthey currently do. Throughout the section, we shall use theissue of climate risk to illustrate the logic at play. This example

is pertinent because it is a core issue of sustainability andbecause a number of institutional investors have recentlyexpressed concerns on the matter, through such initiatives asthe Carbon Disclosure Project, launched in May 2002, and theInvestor Network on Climate Risk (2003), created in November2003.

3.1. Overall structure of the approach

Consider society as stemming from the interaction betweenthree societal spheres–the economy, the social sphere andthe environment–mediated by a political sphere. We assumethat society can follow different trajectories of societalchange, which lead to different societal outcomes charac-terised by mutually compatible social, environmental andeconomic performances. The reason pension funds shouldcare to know which future is best for them is that there is noperfect hedge, i.e. no way of guaranteeing that liabilities willbe financed in all possible future contingencies of the world.We now set out the three steps of the civic investorapproach.

First, pension funds should assess which of the differentfutures they face will maximise their capacity to meet theirfinancial objectives. This is done by comparing the expectedperformance of their investments under different scenarios ofsocietal transformation.

Second, if a pension fund is better off if the societal issue isaddressed, it will logically want a public response to that end.Such a response can take different forms: the state may stepin, or when the state fails, some form of civil regulation mayarise. Each case draws attention to specific aspects ofcorporate conduct that can support or hinder these publicresponses.

Third, it assesses the actual costs and benefits of public-response enhancing corporate conduct from the perspectiveof pension funds. Only those aspects of conduct that generatehigher benefits than costs would qualify as pension funds'preferences for responsible corporate conduct.

3.2. Monitoring the potential impact of various societalissues and trends

The construction of scenarios provides an appropriate meth-odology to paint different possible futures, and then assess themore desirable course of action from the point of view ofpension funds. These scenarios, as in World Business Councilfor Sustainable Development (1997), are intended to replicatethe different paths of societal transformation and equilibriathey lead to in the medium to long run.

Consider the issue of climate risk. The starting point ofthe approach is to assess the stake of broadly diversifiedinvestors in climatic change. To simplify the analysis, wedistinguish between two different scenarios: in a business-as-usual scenario, increases in greenhouse gas emissionscontinue unabated and produce widespread climaticchanges that affect some businesses and economic activitiesdirectly; in a public-response scenario, concerns over currentlevels of greenhouse gases trigger a public response–eitherthrough state regulation or through various forms of civilregulation–to curb emissions, with the consequence that

3 Consider the National Association of Pension Funds (NAPF) inthe UK. NAPF represents pension funds covering some 10 millionemployees, who account for 75% of occupational scheme assetsin the UK and control 20% of the shares of the London StockMarket. In its own words, “NAPF concentrates the power of itsmembership into an influential voice to government, parliament,regulators and the media. It also provides its members withvaluable information and other services to assist them in theeffective running of their schemes”. Given its mission, it seemsreasonable to expect the NAPF to take a position on key policyissues, which may have a strong bearing on their members'capacity to meet their future liabilities, such as climatic change orinternational development. Similar organisations exist in othercountries that base their retirement systems on pension funds.


climatic disruptions are of limited magnitude but with a costto businesses exposed to greenhouse gas emissions.

In each of the two scenarios, pension funds will assess thepotential impact on the value of a market portfolio on thebasis of the type of risks that each company faces: risks fromthe direct impact of climatic changes in the first scenario orrisks linked to a reduction in greenhouse gas emissions in thesecond. The Carbon Disclosure Project 2002 Report (cf.Innovest, 2002) assesses the relative importance of these twokinds of risks for large companies. This information can beused to draw implications for the performance of broadlydiversified portfolios.

On this basis, pension funds can identify which of the twoscenarios is better for them, i.e. under which of the twoscenarios they will have the greatest chance of meeting theirfinancial objectives. If the business-as-usual scenario is morefavourable, then the assessment of the specific societal issuewill stop there.

3.3. Promoting a public-response scenario

We now assume that pension funds prefer the public-response scenario over the business-as-usual scenario. Thelikelihood of such a public response will depend on thecapacity of societies to organise themselves and undertakecollective action. This is the challenge of governance.

This challenge can be met in a number of ways. Standardeconomic and political theory posit that it is the role of thestate to address existing societal problems and prevent theemergence of new ones. Yet, in practice, the state may not beable–or willing–to play the role that theorists assign to it.Cases of state failure are particularly significant in relation tosustainability, as Speth (2003) points out. One cause isjurisdictional gaps, i.e. mismatches between the level atwhich an issue arises and the existence of state institutions,coupledwithmechanisms of accountability at the appropriatelevel (e.g. Kaul et al., 1999). Another cause is a sheer lack ofhuman, financial or administrative capacity at the service ofstate action—an important limitation inmany countries of theSouth. A third is the diversion of the state from its coremission of promoting the public goods and its capture byprivate interests.

Innovative forms of governance have emerged over thepast few years in response to these failures. Many of them–multi-stakeholder initiatives, civil regulation, public–privatepartnerships–are characterised by the active involvement ofnon-state actors, including large corporations and non-governmental organisations, and thus break away from thesimple model of state regulation according to which the statesets the rules and companies abide by them.

Large corporations exercise a strong influence on thesevarious forms of governance, old and new. This influence is asignificant channel through which they have an impact onsocietal outcomes and thus an important component of theiroverall corporate responsibility.

3.3.1. Facilitating and promoting state interventionPension funds can perform a number of tasks to facilitate andpromote state intervention. For instance, they can share theirconcerns with their members and, in this way, influence

public debate. Alternatively or in addition, they can expressthese concerns directly to the public at large and to the state.The involvement of national associations of pension fundsand institutional investors seems a logical way to do thelatter.3

Pension funds can also facilitate state intervention bymonitoring the political influence of the corporations in whichthey invest. Public policy and the design of institutions is acontroversial area, and corporations have often participated inthe process of policy-making to such an extent that, ever sinceAdam Smith's denunciation of the merchants' politicalinfluence in the late 18th century, their political power hasregularly been criticised (e.g. Korten, 1995; Rajan and Zingales,2003, among many others).

The point is that the interests of managers and ownersoften diverge regarding public policy-making. Broadly diver-sified long-term investors will seek public policies thatenhance the value of their portfolio and, usually, this will beachieved by policies that support a performing economy.Corporate executives, by contrast, aim to increase shareholdervalue and will promote public policies that favour theirindustry or, even better, their own companies.

Pension funds should thus be concerned about the politicalinfluence exercised by companies. Indeed, they may findthemselves in the strange position of being owners ofcompanies that lobby policy-makers to hinder the stateintervention that they themselves call for.

3.3.2. Supporting the emergence of new forms of governanceState intervention is not the only form of public responseavailable. In fact, in the context of state failures, new non-state-centred forms of governance are emerging, in particularto deal with issues of sustainability. Revealingly, the speech ofKofi Annan (2003) at the Institutional Investors' Summit onClimate Risk is a barely concealed call on investors to act inresponse to the lack of political will shown by some govern-ments. There is a wide diversity of these forms and, to focusour attention, we shall take the example of just one of themhere.

The governance system known as civil regulation relies onthe demand for corporate responsibility expressed by the keystakeholders of a company—its investors, clients, employeesand the communities wherein it operates (cf. Zadek, 2001).These stakeholders, in on-going contact with public debate,form their own opinion as to what constitutes appropriatecorporate conduct. Such opinion coalesces into expectations


and ethical demands addressed at companies. From thesethen emerge business opportunities as well as reputation andother risks—thence business decisions reflective of stake-holders' new ethical preferences. Higher ethical standards andgreater engagement on the part of stakeholders can thuscontribute to aligning corporate operations with the societalobjectives of sustainability.4

Civil regulation thus requires (i) high levels of corporatealertness and responsiveness to stakeholder expectationsand to the risks and opportunities stemming from issues ofsustainability; and (ii) high levels of stakeholder commit-ment to reward the more progressive companies and punishothers.

Large companies can derail civil regulation by not fulfillingthe role that other actors expect them to play. Pension fundsshould monitor these corporate behaviours when a state-ledresponse is unlikely to address a particular societal issue.Assessing corporate conduct in this perspective will involveassessing the extent to which corporate behaviours (i) are alertand responsive to stakeholder expectations and (ii) support (orhinder) the emergence of a counter-corporate power, notablyin the form of enhanced stakeholder engagement.

In the case of climatic risk, the 10-point action plan of theINCR provides some concrete examples of such counter-corporate power measures. Point 1 calls upon the SEC “toenforce corporate disclosure on requirements under regula-tion S-K on material risks such as climate change (…)”; point2 calls upon the “SEC to re-interpret or change its proxyrules”; points 4 and 5 call for companies to be moretransparent about how they may be affected by climatechange itself and the introduction of new regulations (INCR,2003). Whether companies hinder or facilitate such propo-sals should be considered a corporate responsibility issue—and this is one to which pension funds may be particularlysensitive.

3.3.3. Costs and benefits of public-response enhancing corpo-rate conductWe have identified above a number of specific corporateconducts that may provide benefits to pension funds in thecontext of serious societal issues:

▪ Restraint from exercising political influence that may hinderstate intervention in addressing the societal issues.

▪ Raising corporate alertness and responsiveness to stake-holder expectations, and encouraging stakeholder engage-ment, in order to facilitate the emergence of civil regulation.

We now assess whether it makes financial sense forpension funds to want companies to undertake such action,given that this may have a cost. The costs and benefitsexpected from corporate action comprise two elements:impact on the expected performance of a portfolio within aspecific scenario and impact on the likelihood of occurrence of

4 For statistics on stakeholders' demands for corporate respon-sibility, see Environics International (2002). For the business casebased on stakeholder expectations, see Willard (2002), amongothers.

the three different scenarios—business-as-usual, public re-sponse through state intervention and public responsethrough civil regulation. Furthermore, we assume that theexpected long-term return on a pension fund's portfolio, for agiven level of risk, is inferior in the business-as-usual scenarioto what can be earned in the two public-response scenarios(otherwise pension funds would prefer the business-as-usualscenario).

In this framework, restraining corporations from carryingout political lobbying aimed at hindering state interventionhas a doubly positive effect for pension funds. First, it reducescorporate costs (i.e. the costs of political lobbying) and thusincreases corporate profits and returns for investors. Second,it increases the probability of state intervention, and thus apublic-response scenario, as preferred by pension funds. Wecan therefore conclude that this is indeed a preference thatpension funds should rationally hold.

Things are more complex for other aspects of corporateconduct. Raising alertness and responsiveness to stakeholderexpectations may carry a hidden cost that will not automat-ically be covered by increased earnings or reduced costs at thecompany level. To reach some preliminary conclusions,assume that stakeholder engagement will not be strongenough for the company to recover these costs in thebusiness-as-usual or the public-response-through-state-in-tervention scenarios, and that, by contrast, costs will berecovered in the public-response-through-civil-regulationscenario, because in this scenario stakeholder engagement isassumed to be high.

From these simple assumptions, we derive the followingpoints:

▪ Pension funds, among other stakeholders, will not take thelead in promoting corporate responsibility to address aspecific societal issue through civil regulation. Indeed, ifthe level of stakeholder engagement in a specific societalissue is low, the cost of corporate engagement will not berecovered and the increased likelihood of the civil regula-tion scenario will not be sufficient to compensate for thisloss.

▪ As stakeholder engagement rises, pension fundswill want toraise corporate alertness and responsiveness before man-agement does. The reason is that they havemore to gain, i.e.the increased likelihood that the societal issue will beaddressed.

3.3.4. DiscussionThe civic investor approach defines the responsibilities ofpension funds in the face of threats raised by deep societaltrends in a context of the restricted capacity or willingness ofthe state to intervene. Our analysis suggests that pensionfunds have a number of tasks to perform:

▪ Monitor how societal changes and emerging societal pro-blems put their investments at risk

▪ Facilitate and promote state intervention by– raising members' awareness about the issue at hand– engaging in political lobbying– monitoring corporations' political influence and lobbying

work


▪ Support the emergence of new forms of governance by– raising corporate alertness and responsiveness to stake-

holder expectations– encouraging stakeholder engagement.

These tasks have a cost and, in many instances, issues offree-riding will arise (some pension funds may incur the costsof action fromwhich all pension funds will benefit). These arevalid concerns that require appropriate responses beyond thescope of this paper—although we did allude that some couldbe addressed through associations of pension funds.

The tasks listed above go well beyond the tasks currentlyperformed by pension funds and, for this reason, may seemstrange. Yet, upon reflection, what should seem strange is thatpension funds do not perform such tasks: individuals investhuge sums of money for their retirement, and yet there existsno seriously organised lobbying group to defend theseinvestments against the encroachment of present policiesand practices. The reason for this gap lies perhaps in people'sconfidence in the future. The concept of sustainability wasformulated precisely to challenge this confidence and drawattention to the distribution of economic and social opportu-nities across time. Pension funds have still to draw the fullimplications of this challenge.

5 More than 100 studies have explored the relationship betweencorporate social performance and financial performance. Forreferences, see Forum for the Future (2002). For substantivecritiques of these exercises, see Wood (1991), Rowley and Berman(2000) and Margolis and Walsh (2001).6 In general, the set of corporate strategies that maximizes the

value of a portfolio is logically different from the set constitutedby the corporate strategies that maximize the shareholder valueof each company considered in isolation. They will differsubstantially as soon as interdependencies begin to exist acrosscompanies outside of the market and open to the influence ofcorporate behaviours.7 Note that the current consensus on shareholder value max-

imization is rather new. In the 1970s, economists debatedwhether shareowners could unanimously agree on a firm'sobjectives. Disagreement, rather than agreement, was consideredmore likely, owing to differences in shareholders' investmenthorizons and risk/return preferences, e.g., Grossman and Stiglitz(1977).

4. Conclusion

Over the past few years, a consensus has emerged thatsustainable development should be seen to have three maindimensions: economic, social and environmental. Conse-quently, and following John Elkington's Triple Bottom Lineidea, companies are increasingly evaluated according to theirimpact on the economic, environmental and social spheres(Elkington, 1998). However, this is not sufficient to relatecorporate behaviours to trajectories of societal change and tothe long-term performance of the economy. In addition, itneeds to be specified how the three spheres interact with oneanother, since it is this interaction that shapes societaldevelopment.

This paper has proposed two approaches to identifycorporate behaviours that may have a bearing on societaltrajectories and, in particular, on long-term economic perfor-mance, and for this reason that are of potential concern forpension funds. The two approaches are complementary: thefirst one identifies corporate practices within a given institu-tional setting and the second one corporate practices thatdirectly bears on this setting. It should be clear that there is acertain degree of overlap between the two approaches: indeed,in some cases, it is by adopting new practices such as inenvironmental management that companies will be able tobear on political processes. The combination of these twoapproaches has led us to narrow down substantially thenumber of corporate behaviours of relevance to pension funds(in the sole perspective of fulfilling their fiduciary responsi-bility) as compared, for instance, to the number of indicatorsdeveloped by the Global Reporting Initiative (2002).

Attention to how companies can impact trajectories ofsocietal change through the interaction between differentsocietal spheres has other important consequences. One of

them is to draw attention away from the relation betweencorporate responsibility and financial performance at the levelof one company, and onto the link between corporateresponsibility and the financial performance of broadlydiversified portfolios.5 When broadly diversified investorslook at a company's behaviour in relation to the other assetsthey own–as they should do–they will support the pursuit ofshareholder value maximisation only to the extent that it iscompatible with themaximisation of the performance of theirentire portfolio.6 This paper has provided many examples ofinstances in which the twomay diverge, such as in the case ofpolitical lobbying. This point, surprisingly rarely made in theliterature apart from Hansen and Lott (1996), challengescurrent wisdom that all shareowners would agree with andpromote the corporate objective of maximizing shareholdervalue.7

Another consequence stemming from looking at theimpact of companies on societal trajectories is the need toprecise the society under consideration, thereby drawingattention to the (mathematical) fact that the societal perfor-mance of companies will generally differ across societalsystems. Since pension funds depend only upon the perfor-mance of those economies in which they invest, they will beconcerned about corporate conducts that are responsibletowards a specific territory or economy. This is the reasonthat, as discussed earlier, OECD pension funds will not beconcerned about the “curse of natural resources” phenome-non. For pension funds, the concept of a corporate societalperformance without reference to any specific societal systemis of little interest.

Finally, we may note that this spatial dimension raisesmore than an aggregation issue. It is also about the kind ofinformation that is to be aggregated. Consider, for instance,the amount of water a company uses globally. Corporateresponsibility analysts who use this criterion implicitlyassume that it is meaningful to aggregate the amounts ofwater, measured in litres, that a company uses in differentplaces to assess the sustainability impact of corporations.However, pension funds concerned about the long-termperformance of specific economies will care about theopportunity cost of using water, and this cost will widely


differ between different places. In this sense, a litre of water inwater-rich Canada is not the same thing as a litre of water inwater-poor Egypt. Here our analysis underlines the practicalrelevance of recent attempts (e.g. Figge and Hahn, 2004) tomeasure corporate contributions to sustainability in terms ofopportunity costs.

Acknowledgements

I would like to thank André Burgstaller for his support inwriting this paper, as well as for inputs by Peter Buomberger,Jason Hauser, Alexander Seidler and two anonymous referees.Thank you also to Lucas Bretschger, Bettina Furrer and BerndSchanzenbächer for useful comments. Financial support byEcoscientia Foundation is gratefully acknowledged.

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