23 October 2008
Daniel Litvin
(Former Chatham House Expert)


This era's greatest episode of financial irresponsibility almost brought capitalism to its knees. So where on earth was the corporate responsibility movement?

When historians come to write their account of the great financial crisis of 2008, what mention will be given to "Corporate Social Responsibility" (CSR)? Over the last decade, the world's largest companies and governments have trumpeted CSR - action by companies to improve their impact on society - as a way to moderate capitalism's excesses. CSR should now be centre stage. But it is not.

CSR - together with the related and equally fashionable concept of "socially-responsible investment" (SRI) - is promoted as a way to make business more ethical. Greater sensitivity to social and ethical concerns, the argument goes, should help companies reduce the risk of a backlash from regulators and consumers, and avoid collapses in public trust.

It would, therefore, have been reasonable to expect CSR advocates to have sounded early warning bells about the catastrophe currently engulfing the financial sector. No other episode of corporate irresponsibility over the last half century, after all, has destroyed quite as much shareholder value. In addition to their basic failure to manage risk effectively, banks and other financial institutions engaged in a range of ethically-dubious practices. They sold unsuitable mortgages to poor customers, used complex financial instruments that even the bankers did not understand, and turned a blind eye to internal conflicts of interests. Ultimately this rebounded, just as the theory of CSR would suggest. Public trust collapsed, as did the trust of other banks, bringing with it plummeting share prices and massive regulatory intervention.

Yet the CSR movement largely missed the boat. The problem was not that ethical issues in the finance sector were simply disregarded. (There was actually plenty of activity in CSR circles, of which I count myself a part.) Instead, there was a failure to focus on the particular issues that brought the system down. Recent years have seen a flurry of finance-related CSR initiatives, including the UN Principles on Responsible Investment, while the world's big financial firms have developed CSR policies and invested in glossy "sustainability" reports. But these efforts failed to tackle the particular ethical lapses relating to banks' internal governance, and the way they conducted their core business.

At some points in the run up to the crisis, it is true, questions raised by CSR teams and ethical investors hit the mark. As early as 1993, for example, a US religious investor group, the Interfaith Center on Corporate Responsibility, raised doubts about sub-prime mortgages and predatory lending. But such activism was relatively rare. CSR analysts paid more attention to higher profile, easier-to-grasp issues, like climate change and human rights. Ironically, many SRI funds invested more heavily than average in financial institutions-to balance out portfolios that could not include arms, tobacco and oil companies and the like - and found themselves particularly exposed as bank shares fell. A recent survey showed UK ethical funds have been hit much harder than their less ethical peers.

Is this then a reason for dismissing CSR as a misguided attempt by big companies to persuade us to let them regulate themselves? Not quite. The financial crisis has proven the case for stronger regulation of the financial sector. But, despite this, regulation alone remains a clumsy tool for tackling many social challenges. On issues such as protecting workers' rights or improving the impacts of foreign investments in poor countries, the promotion of ethical norms among companies can be a powerful tool. Equally, on issues such as climate change, voluntary action from companies is an important interim measure until states get their act together.

At the same time, what is clearly needed is a smarter, tougher, and more independent-minded approach to CSR. CSR teams within companies should not only be skilled at engaging with the external world and producing glossy reports, as they currently are. They need to be able to grasp the detail of corporate strategy and the ethical risks that may be involved. And they need the mandate to ask tough questions of senior management before these risks explode. Likewise, SRI analysts need to really understand companies' business models and focus on internal ethical issues whose mismanagement might imperil shareholder value - not just issues such as climate change. They too need to command the attention of mainstream management - in this case, the fund managers deciding where to invest traditional as well as niche ethical funds.

Will such a toughening up of CSR and SRI ever actually happen? It may well do, precisely because it could help companies and investors avoid the sort of multi-billion dollar wipeout of shareholder value of financial firms seen in recent months. This should help focus minds, if nothing else does.

* Originally published by Prospect Magazine

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