06 October 2005

Socially Responsible Investing

Socially responsible investing (i.e. investing only in companies that have "ethical policies" in how they conduct their business (e.g. in paying workers good wages) and who engage only in "ethical businesses" (e.g. avoiding alcohol and tobacco companies)) is not the answer.

Simply put, investors have widely varied political beliefs, although they are, by and large, mostly conservative -- something corrolated with great wealth in this country. Indeed, should investors start investing based on their values in large numbers, the results will be negative and not positive. I don't want the values of the several hundred thousand people who own half of corporate American to govern my life.

In any case, investors have little or no influence over how a company is managed, in this era of a seperation of ownership and control. The idea that shareholders govern corporate American is more myth than reality. Shareholders choose the Board of Directors in the same way that voters in Iraq elected Saddam Hussein with 100% of the vote. There isn't a publicly held company in American that provides its shareholders with a contested ballot for the Board of Directors on a regular basis.

Furthermore, investing is fundamentally about maximizing total return. This objective is never advanced by considering other factors, and if companies are preferred and hence increase in stock value because they are socially responsible, it only has the effect of making less scrupulous companies more attractive investments.

Rather than encouraging people to invest based on their values, we need to have the government, which can much more easily represent all people, regardless of their wealth, regulate business effectively. The eliminates the moral hazard in which management must weigh stock price gain due to being socially responsible against stock price gain from profits, as everyone must comply. Straightforward rules and incentives work better in the marketplace, and customers have more power to change corporate policies than investors (who have already provided the company with the capital it needs) do.

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