The Unbearable Irresponsibility of Being an Investor
Responsible investing is the new normal. But to whom and for what are responsible investors responsible? Is responsible investing sustainable? What does Max Weber have to do with this all? For answers, and a few questions more, read this summary of my Master’s Thesis.
In recent years, corporate responsibility has challenged digitalization as the most misused business buzzword. Its close cousin, responsible investing, is topping the list on investors’ side. But particularly to whom and for what are these companies and investors responsible? In my Master’s Thesis, I aimed at understanding this theme by asking why and how Nordic institutional investors invest responsibly, and what kinds of perspectives on corporate responsibility this reflects. Funded by The Technology Industries of Finland, I conducted an inductive case study interviewing 18 pension fund and asset management investors in the Nordics.
The hows and whys of institutional responsible investing in the Nordics
The most evident approach to studying responsible investing is to analyze how investors practice it. As listed in Table 1, six key practices among Nordic institutional investors can be identified. The effectiveness of these practices, however, provokes fierce debate among investors. For instance, many debate whether labeling only some financial products as responsible or impact-focused reinforces a false belief that only some investments would be responsible to someone for something or have positive and negative impacts. Divesting liquid, publicly-listed stock of irresponsible companies, in turn, is criticized for walking away from problems and for having a very limited effect on the underlying companies’ actions.
As many investors point out, responsible investing can also be pursued by promoting systemic changes at the level of the whole financial system. For instance, investors can aim at affecting real consumption and real investments made by individuals and companies, and lobby for regulation and policies that force and support every investor to be more responsible. Many also note that if the whole capitalistic system was more long-termist, investors would automatically become more responsible.
To improve responsible investing, investors must also be able to measure the responsibility of their investments. Currently, the only practically reasonable way of quantifying responsibility is to use data provided by 3rd party responsibility rating agencies. If capturing something as abstract as corporate responsibility in quantitative measures wasn’t difficult enough a task, the dynamic between investors and rating agencies complicates it even more. Investors depend on the data provided by rating agencies while the rating agencies must provide data that investors are willing to pay for. This interdependence resembles the one between lenders and credit rating agencies and makes it hard for very progressive responsibility data providers and investors to emerge. Too progressive responsibility data could be intellectually more honest but as long as it’s not financially material, investors won’t pay for it. Conversely, the lack of data limits the progressiveness of responsible investment strategies that investors ahead their time might be willing to implement.
“The interdependence of investors and 3rd party responsibility rating agencies resembles the relationship of lenders and credit rating agencies.”
Naturally, investors do not apply these practices by chance. Instead, the practices are firmly rooted in a set of motives to invest responsibly. As shown in Table 2, these include motives related to managing investment risks and opportunities; to marketing and public image; to recruiting and human resources management; and, in a self-fulfilling way, to learning about responsible investing by doing it.
All the motives are reflections of a financial imperative induced by the fiduciary duty of investors. In essence, this means that as investors are legally bound to financial returns, all their actions related to responsible investing must be financially justified, too. Explicitly, this can be seen in the investment risk management and opportunity seeking motives. On the other hand, the financial imperative can also be served implicitly through the marketing, public image, recruiting and knowledge motives. Clients’ demand for responsible financial products and employees’ urge to work for investment firms that are responsible are here projected onto the investment firms’ marketing and recruiting motives, respectively.
“As investors are legally bound to financial returns, all their actions related to responsible investing must be financially justified.”
When it comes to the relative importance of the motives, long-term risk management seems to be the reason why institutional investors invest responsibly. The “long-term” of most investors, however, is still quite far from the “generation-spanning long term” towards which many sustainability scholars (Slawinski and Bansal, 2015; Bansal and DesJardine, 2014) urge capitalism to move its focus.
Legitimacy signaling through voluntary agreements, like signing the UN Principles of Responsible Investing, seems to be the second most important motive. Moreover, asset managers seem to value the risk management and legitimacy signaling motives more while asset owners focus more on the opportunity seeking motive. This is rather logical, as direct contact with clients creates additional pressure for asset managers to manage short-term financial and reputation risks.
Responsible investing is a systemic and wicked issue by nature
Seeing responsible investing just as a typical business decision of the investors would, however, be very myopic. Instead, responsible investing should be understood as a systemic and wicked issue. Rather than a linear business decision controlled by the investors, responsible investing resembles a complex system. This also means that practicing and reforming responsible investing is not entirely in the hands of individual investors but depends on the societal and technological context, and even on the economic paradigm in which the investors operate.
“Practicing responsible investing depends on the societal and technological context, and even on the economic paradigm in which the investors operate.”
Figure 1 summarizes this argument by analyzing the motives and practices of responsible investing from three points of view: the individual level, the organizational level and the normative, economic, legal, technological and knowledge-related metacontext in which the investors operate. Based on the relations of different motives and practices, six key mechanisms driving the system are proposed.
As seen in Mechanism 1, all institutional investors’ motives to invest responsibly are ultimately based on the financial imperative, i.e. on complying with fiduciary duty by seeking financial gains from responsible investing. But as Mechanism 2 describes, this is also implicitly achieved by projecting clients’ and employees’ motives for responsibility onto organizational marketing and recruiting motives, respectively. Interestingly, Mechanism 2 seems to be bidirectional: retail clients and investment professionals seem to adjust their sometimes idealistic motives and desires for responsible financial products and workplaces based on the “financial realism” they face from the investment organizations.
Obviously, as Mechanism 3 states, responsible investing practices follow from the motives to invest responsibly. However, this is not the only driver shaping and constraining how investors practice (or formally operationalize) responsible investing. Instead, the limits of knowledge and technology constrain how responsible investing can be implemented and measured (Mechanism 4). And as discussed in the previous chapter, investors are currently dependent on 3rd party rating agencies when measuring responsibility. Simultaneously, also the rating agencies depend on their clients, the investors. This creates a relationship resembling the one between lenders and credit rating agencies (Mechanism 5).
Finally, as Mechanism 6 states, the “whys” and “hows” are also interdependent. Naturally, the “hows” of responsible investing, the high-level theories and techniques, are driven by the societal normative opinion on what responsible investing should be. But the causation seems to hold also in the other direction. The technical and theoretical breakthroughs — say, the advancement of machine-driven natural language processing, climate science or financial engineering — may also change the collective normative opinion on responsible investing by making certain approaches to responsibility possible and comprehensible.
There are multiple corporate responsibilities but the “iron cage” of fiduciary duty traps investors to weakly sustainable ones
No investor or company is responsible per se, but always (ir)responsible to someone for something. Based on an interdisciplinary literature review, the study identified five archetypal perspectives reflecting different views on who the beneficiaries of businesses are and what the purpose of companies is. As shown in Table 3, these perspectives form a continuum: moving right, the amount of issues not considered to be the “business of businesses” decreases (formally the externality residual), while the breadth and complexity of what corporate responsibility is thought to mean increases.
“No investor or company is responsible per se, but always (ir)responsible to someone for something.”
The first perspective, Friedman doctrine (Jensen, 2002; Friedman, 1970/2007; Levitt, 1958), follows the thinking of the father of neoliberal economics, Milton Friedman (1970/2007): “The social responsibility of business is to increase its profits”. Strategic philanthropy (Husted et al., 2006; Godfrey, 2005), mostly follows the Friedmanian line of thought but accepts some forms of philanthropy-focused responsibility actions given that they serve the profit motive. Corporate citizenship (Matten and Crane, 2005; Logsdon and Wood, 2002) takes a somewhat different stance by arguing that global corporations are nowadays so powerful that they should have similar societal and political responsibilities as nation states or good citizens. Shared value (Engert et al., 2016; Porter and Kramer, 2011), made famous by the business prophet Michael Porter himself, argues that responsibility is not an obstacle to but the very prerequisite for companies to thrive.
Despite their differences, the perspectives are not categorically mutually exclusive. Rather, they could be understood as lenses that can be applied simultaneously. The key factor defining which of these lenses currently prevail and whether the lenses are mutually exclusive or not in the first place, is the operationalization of responsible investing. In other words, the ways corporate responsibility is reflected in societal norms and laws, and the ways investors practice and measure responsible investing define what responsibilities investors actually bear. With the right environmental regulation and incentives, for instance, being environmentally responsible would be the best way to maximize shareholder value and the Friedmanian and Porterian views would converge.
The final perspective, however, belongs to a different paradigm than the others. Doughnut economics, as described by Raworth (2017), states that corporate responsibility cannot be separated from the grand responsibility of the humankind: to preserve the conditions for thriving human and non-human life in the very distant future. The “doughnut” in the perspective is formed by operationalizing the planetary boundaries (Steffen et al., 2015) as an ecological “ceiling” and the essential standards of human welfare as a social “floor”. This challenges many of the underlying assumptions of our current economic paradigm, such as the mysterious disconnect of human and natural realms in our modern capitalistic thought or the belief that our current gold standard of economic progress, the GDP, is also an adequate measure of human welfare.
“Not the irresponsibility of investors but the irresponsibility of the whole capitalism traps us to weakly sustainable forms of responsible investing.”
According to the findings, institutional responsible investing in the Nordics seems to reflect most the views of Shared value and Friedman doctrine. Collectively, the findings indicate that investors invest responsibly because it is financially beneficial for them — either through explicitly improving investment performance or through the implicit means of marketing, recruiting and knowledge acquisition. Simultaneously, however, society has defined investors’ mandate in a quite Friedmanian way by obligating them to fiduciary duty. Combined with strongly-rooted economic beliefs, business cultures and incentive schemes, the fiduciary duty forms, in the words of Max Weber, an iron cage¹ which traps investors to weakly sustainable² forms of responsible investing. As long as our current economic paradigm itself is incompatible with the strongly sustainable² ideals of Doughnut economics, investors, as parts of this system, cannot alone apply them to responsible investing. One could even argue that it is not the irresponsibility of investors but the irresponsibility of the whole capitalism that traps us to weakly sustainable forms of responsible investing.
[1] “A metaphor developed by Max Weber to capture the effects of increased rationalization in society, which leads to people becoming trapped in a ‘cage’ of systems that focus on rational calculations and efficiency at the expense of other qualities. Weber observed that the technical and economic conditions of machine production had become an irresistible force that determines the lives of everyone born into this system, leading to disenchantment and constrained freedom.” (Jeanes, 2019)
[2] “The fundamental debate regarding sustainable development is whether we choose to adopt a strong or a weak conception of sustainability. Weak sustainability postulates the full substitutability of natural capital [to e.g. manufactured, financial and human capital] whereas the strong conception demonstrates that this substitutability should be seriously limited due to the existence of critical elements that natural capital provides for human existence and well-being.” (Pelenc & Dedeurwaerdere, 2015)
Responsible investing is best managed with paradoxical cognitive framing and transformed with systemic reforms
The key message of the study might feel quite overwhelming. If problems in responsible investing are systemic in their nature, what can individual investors, policymakers or other economic actors do about them? Being a wicked problem, there is, by definition, no root cause or silver bullet for responsible investing, and the solutions depend heavily on how the problem itself is framed (Reinecke and Ansari, 2016). This does not still mean that nothing could or should be done.
First, managers and policymakers could apply paradoxical cognitive framing when observing, interpreting and managing responsible investing issues. In this framing, the socially constructed nature and plurality of perspectives to corporate responsibility is acknowledged (Matten and Moon, 2008). The evident tensions between corporate and socio-environmental interests are not attempted to be eliminated but they are instead embraced (Hahn et al., 2014). The complexity of the issue is approached with “both-and” type of thinking instead of trying to find root causes or definite solutions (Van der Byl and Slawinski, 2015). The issue is approached both by “zooming out”, i.e. by analyzing responsibility from a very broad long-term perspective, and by “zooming in”, i.e. by really scrutinizing the complex details and connections of the issue (Schad and Bansal, 2018).
“In the paradox cognitive framing, evident tensions between corporate and socio-environmental interests are not attempted to be eliminated but embraced.”
Second, all actors — were they then investors, company managers, policymakers, scholars or other players — should acknowledge the systemic nature of responsible investing when attempting to reform it. As de Bakker et al. (2020, p. 3) puts it, our current corporate responsibility discourse has been blind to “the elephant in the room” — the systemic constraints to corporate responsibility. It is hence time for us to ask whether current notions of corporate responsibility are strongly sustainable or responsible for the long-term development and well-being of the humankind. It is time for us to acknowledge that corporate (ir)responsibility is woven into the fabric of modern capitalism, and to comprehend and reform corporate (ir)responsibility, we must comprehend and reform this fabric.
“To comprehend and reform corporate (ir)responsibility, we must comprehend and reform the fabric of modern capitalism.”
For scholarly sources, see the bibliography of the thesis:
