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Financial events of the past several years have led to a dramatic increase in the public’s scrutiny of the corporate sector particularly in the United States and Europe. A variety of business companies’ financial reporting scandals have shaken public faith not only in the honesty of corporate officials and the integrity of the information they provide, but also their investment activities in developing countries.
Due to their socially irresponsible investment operations, Corporations stand accused of being agents of immiseration in the developing world. Social and economic critics tie this problems to those of public health, child labor, environmental preservation, and workplace safety in developing nations where the firms have invested. Conservative economist Milton Friedman once proclaimed “There is but one and only one social responsibility of business – to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game.”
Socially responsible investing has been around for several decades, dating back at least to the launch of the Calvert Social Investment Fund in 1982. Since then, ethical investing has brought about many improvements in the way companies conduct their business. It has been all too easy for corporations to avoid responsibility by arbitraging regulation to find the least restrictive environments. Only today, however, does socially responsible investing stand ready to fully come of age and realize its potential to enforce sustainable and ethical behaviour among major participants in the world economy.
Over the past several decades, the world economy has been subject to the dominant influences of increasing global integration and reliance upon market-based economic structures. These two influences, supported by technological innovations, have worked interactively to present national governments with significant regulatory challenges. In some cases, they have made effective regulation impossible to enact. In others, they have diluted regulatory initiatives to the point where enacted regulation is hollow and ineffectual.
Faced with a global sprawl of disparate and often conflicting regulations, it has been all too easy for corporations to avoid responsibility by arbitraging regulation to find the least restrictive environments. According to Richard Phillips of New York University, in the United States, for example, the implied threat and resulting fear is that companies will simply relocate their operations to a more tolerant jurisdiction. That effectively puts a muzzle on lawmakers, often rendering them mute in the face of potential injustice.
Socially responsible investing, however, creates an effective mechanism that enables the markets to self-regulate in the current global environment. Simply put, capital is the only practical force capable of restraining capitalism’s own excesses. Socially responsible investing examines a company’s environmental, social and governance practices, referred to as “ESG” in the parlance of practitioners. Within these three pillars reside the chief risks facing the global economy. They are environmental degradation, social dislocation and the undermining of confidence in capitalism itself, due to disingenuous and opaque governance practices. The outspoken social activists and parliamentarians in United States and Europe protest against the currently famous land grab in Africa and the roots it’s planting on these three global economic risks.
Fear that companies will simply relocate their operations to a more tolerant jurisdiction effectively puts a muzzle on lawmakers. These also happen to be the overarching risks facing those responsible for the allocation of global capital. To date, several factors have held socially responsible investing back from reaching its full potential.
Again, according to Richard Phillips of New York University, until recently, most socially responsible investment applications have focused on excluding “bad” companies with varying definitions as to what constitutes “bad.” For example, many socially responsible investors seek to strip certain industries and companies out of their portfolios such as alcohol, tobacco, firearms and nuclear energy. This approach forces investors to allocate in accordance with their value systems. However, as many academics have suggested, negative screening undermines sound investment management processes. Perhaps a better approach would be to identify those companies in the relevant sectors that are the most environmentally and socially responsible and are governed most effectively. In this way, some companies would be rewarded for responsible and ethical behaviour by having greater access to capital. Companies that act irresponsibly and unethically will be punished by being denied access.
A second drawback to socially responsible investing has been that it has historically been nondemocratic. As a practical matter, the raw input data needed to define “ESG” efficiency is extensive and highly complex. Only when investors are fully empowered with fair, impartial and transparent tools for measuring their company’s “ESG” compliance with socially responsible principles will socially responsible investing become relevant in the vast cross-section of global capital formation. As long as standards are expensive, arcane and inconsistent, broad-based acceptance will fall short.
Companies should be rewarded for responsible and ethical behaviour by having greater access to capital. A final drawback is that, to date, many corporate executives have viewed corporate social responsibility at best as an investor relations’ initiative and at worst as a cynical public relations stunt. This has tarnished the image of socially responsible investing. For example, BP (British Petroleum) had to deal with major environmental issues which includes pipeline leaks on the Alaskan tundra, a refinery fire in Texas and offshore oil rig blowout in the Gulf of Mexico, even as it stood behind its organic sunflower logo. Apple has presented itself as socially responsible, a friend to man and child alike, even as it employed sweatshop labor through its Chinese contractors.
Similarly, as the Financial Times reported, JP Morgan Chase, one of the world’s financial giant, had presented itself as the very model of good governance, a position that lost some credibility with the revelation of losses caused by a corporate deformity known as the “London Whale.” The point here is not to single out these three companies, although the opprobrium may be fully warranted. Rather, it is to underscore the complex issue of duplicitousness in corporate principles.
The only effective way to diminish this duplicity and to mitigate associated risks is for owners of capital to make corporate managements increasingly more accountable for maintaining sustainable “ESG” operations. Only when there is consensus that strict adherence to sound “ESG” principles becomes a positive determinant of corporate performance and risk and not some Pollyannaish expression of do-goodism will the system take hold. Socially responsible investing is rapidly transitioning to a “best in class” approach that is inclusive and respectful of key investment considerations.