Do Responsible Investment Indices Improve Corporate Social Responsibility? FTSE4Good's Impact on Environmental Management

• Author: William Rees,Tatiana Rodionova,Craig Mackenzie
• DOI: http://doi.org/10.1111/corg.12039
• Published date: 01 September 2013
• Date: 01 September 2013

Do Responsible Investment Indices Improve

Corporate Social Responsibility? FTSE4Good’s

Impact on Environmental Management

Craig Mackenzie, William Rees, and Tatiana Rodionova*

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: This study investigates the impact of a responsible investment index on environmental manage-

ment practices. Firms that were included in the FTSE4Good index but failed to meet enhanced requirements were subject

to both engagement by FTSE and the threat of expulsion from the index. We examine the combined effect of these actions,

estimate the contribution of both elements separately, and the inf‌luence of concentrated equity ownership, corporate

governance, and the institutional environment. We also evaluate whether the effect is persistent or transitory.

Research Findings/Insights: For a sample of 1,029 f‌irms from 21 countries, our f‌indings demonstrate that engagement

combined with the threat of expulsion from the FTSE4Good index doubles the probability that a f‌irm failing to meet the

environmental management criteria in 2002 would comply by 2005. The higher compliance rate for the f‌irms receiving

engagement persists until the end of our study in 2010. We also f‌ind that compliance is positively associatedwith low levels

of concentrated ownership and with f‌irms based in coordinated rather than liberal market economies.

Theoretical/Academic Implications: Our results contribute to the understanding of the complexities of governance, where

decision makers are constrained or inf‌luenced by equity holders, the f‌irm’s governance system, institutional arrangements,

and collective engagement by institutional equity holders. Our f‌indings are consistent with both institutional and agency

issues impacting on decision making.

Practitioner/Policy Implications: Our study suggests that engagement via a responsible investment index reinforcedby the

threat of public expulsion from the index provides an effective route for large-scale collaborative investor engagement on

corporate social responsibility issues targeting large and internationally diverse f‌irms. It also demonstrates why regulators

may wish to encourage engagement of this type to achieve social benef‌its.

Keywords: Corporate Governance, Corporate Social Responsibility, Environmental Management, FTSE4Good, Investor

Engagement, Responsible Investment Indices

INTRODUCTION

We examine whether a responsible investment index is

able to effect substantial change in environmental

management practices across a large sample of internation-

ally diverse f‌irms. There is some evidence from both the US

and the UK that engagement by institutional investors can

inf‌luence management, but this comes from small sample

case studies and is not typically focused on corporate social

responsibility (CSR) issues (Becht, Franks, Mayer, & Rossi,

2009; Dimson, Karakas¸, & Li, 2012; Gifford, 2010). There is

also evidence that engagement by shareholders can be

driven by considerations of f‌inancial or social performance

and is conditioned by the institutional setting (Rees &

Rodionova, 2012; Sullivan & Mackenzie, 2008; Young &

Marais, 2012). Conversely, institutional shareholdings are

typically associated with lower performance in the CSR

rankings and, whilst this might be most strongly driven by

entrenched shareholders, there is no evidence that diversi-

f‌ied institutional investors impact benef‌icially on CSR prac-

tices (Rees & Rodionova, 2012; Starks, 2009). It is, therefore,

unclear whether investors effectively engage with f‌irms to

improve CSR practices and which institutional or gover-

nance characteristics impact on the effectiveness of that

engagement. Our analysis assesses the impact on environ-

mental management of engagement by institutional inves-

tors via a responsible investment index combined with the

threat of exclusion from that index.

*Address for correspondence: TatianaRodionova, The University of Edinburgh Busi-

ness School, 29 Buccleuch Place, Edinburgh EH8 9JS, UK. Tel.: +44 (0) 792,388 0594;

E-mail: tatiana.rodionova@ed.ac.uk.

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Corporate Governance: An International Review, 2013, 21(5): 495–512

© 2013 John Wiley & Sons Ltd

doi:10.1111/corg.12039

Our analysisis based on a natural experiment provided by

the enhancement of the environmental management

requirements necessary for membership of the FTSE4Good

index. In 2002 FTSE strengthened the criteria and engaged

with index members that failed to meet the new standards.

The engagement was designed to improve the environmen-

tal practices of the f‌irms and was reinforced by the threat of

exclusion from the FTSE4Good index if the new criteria

were not met by 2005. All constituents of the FTSE All-World

Developed Index were potential members of FTSE4Good,

and independent experts assessed their environmental man-

agement practices. FTSE4Good constituents failing to meet

the criteria in 2002 form our treatment group, whilst non-

members failing to meet the criteria form the control group.

We examine the response of these two groups between 2002

and 2005 and whether an effect is temporary or persists until

2010. We also investigate the impact of ownership, gover-

nance, and institutional environmenton rates of compliance.

The results show that engagement allied to the threat of

exclusion substantially increases the probability that a f‌irm

will meet the FTSE4Good environmental management crite-

ria. Tothe extent that high levels of index membership among

matched f‌irms ref‌lect benef‌its frominclusion, we separate the

engagement and the incentive to stay in the index. We f‌ind

that both engagement and the incentive to stay stimulate

compliance but that engagement is most eff‌icient when

coupled with a high probability of index membership. We

also show that compliance is negatively affected by concen-

trated ownership, and positively affected by the f‌irm’s loca-

tion in a coordinated rather than a liberal market economy.

Theseresults demonstrate that managementreacts to engage-

ment but not that engagement necessarily improves environ-

mental performance. TheFTSE4Good criteria are demanding

and it would be reasonable to assume that a f‌irm meeting

these criteria would tend to have better environmental man-

agement than one that does not. However, we only have

evidence that management has undertaken the necessary

action to comply with FTSE4Good criteria.

We believe these results to be of particular relevance to

both the theory of corporate governanceand to practitioners

in the investment community. With regard to the theory,

previous evidence has generally shown no robust link

between institutional shareholdings and CSR practices. We

demonstrate that engagement by a responsible investment

index, combined with potential exclusion, can affect CSR-

related managementdecisions and that this is conditional on

factors consistent with both agency and institutional theo-

ries. With regard to practitioners, our results are of signif‌i-

cance to investment institutions seeking to inf‌luence

management, to regulators who may wish to encourage

responsible investment, and to the responsible investment

suppliers such as FTSE who are advocating engagement via

responsible investment indices.

PRIOR RESEARCH AND HYPOTHESES

CSR and Index Engagement

Whether or not a f‌irm engages in CSR-enhancing projects

depends on managerial decisions and the underlying moti-

vations can be either prof‌it-oriented or non-f‌inancial

(Fisman, Heal, & Nair, 2006). CSR may trigger a “warm-

glow” effect for the manager as a “good citizen,” signal

competence, and lead to a stronger reputationand enhanced

job security (Barnea & Rubin, 2010; Renneboog, Ter-Horst, &

Zhang, 2008; Solomon, Solomon, & Suto, 2004; Stephan,

2002). Personal benef‌its aside, strong CSR can potentially

reduce conf‌licts with stakeholders and signal business value

(Jo & Harjoto, 2011). It may also emphasize product quality

(Becker-Olsen, Cudmore, & Hill, 2006; Fisman et al., 2006; Jo

& Harjoto, 2011; McWilliams & Siegel, 2001), improve the

ability to raise capital (Cheng, Ioannou, & Serafeim, 2011;

Kiernan, 2007), and attract motivated employees (Brekke &

Nyborg, 2008; Turban & Greening, 1997).

From the institutional theory perspective, the propensity

to invest in CSR may be inf‌luenced by several factors: state

and industrial regulation, the f‌irm’s f‌inancial and competi-

tive situation, pressure groups such as NGOs, and dialogue

with stakeholders (e.g., Bansal& Roth, 2000; Campbell, 2007;

Christmann, 2000; Delmas & Toffel,2010; González-Benito &

González-Benito, 2006; Hart, 1995; Sharma & Vredenburg,

1998). In particular, evidence shows that companies facing a

poor environmental rating may become exposed to sanc-

tions by regulators or put under increased scrutiny by activ-

ist groups and NGOs (Lenox & Eesley, 2009; Stephan, 2002).

This, in turn, can send a negative signal to shareholders

concerning increased operational costs and long-term

wealth loss (Barnea & Rubin, 2010; Hamilton, 1995;

Renneboog et al., 2008).

One of the channels by which a company’s efforts in CSR

can be communicated to its stakeholders is via responsible

investment indices and ratings. Chatterji and Toffel

(2010:921) argue that “the growing interest in corporate

social responsibility and socially responsible investment has

increased both the salience of independent ratings agencies

and companies’ responsiveness to risks to their brand repu-

tations.” While there is an on-going, often critical, discussion

about how well these indices and ratings capture the under-

lying socially responsible behavior, some of them at least

present a credible ref‌lection of investor expectations regard-

ing CSR and can increase the transparency of company

reporting on its CSR activities. Rees and Mackenzie (2011)

report that in 2011 the FTSE and ASSET41metrics exhibit a

signif‌icant positive correlation. Using a large sample of US

companies in 2003–2008, Semenova (2010) shows that the

environmental performance assessments provided by KLD,

GES, and ASSET4 correlate positively both for environmen-

tal performance and environmental risks.2Chatterji, Levine,

and Toffel (2009) also show that KLD’s assessment of f‌irms’

environmental performance ref‌lects environmental perfor-

mance measures such as toxic emissions and environmental

f‌ines. However, they note that the assessment seems to

provide a better estimation of past performance than future.

At the same time, Chatterji and Toffel (2010) f‌ind that low

KLD environmental scores stimulate companies to reduce

their toxic emissions. The above evidence suggests that

responsible investment indices and ratings consistently

assess reported CSR practices.

Shareholders can also inf‌luence CSR decisions. Invest-

ment institutions on the whole attribute a growing impor-

tance to sound CSR practices (Cox, Brammer, & Millington,

2004; Kim & Lyon,2007; O’Rourke, 2003; Reid & Toffel, 2009;

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