Finance and Sustainability: Towards a New Paradigm? A Post-Crisis Agenda: Volume 2

Since Thomas Kuhn (1962), a historian of science who gave ‘paradigm’ its contemporary meaning, the term ‘paradigm’ has been widely used in science and social sciences to refer to a theoretical framework or thought pattern in any given discipline, or broadly, a set of experiences, beliefs and values that affect individual perceptions of a reality and their subsequent reactions. A dominant paradigm is the widely held system of thought in a society at a particular period of time. For Kuhn, a dominant paradigm can be changed and replaced by a new one, which often occurs in a revolutionary manner in science. In social sciences, ‘paradigm shift’ implies the changing ways of understanding and organising a social reality.

Andrew Williams and I have argued since the early 1990s that not only have equity (and subsequently most other assets classes) come to be dominated by institutional ownership of various types, an observation that many have made and documented at length, but that the majority of those institutions are fiduciary ones (primarily pension and mutual funds in the United States). More recently pension and mutual funds have been the source of the majority of funds for many ‘alternative’ investments, such as hedge funds, private equity and commodity funds. In the last two decades there have been parallel developments in other countries, although the form of the institutional investors vary widely, from fiduciary ones mostly in common law countries to fiduciary-like ones in many civil law jurisdictions (e.g. the Netherlands), to some sovereign wealth funds (e.g. Norway and Australia and some others) which do not have fiduciary obligations as such, but in their legal mandates and practices are structured much like those that are fiduciary or fiduciary like. As discussed below, all these (in addition to some other large institutional owners) are universal owners, that is, they own a representative cross section of their investment universe (which increasingly is a global universe). Given their ownership structure characterised by a large degree of diversification, universal owners' long-term interests to a large degree coincide with the economy as a whole.

The Fordist wage compromise may resemble an attempt to macroeconomically establish ethico-political rules governing the conflicting cooperation between capitalists and employees (Aglietta, 1998; Boyer, 1993). The question of the relationship between ethics and economics is, thus, not contemporaneous with the CSR movement. It is particularly misleading to see this recent movement as a fundamental break with the era of relationships between capital and labour, or even, as a definitive and modern break with the old ‘conflicting’ form of productive relations. The Fordist compromise represents a very subtle and substantial means of linking ethics and efficiency, but it is situated at the macro-social level, in contrast to the CSR movement.

Even though there is neither case law nor policy negating the concept of the maximisation of shareholders' profits, the ‘schizophrenia’ of the legal conception of the corporation (Allen 1992), and the incertitude that stems from this, justify a new definition of the ‘best interests of the corporation’. Doubt is accentuated by the statutes of American companies, called non-shareholder constituency statutes, which refer to ‘best interests’ in the assessment of corporation director duties. Indeed, nearly half of U.S. states have adopted ‘constituency statutes’ which allow the board of directors to take into account the interests of non-shareholders when making decisions (Mitchell, 1992; Orts, 1992).⁷

Responsible investors have been the precursor in using ESG information in investment decisions. The growing attention to ESG issues across the more traditional investment community is considered as the mainstreaming of RI. However, it is important to note that the integration of ESG information by mainstream investment companies is a fundamentally different approach than RI. While RI derives from moral and ethical concerns, the new trend of integration of ESG information by mainstream investors is business driven.

Grahl (2006) has commented that current manifestations of institutional shareholder activism are limited by the rise of the shareholder value doctrine in EU member states and the absence of strong legal frameworks restraining corporate practice. Survey studies have pointed to a generally muted response to legislative encouragement that financial institutions engage in reformist activist practices. Several studies have attempted to measure the effect of legislation calling on financial institutions to disclose the extent of their involvement with companies in which they have invested. All such studies have concluded that strong shareholder activism policy would require adjustments to the manner of remuneration of investment managers and intermediaries. For example, a study of pension fund reporting immediately following the introduction of British legislation in 2000 found that most surveyed organisations had disclosed the use of ‘social considerations’ in investment processes (Mathieu, 2000), with little more added by way of elaboration. (The latter observation is also couched a high non-response rate (67 per cent).) More recent studies demonstrate the struggle of pension funds in this regard. Pension funds have tended to follow conservative ‘hands-off’ ownership strategies, whereas activist approaches typically require a very different ‘hands-on’ approach (Johnson & De Graaf, 2009; Eurosif, 2010).

In France, a religious congregation created the first ethical fund in 1983. By the end of the 1980s, only two ethical funds were operating. During the second half of the 1990s, the number of SRI funds rose rapidly – only 7 were available in 1997, by December 2001 this number had jumped to 42 and then to 137 by the end of 2007. In 2010, almost 300 SR funds were available. During the period from end of 2001 to end of 2010, the percentage of total French mutual fund capitalization represented by SRI funds climbed from 0.12% to nearly 1% (www.novethic.fr). Despite the fact that this total amount remains modest, still all retail networks are now offering such funds.

Financial scholars have paid great attention to the performance of SRI funds relative to conventional investments (Bauer, Derwall, & Otten, 2007; Cortez, Silva, & Areal, 2009a, 2009b; Derwall, 2007; Goldreyer & Diltz, 1999; Gregory & Whittaker, 2007; Hamilton, Jo, & Statman, 1993; Hoepner & Zeume, 2009; Luther & Matatko, 1994; Luther, Matatko, & Corner, 1992; Mallin, Saadouni, & Briston, 1995; Renneboog, Ter Horst, & Zhang, 2008b; Schroeder, 2007; Statman & Fisher, 2002). In parallel, empirical and experimental studies have been conducted that investigate the importance of financial performance to SRI investors, as compared to conventional investors.

The world of ‘responsible’ ethical and social investment is more substantial than it might seem. At the end of 2007, holdings in ‘responsible’ funds amounted to 20 billion, against the 5 billion three years earlier. Although these ‘responsible’ holdings tend to be ‘best-in-class’ funds (Fig. 9.1), the significant rise in ‘sustainable funding’ in this area is clear.

The sector of interdependent venture capital in France will be detailed henceforth. We will try to understand why its investments deserve to be called ‘interdependent’.

Although people have been working together for their mutual benefit throughout human history, the cooperative form of business organisation began during the Industrial Revolution.

Our objective is to test the consistency between share capital financialization, implementation of responsible restructuring and sustainable development policy, focusing more particularly on the implementation of corporate social commitments. In order to develop a model that puts these three processes (restructuring, financialization and social policy) in perspective, we proceed in two steps: we examine the consequences of financialization on both the restructurings and on HRM practices and then the consequences of restructurings due to financialization on employment, the evolution of labour management and the functioning of HRM as seen in management literature. The methodology used to test this model on the Accor Group case is presented.

The events which unfolded during the period of the financial crisis can be seen as a counterexample to the world depicted by adherents of the rational expectations paradigm, presenting as much a challenge for modern macroeconomics as it has for the more traditional economic models. For instance, the Royal Bank of Scotland (RBS) had been widely acclaimed by the UK government and the public for their corporate strategy, yet in February 2009 RBS reported a pre-tax loss of £24 billion, the largest in UK corporate history. For another example, executives operating in the banking system often imitate the investment strategies of good performers, which can lead to under-performing investors lending to high-risk borrowers, resulting in ‘herding behaviour’ and frequent runs on the bank (Shiller, 1995), a situation exacerbated by the activities of fund managers and the forecasts of financial analysts which serves only to accelerate speculative bubbles (Froot, Scharfstein, & Stein, 1992). A financial crisis is inevitable. A further example is provided by Lehman Bros who filed for bankruptcy in October 2008 after the value of money market funds fell considerably over a very short period, revealing knowledge about the riskiness of trades in which market operators were trading high-risk securities believing they were low risk. It should also not be possible in a rational expectations world for banks to market subprime mortgage-related securities knowing they have a high likelihood of default to buyers that have not factored this risk into their expectations.

Unfortunately, the answers given are thoroughly embedded in the physics-inspired view of the financial economy as a stable and an equilibrium seeking system. In such a view, if some changes do occur in the financial markets, those changes present no discontinuities and the model has ample time to react by slowly adjusting risk forecasts as the volatility rises. As almost everybody in the world by now knows, currently accepted risk models have time and again shown their inability to deal with financial market reality. Frequent talk of ‘hundred year floods’ and ‘rise in correlations’ not only suggests frequent failures of a theory, but also the inability of the theory to learn from past mistakes by incorporating new data. The crash of 2008, completely unforeseen by all traditional risk systems, should serve as the final wake-up call to re-examine the foundations of the old paradigm and consider how sound they really are.

The income is attributed to PSIA^U holders after setting aside the reserves (PER and IRR) and deducting the bank's share of income called mudarib share.

With the help of financial engineering – and equipped with the modern technique of risk management – securitisation was supposed to identify and evaluate risks and parcel them out to informed parties who could bear them. In hindsight, we can see that this somewhat simplistic thesis – espoused by market participants as well as the academic promoters of modern techniques of risk management – seemed to promise a great deal more than it could ultimately deliver. At this juncture, however, the danger of regulatory over-reaction – which might be throwing the baby (financial innovation) out with the bath-water (overlooking/under-pricing of risk) – is very real and (in my view) calls for policy measures of this sort should be resisted firmly not only by market participants but also by regulators. This is not to say that regulation should be seen as immune from responsibility in the unfolding of the current credit crisis (quite the opposite would more likely be closer to the truth). As we shall see below (Section “Financial Crisis and Credit Ratings Debacle in SF”), the best risk-management practices – and related tools available before the crisis – provided enough ammunition to caution against the uncertainty surrounding risk assessment for some categories of SF products. However, the increasing complexity embedded in an increasing number of deals did provide genuine new challenges even to best risk-management practices.