October 28, 2005
SRI Research from UBS Strikes Balance Between Ethics and Economics
by William Baue
The new socially responsible investing team at UBS quantifies the costs of corporate social and
environmental impacts as a means of effecting ethical and economic rectification.
Socially responsible investing (SRI) is far from monolithic, encompassing a wide diversity of
approaches spanning the political spectrum and the palette of investment strategies. Inevitably,
mainstream financial institutions taking up SRI strategies similarly diverge significantly in their
approaches. These differences can be telling. Take, for example, the report released earlier this
year by UBS Investment Bank, the first such
work by the firm's SRI research team that formed in December 2004 with the assignment of analysts
Julie Hudson and Shirley Knott.
The report, entitled Why Try to Quantify the
Unquantifiable?, takes a hard-nosed approach to quantifying corporate social responsibility
(CSR) issues. The UBS team acknowledes the inherently ethical implications of corporate actions
while simultaneously noting that social and environmental impacts invariably create financial
consequences on what UBS calls enterprise value. Mss. Hudson and Knott utilize a "stakeholder
balance sheet" to quantify costs when potential corporate social liabilities crystallize
into actual liabilities. The authors define corporate social liabilities as the "potential
obligation to make good any adverse environmental, social, or economic effects of corporate
Specifically, they look at the cost of internalizing that which companies
formerly externalized. For example, companies may damage the environment without having to pay for
it upfront; some companies recognize this and choose to minimize the damage while other companies
may eventually face costly lawsuits requiring them to clean up their pollution.
"If a firm
or industry 'externalizes' costs, the affected stakeholder is very rarely given the opportunity to
agree the transfer of costs, and so the 'price' (perhaps very small in the eyes of the firm but
very large in the eyes of other stakeholders) is not negotiated at the time when costs are
externalized," write Mss. Hudson and Knott. "The danger to firms is that, if the balance of power
between stakeholders changes, the price of the exchange may be renegotiated at a future date, and
sometimes, but not always, in a court of law."
The UBS report sets out a framework for
quantifying corporate social liabilities, first identifying issues that may give rise to such
potential liabilities, such as climate change, electronic waste management, human rights risks, and
bribery and corruption, among others. The UBS framework next ranks potential corporate social
liabilities in terms of likelihood of crystallization, then assesses potential scale, and finally
estimates potential impact on enterprise value. UBS applies its framework across nine sectors:
basic materials, consumer, energy, financials, healthcare, industrials, technology,
telecommunications, and utilities.
The UBS team additionally applies to its analysis the
discipline of industrial economics, which addresses asymmetries between economic actors. For
example, global corporations have the power to demand production deadlines that have the effect of
stripping supplier factory workers of their power to maintain basic labor rights. In other words,
corporations externalize the negative impact of time constraints onto the health of their supplier
One potentially controversial aspect of the UBS approach is the quantification of
social and environmental liabilities, in that it essentially puts a price tag on human suffering
and ecological destruction.
"Putting an absolute monetary value on a clean environment, or
an organization's indirect economic impacts, the quality of life, or life itself, may be regarded
as unethical or nonsensical," write Mss. Hudson and Knott. "In our opinion, putting a price on
something 'priceless' when the aim is to facilitate a mutually beneficial, orderly, and equitable
reallocation of resources (or to prevent expropriation) need be neither unethical nor nonsensical."
If the purpose of quantifying adverse social and environmental impacts is rectification,
then the effort is ethically (and economically) justified, the UBS team argues. In other words,
pricing corporate social liabilities creates benefits not only for people and the earth but also
for companies, as markets ultimately require internalization of externalities and asymmetrical
power relationships are often equalized. Recognizing the financial implications of these realities
incentivizes the identification of mutually beneficial solutions.