I'm interested in a different set of questions focused on environmental issues and socially responsible investing. Permit me to list them:
1. Why should we trust the environmental certifiers such as KLD to do a good job in figuring out who are the top 100 firms in terms of "greenness"? If SRI is about more than simply "warm glow" for the investors, if the true goal of SRI is to "change the world", then investors need credible signals indicating which firms are green and which are brown. Is there enough competition in the system of certification to guarantee that "brown" firms can't hide as "green firms"? Does KLD invest enough in updating its records? If a past green company goes "brown", how many years pass before KLD downgrades them and throws them out of the SRI set of green companies? Below I report KLD's methodology for ranking firms.
2. Is it profitable for firms to take costly actions such that they make KLD's top Green 100 list and attract more SRI investment? To answer this question, ideally we would conduct a discontinuity analysis where we would compare the performance of KLD certified "Green Companies" to a control group that would represent similar companies who just missed being assigned the "Gold Star" of being a Green company by the KLD certifier. More formally, I want to know: "is there a treatment effect on a firm's stock performance if it is placed on the SRI buy list?"
3. Selection --- It could be the case that SRI highly ranked companies perform better than other companies for reasons unrelated to being assigned a high rank by KLD on their green index. These companies may have special CEOs or other factors.
My BIG POINT in this blog entry is to make an analogy. After Enron and Arthur Anderson, we learned that accounting firms "cook the books". It is difficult to know a firm's profit levels from seeing its accounting statements. Is a similar point true about environmental accounting? I view KLD and other environmental certifiers as a type of accounting firm. What data do they collect on each company? Do they have the right incentives to create up to date honest rankings of which companies are Greenest versus Brownest? If such firms are "dirty", then the SRI movement will have little impact on bringing about environmental sustainability. To vote their pocket book, investors need correct information. Does the current market structure supply this?
Here is what KLD has to say about itself.
http://www.kld.com/indexes/gc100/faq.html
Methodology
Index Construction
The Global Climate 100 Index includes a mix of 100 global companies that will provide near-term solutions to global warming while offsetting the longer-term impacts of climate change through renewable energy, alternative fuels, clean technology and efficiency.
Constituents are selected from the global universe of companies for their involvement in the following themes: Renewable Energies, Future Fuels, and Clean Technology and Efficiency. In addition to activities in these areas, KLD evaluates each company’s eligibility for the Index based upon its specific climate-related efforts, market influence, geographic distribution, and offsetting negative climate impacts. The leading companies in each category are included on the Index.
The Index seeks companies representing a range of corporate responses to climate change, including a group of large-, mid-, and small-cap companies representing sectors ranging from energy and utilities to industrials and consumer products. As a result, the Index is more broadly diversified than a traditional energy sector index.
The KLD Global Climate 100 Index allocates a 1% weight to each of the 100 constituents to provide higher exposure to small-cap companies and lower exposure to large-cap companies than a cap-weighted index. The weights will vary between quarterly rebalancing, depending on market conditions.
Index Maintenance
KLD continuously monitors constituents on the Index to ensure they meet standards for involvement themes, liquidity and financial viability. KLD may remove companies due to corporate actions resulting in mergers, acquisitions and bankruptcies. KLD may also remove companies at rebalancing if their climate rating falls below an acceptable level. KLD rebalances the Index each quarter to bring each holding back to 1%.