Socially Responsible Investing: Heading Off Principal-Agent Problems

Socially responsible investors want to invest in companies that reflect their values. As owners, they want the managers who work for them to behave in responsible ways. But managers, being human beings, may want to do what's best for themselves, not necessarily for the people they work for. Then throw into the mix that investors themselves have different opinions about how best to increase their returns: Some investors have a short-term perspective, while others want the company to be around for the ages.

The term denoting the conflicts of interest between managers and different types of investors is principal-agent problem. The investors (or owners) are the principals, and the managers are the agents.

Principal-agent conflicts are hardly insurmountable, but they require the following:

  • That management be transparent about what it's doing so the shareholders have enough information to make decisions: As a shareholder, you don't have the right to information about the tiniest details of the business, because the business can't compete without keeping some information confidential. However, you have the absolute right to basic information about the company's finances. Find out more about that in the later section "Paying Attention to Company Reports."

    In a perfect world, the managers tell you everything you need to know. But most managers report only what they have to, usually as mandated by such government regulators as the U.S. Securities and Exchange Commission (SEC), and not always in a format that's easy for regular folks to read. Because the managers don't perfectly represent the interests of all the shareholders, you have to do your own research to see how management is doing.

  • That shareholders pay attention so they can influence what the management team is doing before problems develop: In addition to doing all the work that regular investors do (figuring out your risk parameters and your desired return, setting appropriate financial goals, finding suitable investments, and tracking your returns to see whether you need to make changes), as a social investor, you also need to track how an investment is meeting your personal goals. As an owner, you take on the task of making sure that the business you invest in meets your priorities.

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