While ethical indices can sometimes cause confusion, they provide a useful benchmark for companies and stakeholders

There are over 250 global and local ethical indices schemes, with FTSE4Good and the Dow Jones Sustainability Index (DJSI) two most well known ethical investment indices for UK companies. They provide an index for investors as to what can be considered an “ethical investment”. But how is “ethics” measured?

In recent updates to the indices, Johnson & Johnson and Vodafone were among the 41 deleted from the DJSI; there were no deletions from FTSE4Good. These companies lost their places in the DJSI because they are no longer judged to be among the “best in class” in their sectors.

Deletion from the index can be a reflection of relative improvement by other companies rather than any necessary deterioration in performance by the company that has been dropped. But Vodafone, the world’s largest mobile phone company, has been in the reputational spotlight over the past year as it has tried to fend off accusations that it has avoided paying taxes in the UK.

Compilers of ethical indices do not comment as to why some companies are included and others are not, and this often leads to criticism. The recent addition of Bank of America to the DJSI has generated a fair amount of controversy among nongovernmental organisations such as Greenpeace and the Rainforest Alliance, because of the bank’s ongoing financial support of the coal industry.

Another example of the opacity of indices compilers is that in September 2010 both AOL and Chubb Corp were deleted from the DJSI and simultaneously added to the FTSE4Good index. The confusion related to this lack of correlation between the indices gives the impression that there is no clear consensus on what best practice may be.

Poor prediction

The indices also fail as proxies for future sustainability performance. In 2010, BP was included in both the DJSI and the FTSE4Good indices; however, they were promptly ejected from both in the wake of the Gulf of Mexico oil spill.

Although these indices are often intended to assist organisations in tracking their corporate responsibility progress over time, the questions posed can change annually making year on year comparisons challenging. In reality, because feedback on entry submissions is limited, companies are left guessing as to how they could improve without any real guidance.

It has been suggested that indices reward the companies with the greatest capacity to respond to the questionnaires rather than those with the best socially responsible practices and that they are more of a reflection of successful marketing than proven sustainability performance.

Frustrations such as these are reflected in the low levels of business trust in ethical indices as reported in SustainAbility’s Rate the Raters survey which revealed that only 48% of the sustainability professionals surveyed considered the DJSI to have a high credibility, and 34% for FTSE4Good.

Different criteria

Some of the confusion may arise because both use different criteria to measure the corporate performance of companies around economic, environmental and social criteria. FTSE4Good applies a negative screen to organisations listed on the FTSE All-Share Index, meaning that companies from the tobacco, nuclear power and arms industries are excluded.

Remaining organisations have their performance assessed against environmental, social and governance criteria including human rights, labour standards and countering bribery.

As opposed to the negative screen approach adopted by FTSE in the calculation of their indices, Dow Jones adopts a best in class approach, which enables the selection of sustainability leaders from across all sectors, with no discrimination against organisations from certain industries.

In addition to general performance measures, a company’s response to ethical issues which may arise during the course of their operations, such as corruption, fraud, human rights abuses, etc, is also considered. The result of this media and stakeholder analysis has the power to affect a company’s total sustainability score significantly and their subsequent inclusion in the DJSI.

Does inclusion or deletion have an impact on companies? Some academic research suggests not. However, inclusion can provide a benchmark and assurance about how well ethical values and sustainability are embedded in corporate practice.

IBE research has suggested that companies use the findings as a valuable gap analysis tool. For example, following deletion from the DJSI in 2012, GSK chose to review their sustainability performance against the DJSI inclusion criteria to ensure they regained their position for 2013.

Compensation link

Some companies link executive compensation to inclusion in one or more of these indices. Akzo Nobel link 50% of their long term bonus scheme for 600 of their top managers to the company’s position in the DJSI for chemicals companies. Eni include “maintenance of Eni’s presence in the FTSE4Good index and the Dow Jones Sustainability Index” as one of the objectives related to annual variable incentives of the CEO and general manager.

Inclusion may also be regarded as external recognition of good performance; a positive PR opportunity or reputation risk management tool and so is quoted in corporate responsibility reports and promoted on the company website; for example Diageo, Sainsbury’s and Anglo-American.

But rather than knocking them as a PR tool for companies, or for the indices companies themselves, perhaps we should be grateful that ethical indices exist, imperfect though they may be. They seek to highlight those companies that are doing well and improving their performance in social, ethical and environmental terms.

Like a sticker chart for good behaviour in a classroom, it always helps to benchmark, to see what you can strive towards. The IBE advocates doing the right thing for the right reasons, but any tools which encourage ethical behaviour are to be applauded. Companies want to aim high in everything they do, and high ethical standards are a part of that.

IBE’s briefing on ethical indices is available here

DJSI  Ethical indices  FTSE4Good  SRI  Sustainable finance 

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