Stock Screening

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Read Section 3.5 on Stock Screening. At the end of Chapter 3, complete the activity Apply Your Knowledge: Stock Screening. In a two-page paper (not including the title and reference pages) you must:

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  • Define stock screening in your own words. Cite your source for this.
  • Develop a list of five criteria for activist stock screening. These might include social, political, or environmental issues that are meaningful to you, such as child labor, solar energy, or compliance with certain government regulations.
  • Summarize the stock screening procedure citing your sources.

You must use at least one scholarly source in addition to the text and your paper must be formatted according to APA style.

Title must appear on the first page of text; headings must be used in all APA essays; and, the final heading of your paper must be the word: Conclusion.

SECTION 3.5

Corporate governance refers to the structure and relationships that determine corporate direction and performance; the term describes both the act ofgoverning and the way in which an organization makes and follows its own rules. If corporate leaders enact rules and regulations that encourage CSR,then the entire firm must comply with the rules, and CSR and sustainability have a higher chance of success. On the flip side, if corporate leaderscreate rules and regulations that discourage or deter CSR and sustainability, then CSR and sustainability will be more difficult to enact. The ideabehind corporate governance is that corporations must comply with certain leader-prescribed regulations and use transparent processes whileoperating. The assurance that leaders are in compliance with government and internal regulations (meaning they are enacting good corporategovernance) allows investors to make judgments about the quality of investments. This fact also allows some firms to stand out as exemplars ofsustainable and responsible governance (while others stand out for horrendous violations). Here, we argue that understanding these extremes can helpleaders and investors decide how to improve firms’ sustainability and social responsibility.

Board of Directors

The board of directors is the group of people who typically govern an organization. As a result, it has power and oversight over company behaviorsand leaders. A board is an elected group that has a legal duty to oversee the establishment of corporate objectives and to select leadership to carry outthese objectives. The board regularly reviews the company’s performance and oversees stockholder interests. Boards generally meet four to six timesa year. Corporate boards vary in size and composition, but most large companies try to keep the number of board members to around 12. Usually 10or 11 of these members, or 90%, are from outside of the company. The New York Stock Exchange, for example, requires listed companies to have atleast a majority of their board members from outside the company. Other board members from the inside may include chief executives, presidents,founders or major stockholders, and financial officers from within the company. In Europe board composition is different. Most European companieshave two different boards. The first is an executive board made up of members of the company. The second is an external board that supervises theexecutive board and represents the interests of shareholders, stockholders, and even employees.

One of the most important things a board can do is conduct an audit, or contract someone else to do so. The audit committee on a U.S. board ofdirectors must annually examine the company’s financial well-being. It is thus required that board members be financially literate and able to make thejudgments required of high-end accounting and finance.

Challenges for Corporate Boards

Boards often struggle with transparency in terms of what information to release to the media, employees, and the public. Board meetings areconfidential, which leaves a considerable amount of confusion and hidden or partially hidden information in terms of how they operate and manage.

Another important corporate governance issue relates to salary and wages, particularly salary and wage differentials between management andemployees. Publicly held corporations are generally run not by their owners, founders, or boards, but by hired professional executives. This createswhat is known as the agency problem. Executives in corporations act as agents for the founders or owners (stockholders), and while such executivesare mandated (and paid) to look after corporate interests, there is little to prevent them from looking after their own interests instead. In some ways,salaries play a role in mitigating the agency problem, since higher pay can incentivize the executives to do what is best for the owners who, inessence, pay the salary. Yet because boards meet a few times a year while executives work at firms daily, executives have more opportunities to takeactions that may not benefit corporate leadership. Large corporations typically pay board members a high salary for their work; companies may pay incash, stock, or stock option rights. Some critics believe board compensation sometimes taints the ability of a corporate board to oversee leadershipand appropriately represent stockholders (Twaronite, 2013).

Regarding salary and compensation, many people feel that board member and executive pay is excessive, particularly in the United States. Corporatesenior leadership in the United States receives almost twice the salary as an equivalent position in France, Belgium, and Sweden. In the United States,CEOs typically make 325 times more than the average worker. Since 1990 the ratio of average executive to average worker pay has increased everyyear (Statista, 2016). Executive compensation has been the subject of some government regulations. For example, a provision in the 2010 Dodd–Frank Act required major corporations to disclose executive compensation to the public; companies must reveal compensation packages for at leastthe top five executives. Firms must also report all of the financial and nonfinancial benefits received. These benefits might include access to acorporate aircraft, gifts received from clients, or tickets to sporting or cultural events. In addition, conflicts over executive compensation are commonin boards. One view holds that corporate leaders have such an important influence on the success of the company (and the talent pool for topexecutives is so small) that high compensation is warranted. Those in favor of high compensation for executives also argue that overall, the amountgiven to a corporate executive represents a small percentage of the overall corporate value. The other side points out that such high wages areextreme, unwarranted by the workload, and possibly inflammatory to employees and the public. Others in favor of more restrained executivecompensation argue that high executive compensation creates a corporate culture of greed and short-term decision making and underminestransparency. They also argue that providing a living wage to all employees is a moral obligation, though defining this can be problematic. Essentially,the issue of compensation remains an area in which firms have considerable discretion; the compensation choices firms make send signals about theircommitment to social responsibility and sustainability (Gerstein, Connelly, Lightdale, & Rowen, 2015).

Wages and executive compensation have been a social responsibility issue for decades, but Ben & Jerry’s in Vermont made the issue famous when,upon founding their company, CEOs Ben Cohen and Jerry Greenfield committed to keep the ratio between executive wages and the lowest paidemployee no higher than 5 to 1. The company adjusted the ratio in a transparent way over the years, moving it to 7 to 1 and then 17 to 1 when it couldnot attract talented management without the increase. When the company was purchased by a large corporation in 2000, the salary information was nolonger made public (Weiss, 2013). The topic of salaries represents just one of the difficult and controversial decisions that boards and executives mustaddress; CSR and sustainability represent other topics that often require board-level action. When boards and executives remain unresponsive to suchissues, shareholders sometimes attempt to encourage change through behaviors known as shareholder activism.

Shareholder Activism

Frustrations with executive compensation, environmental concerns, and other issues related to corporate strategy cause many shareholders to becomemore active in corporate governance. Shareholders need not rely on the board of directors to make changes in corporate direction, as institutional andindividual shareholders have the option to work together to protect their interests.

Shareholder activism is a strategy for shareholders to influence the decisions of the corporate board and other leaders of the firm. Shareholderactions may include lawsuits or negative media campaigns that are intended to influence corporate leaders. Shareholder campaigns often cause thestock price to decline, making owners and managers more willing to bargain with the activists or comply with the shareholders’ demand. In addition,corporate boards typically work with shareholders to avoid going to court and paying related expenses. Choosing to consistently make sociallyresponsible and sustainable decisions is one way firms can avoid shareholder activism. When leaders decide to pay fair wages, treat employees andsuppliers fairly, manage water and electricity use with a stewardship mind-set, and follow other pro-CSR and sustainability behaviors, then pro-CSRshareholders have fewer reasons to complain and less incentive or need to turn to activism.

Stock Screening

Another way stockholders try to exert influence over corporate governance is through stock screening. Socially responsible investing (SRI) describesinvestors who choose stocks based on environmental or social issues. SRI allows investors to reward firms that sell products they admire(environmentally conscious investors might be attracted to solar start-ups, for example) or punish firms that sell products of which they disapprove(so-called sin stocks traditionally include alcohol producers, gun manufacturers, and tobacco companies). A growing number of professionallymanaged funds also have social filters to help select companies that deserve investment. A socially responsible investment fund might screen outcompanies that have an excessive impact on the environment, overpay executives, or have a history of discriminating against employees. Sociallyresponsible investors can be as varied as the number of fund managers and the causes they espouse, but estimates suggest that when screening andselection strategies are considered, more than 1 of every 9 dollars under investment is invested in an SRI fund; the total size of the SRI market is inexcess of $4 trillion (Forum for Sustainable and Responsible Investment, 2016). This fact means that social responsibility concerns have becomemainstream enough to affect Wall Street; it also means that socially responsible and sustainable firms looking to attract capital can identify themselveswith the SRI movement.

Stock screening is a kind of social activism that has an indirect impact on board decisions, but it may have a direct impact on a stock’s price and value.Many companies have initiated social responsibility resolutions to guide corporate decisions in the hopes that such moves will increase the value of shares to certain investors.

Benefit Corporations (B Corporations)

In response to the call for firms to behave in more socially responsible ways, a small group of innovators created a new corporate form intended tobreak the paradigm that corporate managers have a binding duty to put shareholder interests above all other decisions. This new form is called a benefit corporation (B corporation). A B corporation is a for-profit corporate entity with one significant difference from a traditional corporation: Ithas a legally binding mandate to positively impact society and the environment, in addition to making a profit. A B corporation’s board of directorsmakes the same decisions as leaders in a traditional corporation but goes one step further by considering the impact that decisions have on society and the environment. According to the B Corporation (2016), about 1,600 B corporations exist in 43 different countries.An example of a certified B corporation is Patagonia, the outdoor clothing manufacturer. The corporate website describes in detail how it tries to be different from other companies:We learned how to make fleece jackets from recycled plastic bottles and then how to make fleece jackets from fleece jackets. We examinedour use of paper in catalogs, the sources of our electricity, the amount of oil we consumed driving to work. We continued to supportemployees with medical insurance, maternity and paternity leave, subsidized child-care and paid internships with non-profit environmentalgroups. As we have for many years, we gave one percent of sales to grassroots activists. This one percent commitment isn’t typicalphilanthropy. Rather, it’s part of the cost of doing business, part of our effort to balance (however imperfectly) the impact we have onnatural systems and to protect the world on which our business, employees, and customers rely. (Patagonia, n.d.)

Benefit corporations expand directors’ duties to include consideration of nonfinancial and social interests. It is often hard to assess the actual impact ofa B corporation on the community, environment, or other social environment. In cases where firms are not ready to become a B corporation, there isalso the option to become B certified. Such certification is a way for standard corporations to signal they are on the move toward social responsibilityand sustainability.

Apply Your Knowledge: Stock Screening

Develop a list of five criteria for activist stock screening. These might include social, political, or environmental issues that are meaningful toyou, such as child labor, solar energy, or compliance with certain government regulations.

Then, list 20 commonly traded stocks from the New York Stock Exchange: https://www.nyse.com/index. Research event information for eachstock, paying close attention to their products, or management processes, and how they do business. Rank the stocks based on theircompliance with the stock screening criteria developed.

Based on your activist portfolio, select which of the stocks you would purchase. Then determine what portion of your portfolio each selectedstock should constitute. For example, you may choose one particularly positive stock to be 50% of your portfolio while some mix of otherstocks will represent the other 50%.

Reference:

Hammond, S. C., & Christensen, L. J. (2016). Corporate and social responsibility: Road map for a sustainable future [Electronic version]. Retrieved from https://ashford.content.edu

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