would think that corporate social responsibility and social investing
advocates would have learned something after failing abysmally to
anticipate the accounting and corporate governance mess that has ravaged
European and American markets. Unfortunately, most were too busy playing
the casino stock market, investing in high-flying technology stocks
and singing the virtues of environmentally-friendly Internet and communications
companies which inopportunely crashed, wiping out the nest eggs of
so many families.
Well, you ain’t seen nothing yet. History is about to repeat itself.
Pension fund liabilities at private companies are soaring into the
stratosphere, savaging balance sheets, pushing many firms into or
near bankruptcy, forcing R&D cutbacks and layoffs and generally making
life miserable for stakeholders. Yet many of these firms are considered
models of social responsibility. Moreover, social research advocates
not only seem oblivious, many are contemptuously wary of turning their
focus away from hot-button social issues that have dominated the movement
to track such arcane concerns as pensions.
With their historical anti-corporate bias, the CSR and social investing
communities for a long time have paid short shrift to corporate governance
and financial issues. “Focusing on non-issues such as independent
boards, transparency and the like makes it easy to avoid taking stands
on real issues of corporate accountability,” writes Peter Kinder,
principal of Kinder, Lydenberg, Domini. Even after years of corporate
scandals, US social research giants KLD and Calvert have no formal
screens for the vast array of corporate practices – in particular
whether their favourite companies will be in a financial position
to pay benefits to its retired workers.
How serious is the problem? At least 23 million Americans work for
companies that offer traditional pension plans that provide a defined
benefit – a fixed monthly income based on length of service. According
to a recent study by Credit Suisse First Boston, 325 of the Standard
& Poor 500 companies now have underfunded plans – that is, the value
of assets has sunk below the cost of estimated pension obligations.
This is not just an American problem. Global consulting firm Watson
Wyatt puts the UK pension shortfall at £70 billion. In reaction to
the crisis, one in three company schemes have been scrapped in recent
years, including at BP, Sainsbury, Whitbread, ICI and Lloyds TSB.
“To many members – those in their forties and fifties – this will
feel like theft,” commented Nicholas Timmins of the Financial Times.
“A contract in which the job would deliver a predictable pension has
What’s behind the crisis? Pension funds have been hit by a double-whammy
of plummeting stock prices and low interest rates. Back in the heady
days of the market bubble, companies regularly used pension surpluses
to inflate the bottom line. But now, as the value of these funds sinks
with the market, pension income is being replaced by pension expense.
The current shortfall is US$240 billion and soaring. Yet many companies
still are not facing up to the dimensions of the problems. IBM, which
once used the pension fund kicker to boost earnings by 10% but was
forced to contribute US$4 billion to its plan in December, still fantasises
that its pension fund will return more than 8% this year. If the market
coasts or sinks, ballooning payments and more layoffs will follow.
Some companies, such as IBM, are embroiled in age-discrimination suits
by workers for trying to change how their plans are funded. Oddly,
though Domini Funds sponsored a shareholder resolution targeting AT&T
for trying to change its plan, it ignores similar concerns among its
long-term favourite stocks. Consider Cummins Engine. KLD and Domini
Social Investments extols its community involvement and profit sharing
plans. What its spotty research hasn’t turned up is that its subsidiary
Onan Corporation is being sued over its pension fund under the Employee
Retirement and Income Security Act. Cummins is also in pension funding
hot water. Its tight free cash flow may barely cover an expected US$105
million shortfall. In the meantime Cummins is still gambling with
pensioners’ money by projecting longshot investment returns of 8.5%.
Cummins is not alone among troubled companies that are rolling the
dice for their pensioners yet being given free passes by social researchers.
Dozens of “socially responsible” companies show up on approved lists.
For example, Delphi automotive, a KLD and Domini favourite, recently
announced a US$3.5 billion pension gap. Favourites American Airlines
and Lucent are on life support.
“We're starting to see billions of dollars of shareholder equity vapourised
because of pension underfunding," says Marc Siegel, an analyst at
the Center for Financial Research & Analysis in Rockville, Maryland.
“It’s much more pervasive than anything Enron was doing.”
Perhaps the most egregious example is Verizon, the Domini Social Fund’s
seventh largest holding at 2.4%. According to its annual report released
last March, the US’s largest local phone company had a strong fiscal
year with profits of US$389 million. Only those investors who dug
into the small print at the back of the document learned that Verizon’s
reported earnings included US$2.7 billion in gains from its pension
fund investments. One problem: those profits didn’t really exist.
The company pension fund actually lost US$3.1 billion, a footnote
on page 58 of the 68-page report revealed, and US$15 billion since
2000. These are not just abstract accounting issues, mind you. Verizon’s
pension fund fiasco has killed more than 30,000 jobs including 25%
of the union workforce. If Verizon or any company fails to meets its
pension obligations, the US taxpayer will likely shoulder at least
part of the bill through emergency funding of the federal agency that
insures pensions, the Pension Benefit Guaranty Corporation (which
faces its own US$2 billion deficit for bailing out insolvent firms).
Apparently neither Domini nor KLD, nor frankly most social investor
advocates, find such shenanigans serious enough to warrant removal
from their “socially responsible” high flyers list. Most just don’t
consider corporate practices an important enough “social issue”.
This abdication of responsibility recalls a Sixties song by folk singer
Tom Lehrer about rocket scientist Wernher von Braun. Von Braun headed
the V2 ballistic missile programme for the Nazis until late in World
War II, then engineered its transfer to the US, where he developed
missiles for the Americans without missing a beat. As Lehrer joked,
von Braun didn’t seem to care whether his pet project landed on London
or Berlin – he was just doing his job. “‘Once the rockets are up,
who cares where they come down. That’s not my department,’ says Wernher
Unfortunately this is no laughing matter for the workers and shareholders
at companies with underfunded pension funds. It would certainly mark
progress if the social investing watchdogs busily obsessing about
banning genetically modified organisms would instead focus on corporate
governance and financial issues including pension fund liabilities
– an issue that could do more damage to stakeholders than all of the
combined trendy concerns currently occupying their attention.