Ethical finance case, master level

FIN 501 New Century Financial – Team B Martin Essenburg

Generation Investment Management

Prepared for:

Professor Martin Essenburg

Prepared By: Team B

Mike Achmar

Xin Gao

Aditya Kalra

Hongzhi Zhang

FIN 501 Generation Investment Management – EAF – Team B Martin Essenburg

Ethical Analytical Framework

Recognize an Ethical Issue Generation Investment Management is an investment management firm focused on making integrated sustainability research a part of investment decision process. It believed that environment, social, governance and ethical factors are responsible for outperformance of a company against its peers. By harnessing this view and amalgamating with fundamental equity analysis framework, they made investment decisions in the companies with sustainable approach. In this case, the company had to decide whether ABB India which is a market leader in power and automation in India, a potential investment and can it be included in the focus list . Although, ABB India had a strong financial position, disciplined management team, well positioned to capitalize on future growth trends, presence in second most populous country in the world with huge demands of energy i.e. electricity, yet it still did not align perfectly with the sustainability objectives of Generation. Although, the investment could improve the quality of life for impoverished rural population, it would also expose the population and environment to higher levels of greenhouse gases potentially leading to global warming. As more CO2 would be generated from primarily coal fired plants in India, it will cause higher levels of pollution seriously damaging the environment. Thus, the ethical issue is a dilemma between environment damage due to potential climate change or economic development by providing a poverty relief solution. This issue is more than what is legal or what is most efficient, because the decision of Generation and ABB India will affect all the people living in the country.

Get the Facts

The company’s organization and philosophy

The company’s mission incorporated people and culture being critical to the long term success. Integrity

and honesty were the bedrock of the business. The company demanded highest standards of ethics in

work and personal lives. Their investment philosophy integrated issues such as climate change into

investment analysis. By recognizing the global challenges ahead, rather than acquiring existing firms such

as Sustainable Asset Management, they build a team incorporating their culture and ethics.

The team’s structure was designed unconventionally unlike a traditional asset management firm. The professionals worked together jointly as a part of research and analysis. The methodology adopted certainly took time to align itself with the objectives of the firm. This is because of diverse industry experience of the members. The firm also advocated the concept of sustainable investing by allocating 5% of their profits. Internally, the firm ensured that investments by everyone were at same basis as their clients i.e. paying same fees, adhering to same polices, one year lock in period etc.

FIN 501 Generation Investment Management – EAF – Team B Martin Essenburg

Generation Investment Process The investment process for the firm involved three critical steps:

I. Idea Generation The process involved an advisory board which advised the investment team on changes in global

business and establishing research around key driver of economic conditions across the globe. The board was entrusted with identifying sustainability themes such as poverty, climate change, pandemics, water etc. The inputs led to generation of Thematic Whitepapers detailing sustainability in terms of business risk and opportunities vs emerging issues. This was followed by generation of Industry Roadmaps focused on long term trends, relevant sustainability issues and traditional investment analyses. Its materiality based approach sometimes ended in blind alley. But it generated new industry insights and identified company investment ideas.

II. Focus List Decision

This step involved financial and quantitative analysis to ensure that companies are in line with the industry’s future challenges and the objectives of the firm. The analysis was debated upon and given ratings through Business Quality (BQ) and Management Quality (MQ) based on internal criteria:

Higher BQ: because of dominant market position, strong industry barriers, secular growth trends, pricing power, well positioned to meet future challenges and part of sustainability solution.

Higher MQ: because of integrity in management culture, respect for stakeholders and well managed long term.

The companies were rated from 1-5 where 1 being highest and 5 being lowest. A company with BQ3 and MQ3 would also not be admitted into the focus list.

III. Portfolio Management

The stock purchase and size of investment depended on level of analyst, team conviction and delivery of superior long term returns. The exposure risk was tracked through proprietary and third party tools. The firm was audacious to communicate what they felt about the companies on their focus list if they deviated from the objectives of the firm. In addition, they had a robust sell discipline and review mechanism.

ABB India Investment Decision Given a rudimentary electrical system, greater market size and ABB India being a market leader in domestic power and automation, the firm thought it could be included into the focus list. Even with a MQ2 and BQ2 rating, environmental concerns were raised as India has large reserves of coal and the country is primarily a coal generated electricity nation. By providing capital to ABB India which invests in coal fired plants, it could lead to higher CO2 emissions and thus, higher global warming. Coal released about 75% of C02 per unit energy. With a huge demand by India ( two thirds of electricity produced by coal), it would lead to higher levels of global warming in the country. Although, some at the firm believed that their actions could help industrialization through electrification and help reduce poverty in the country.

FIN 501 Generation Investment Management – EAF – Team B Martin Essenburg

Evaluate Alternative Actions Below are the two options that Generation has:

1. Invest in ABB India 2. Do not invest in ABB India

Utilitarian Approach: (Option #1) – Which option will produce the most good and do the least harm? In the above case, the option that does produce the most good and does the least harm would be to invest in ABB India. By investing in ABB India, it would provide greater returns to the stakeholders that are involved in the process. Also it would give a chance to be part of the growth process of an underdeveloped country. Rights Approach: (Option #1) –Which option best respects the rights of all who have a stake? In the above case, the option that does the best for all stakeholders i.e. Generation, India, ABB India, Mankind and customers would be to invest in ABB. Although it would mean higher levels of CO2 emissions, yet it would provide capital to improve the poverty of the people along with the higher returns from the investment Fairness or Justice Approach (Option #1) – Which option treats people equally or proportionately? The best and most effective way to treat everyone equally is to ensure that there is more transparency within and outside of the company and the investments they make. They can ensure that the capital that they provide would help in the growth process of the country. Common Good Approach (Option #2) –Which option best serves the community as whole and not just some members? The best option that best serves the community as a whole and not just some members would be to do not invest in ABB India. This could protect the environment from global warming and greenhouse gases emissions. But, it would eliminate the possibility of contributing towards the growth of the country. Virtue Approach (Option #1) – Which options leads me to act as the sort of person I want to be? The virtue approach would require that Generation should invest in ABB India. This would give a chance for the firm to serve the community needs of the second most populous country in the world. Electricity has been one of the major demands of this developing economy. With large amounts of power shortages, the country needs a tremendous supply of electricity which could be catered by investments in ABB India. .

FIN 501 Generation Investment Management – EAF – Team B Martin Essenburg

Make a Decision and Test It Most of the decisions lead to the selection of option of investing in ABB India. This could be achieved by Lowish by presenting an argument of being a part of development of a country. They would have to put ABB India on focus list and keep track of its progress and its initiatives for a sustainability solution. Any deviations from its long term objectives should be communicated to the management team. Also, they should ensure that the future efforts of ABB India to produce cleaner coal plants are met within the stipulated timelines. Technologies such as carbon capture and sequestration (CCS) i.e. process of trapping CO2 and pumping it into underground reservoirs would create a real impact. Efforts and investments should be made to support such initiative and determine their feasibility on large scale deployments. He should also incorporate the benefits of industrialization to the investment team.

Act

We believe as a firm that the greatest care and attention regarding the concerns of all stakeholders is to invest in ABB India. We understand that our investment in ABB India is going to contribute to the increased levels of CO2 emissions. We believe that bringing electricity to the underdeveloped country is strongly needed but will come at a cost at first due to coal being the major source of energy. We do not believe it is appropriate to eliminate India from the opportunity to advance and catchup with world powers because in doing so it would create an increase level of CO2. As of year 2000 India produced 1.1 metric tons of CO2 emissions per capita as compared to 21.1 and 8.0 in the U.S. and Euro Area respectively. We strongly feel that with the increased CO2 emissions levels from India being capped at a reasonable level in the high single digits to low teens can be offset by the U.S. and Europe reducing their levels to be aligned with India. With the increased level being offset by others who are over contributing to the CO2 problems India will be able to bring electricity to a population that is greater than 1.1 Billion with half of them not receiving a reliable power source. By providing electricity to such a large world population the benefits will be an increase in school attendance which will lead to more educated individuals who can help develop their country and provide for their families. These individuals will help increase the country GDP which will help the world economy. Electricity will also provide a higher standard of living and increase the life expectancy from a low 64 to hopefully more in line with the developed world around 80 years of age. The investment will not only help India and world in the long run but also in the near future for ABB India and Generation stakeholders. An investment in ABB India will potentially see a significant increase in share price in the near future as they begin to reap the benefits of being one of the major contributors to the development of India’s power infrastructure. This will lead to large margins for investors.

What we have learned from this is the need to take a step back from immediately placing a judgment on a situation based on our values without first evaluating those same values across other areas we are currently investing in. Knowing that our main ethical dilemma with investing in ABB India is the CO2 emission levels rising and contributing to our overall environmental health decay, we first need to look at the same issues with our current investments. Knowing that the U.S. is producing CO2 emissions at levels 20x what is currently produced by India we saw that the issue is not so much that India would be increasing its levels but rather a need for world leaders such as the U.S. to reduce their share to the overall contribution. If we took the stance to not invest in ABB we would not be serving the greater good for the world in controlling emission levels but rather contributing to the slow development of India’s economy. This investment would show support for the need to get access of electricity to India’s population who currently do not have it.

FIN 501 Generation Investment Management – EAF – Team B Martin Essenburg

Comparison with Business Evaluation

Decision: Invest in ABB India

Whether the company goes on to invest in the company or not, the government will still go on with its plan to fund electricity production either through green energy or other reforms in energy sector. ABB is not a contributor to pollution but a mitigating agent by making efficient systems.

The decision on whether to invest in ABB India or not does not raise any questions about the conflict with any law. ABB India is not engaging in any illegal business nor do their activities directly contribute to pollution. The only conflict is with the company’s philosophy. The impact of investing in ABB India according to the analysis carried out is that there will be increase in returns for Generation. As for the reputation, I foresee some mixed reactions with no clear consensus. This is because of the perception that ABB India activities are not consistent with the sustainability milestone. However, whether ABB India is there or not there , electricity production through coal is bound to happen.. In any way making equipment that improves the efficiency of electric systems is way of reducing energy leakages and wastages and therefore part of the solution. Therefore in terms of reputation the decision to invest in ABB will boost the company’s reputation more than it will harm it. This investment will further position the company strategically for other investments in India and this will lead to more presence and diversification globally.

In terms of the management reaction, the number one goal of every investor who happens to be the customer in this case is return. If given choice between values and returns any investors will choose returns. This decision to invest in ABB might be treated with doubt from the management due to the company’s reputation being at stake but the fact that it makes financial sense will be enough to convince the management.

Alternative Decision: Ethical point of view

From an ethical point of view, global warming is a real threat to humanity. Investments which promote the production of these pollutants are against the very core values of ethics. However more and more research can be done on how to reduce global warming. By the use of the voting power presented to me by the investment in ABB India, I will ensure I vote against any decision that seeks to promote global warming.