By: Yatharth Manuja
Ethical leadership is a term used to describe a style of management that emphasizes integrity, accountability, and social responsibility. In this article, we will provide some examples of recent legal, short seller and activist investor actions that underscore the value of ethical leadership and explore the benefits of ethical investing.
Companies that engage in fraudulent or unethical behavior, exploitative practices or violate human rights could result in legal problems, reputational damage, or financial losses. This happens via legal or regulatory action, or via activist investors.
Stakeholders are now demanding more from the companies they engage with and are now bringing their claims to more sympathetic courts. For example, in Vedanta Resources Plc and anor v Lungowe & Ors legal action was brought against Vedanta (the UK-domiciled parent company) for environmental damage to farmland in Zambia allegedly caused by Vedanta’s Zambian subsidiary, KCM.
And while there is a rise in legal action where it is still hard to regulate unethical behavior directly, regulators are often finding it easier to punish companies under the universal regulatory regime of securities fraud. As Matt Levine of Bloomberg fame says, “Everything is securities fraud”. Security fraud occurs when companies make false or misleading statements about their financial performance or other material information, which can deceive investors and artificially inflate their stock prices. These days many more firms are finding themselves facing securities fraud legal action for unethical or other bad behavior.
Legal and regulatory actions aren’t the only means of keeping companies accountable for their actions. Investor actions also help keep them in check. Short sellers are investors who bet against a company’s stock price, usually by borrowing shares and selling them in the hope of buying them back at a lower price later. Short sellers often target companies that they believe are overvalued or engaged in fraudulent or unethical behavior. One recent example of a short seller targeting an allegedly unethical company is Hindenburg Research’s report on the Indian conglomerate Adani Group. In January 2023, Hindenburg accused the infrastructure group of fraud and stock price manipulation. As a result of the report, within a month the group lost $135 billion in market value , scrapped a $850 million coal plant purchase, reined in expenses, repaid some debt and promised to repay more.
Furthermore companies with management that prioritize corporate governance, competitive behavior, and risk management, and provide equal treatment of stakeholders tend to have more stable earnings, stronger financial positions, and a more positive reputation among consumers and investors. This leads to a stronger position in the marketplace as well as easy access to financing creating a positive flywheel for the business to grow and expand.
As such, investors should consider ethical factors when evaluating potential investments and seek out companies that prioritize integrity, accountability, and social responsibility. It is not only the right thing to do from a moral perspective, but it can also be a wise decision from a returns perspective.
At Interactive Advisors, we believe that Ethical Leadership as a factor that drives returns, is here to stay. And though one cannot predict when unethical behavior occurs, we think yellow flags are indicative of future red flags. Using data based on news, research and other items provided by our two data providers, we have constructed the Ethical Leadership Portfolio to allow investors to invest in large cap companies in the US that follow best-practice corporate governance, competitive behavior, and risk management principles, and provide equal treatment of stakeholders. As of 03 Mar 2023, the portfolio has proven that these companies can provide superior returns. Since its inception on July 17, 2020, the portfolio has outperformed the S&P 500, cumulatively returning 71.6% vs 30.8% for the S&P 500.
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DISCLOSURE
Investing involves risk, including the possible loss of principal. Diversification does not ensure a profit nor guarantee against a loss.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information is not intended to be individual or personalized investment or tax advice and should not be used for trading purposes. Please consult a financial advisor or tax professional for more information regarding your investment and/or tax situation.
