Saturday, March 11, 2006

On Socially Responsible Investing

If a company were performing badly, but had noble cause, would you invest in it?

In a casual survey, many students surveyed at liberal arts colleges answered “Yes” enthusiastically. They explained that they wanted to help the troubled company because the world needed more of its socially responsible product or service.

Most people, understandably, find this response to be quite naive. The reasoning follows: If I buy shares of a company, the seller’s proceeds are exactly what I pay for the stock. The company doesn’t reap any of the benefit when paper representing ownership changes hands. The idea that buying a company’s stock helps them do business is simply wrong. For instance, if I were to purchase Northrop Grumman shares, the company wouldn’t benefit. Their capacity in building electronic warfare systems would be unaffected. Following this argument, the ethics of investing are of no consequence.

This logic, however, has a severe flaw. The truth is, when you buy shares of a company you are helping them do business. Your purchase of Northrop is directly helping them build weapons. The reason lies in Exit Strategy. Then Northrop offers shares to the public to finance their operations people only buy it because they believe that they will be able to sell it to someone else at some point in the futures for a capital gain. The IPO unequivocally helps a company produce its good or service. What people fail to realize is that if there were no buyers out there to purchase the stock at a time after the IPO, the company wouldn’t be able to raise any capital to fund business. The idea goes back to the concept of capital markets. If there is no market, there will likely be nobody backing a business for lack of an Exit Strategy.


CowTownGurl said...

What would be a "noble cause" for a company performing badly? You suggested that this company also has a socially responsible product. Why would you assume that this product is so important and why should we support them by buying shares when no one else would?

Will C. Hambly said...

Dear Cowtowngurl,
I refrain from making value judgments, as I hope you can infer from the tone of my post. I would never buy a company that wasn't going to make me enough money to stuff my pillows with.

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