Some advice to climate scientists on ethics from a finance professor
by Theo Vermaelen, courtesy of INSEAD Knowledge
Climate scientists from the Climate Research Unit (CRU) at the University of East Anglia have come under fire for alleged data manipulation following the release of thousands of emails and documents. As a result of ‘Climategate’, some of the climatologists involved have stepped aside or are under investigation by their university.
Why did the ‘Medieval Warming Period’ disappear?
Most observers agree that the most damaging email is the one sent by Phil Jones, head of the CRU, in 1999, to three of his colleagues:
“I’ve just completed Mike’s Nature trick of adding in the real temps to each series for the last 20 years (from 1981 onwards) and from 1961 for Keith’s to hide the decline.”
What ‘decline’ are the scientists apparently trying to hide? A detailed discussion can be found in an article written by Marc Sheppard. I will only provide a brief summary of the arguments for those who have not being paying attention. His article may be useful in continental Europe where the whole controversy is barely discussed in the mainstream press in spite (or perhaps because) of the Copenhagen conference.
The leading authority on climate change is the IPCC, the Intergovernmental Panel on Climate Change. It provides policy recommendations to government officials. In its first climate change assessment report in 1990, the IPCC published a graph (Figure 1) which showed average global temperature changes during the last millennium. The graph shows a large increase in temperature from 900 to 1300, called the Medieval Warming Period (MWP). This period was followed by the Little Ice Age until 1850, when the current warming period began. Obviously, if temperatures were higher in the MWP than today, global warming is not “man-made”, i.e., it cannot be the result of economic activity but rather a result of external forces we can’t control.
Figure 1: Temperature changes since 900 AD (Source: IPCC 1990 Figure 7c)
In 2001, the IPCC assessment report shows a very different graph (Figure 2) without a MWP but with a gradual decline in temperatures from 1000 to 1850, followed by a strong increase in temperatures, especially in the second half of the 20th century. The graph is based on two papers by Mann et al. (1999), Jones et al. (1999) and Briffa (2000). The graph that fits actual temperatures best from 1900 to 1980 (Mann et al. (1999)) is then shown in Figure 3 (below), which is the figure that is published in the IPCC 2001 Summary for Policy Makers. This graph (also called Mann’s “hockey stick”) has become the poster child of the man-made global warming movement and is regularly published in newspapers (e.g. the International Herald Tribune, December 8, 2009, p6).
Figure 2: Average Northern Hemisphere temperature anomalies: results from individual studies. (Source IPCC, WG1, Figure 2.21)
http://www.grida.no/climate/ipcc_tar/wg1/images/fig2-21.gif
So why did the MWP disappear? Because actual measurement of temperatures with thermometers only started in 1850, all temperature data for prior years have to be estimated by proxies such as a lake sediments, ice cores, boreholes and tree rings. These proxies are then combined in complex computer programs. Occasionally proxies are based on tree rings only. For example Keith’s Briffa’s proxy is based on tree ring Polar Ural data.
All three graphs in figure 2 show a strong correlation between the proxies used in the papers and the actual temperatures from 1900 until 1960, which is not surprising as it appears from the source files (revealed together with the e-mails) that proxies that did not fit well with actual temperatures were purposely ignored. The problem is that these proxies are not really correlated with temperatures outside this estimation period. For example, while real temperatures rose after 1960, Keith Briffa’s proxy shows a decline in temperature. The same decline must have happened with the Mann and Jones papers after 1980, which now makes it clear what Jones meant in his e-mail. The “trick” consists of “hiding the decline” by replacing the proxy with the real temperatures after 1961 for Briffa’s paper, and after 1980 for the Jones and Mann papers. That explains the puzzling fact that in all figures the reconstructed data stop in 1980 and are replaced by instrumental data. Moreover, although instrumental data are available from 1850 to 1900, these data are not used in figure 3. One possible reason is that, as with the post-1980 data, the pre-1900 data don’t match with the reconstructed data.
Figure 3: Average Northern Hemisphere temperature anomalies: pooled results (Source IPCC, WG1, Figure 2.20)
But this of course means that the proxies in the reconstructed data are wrong, as the quality of a proxy depends on its ability to forecast outside the estimation period. This makes the whole pre-1850 period analysis irrelevant. In other words, the research does not prove that there was no MWP, which is the necessary condition for claiming that warming is driven by human activity. This is why it is not surprising that the scientists are being blamed for having manipulated the data to hide the MWP.
Lessons from finance
I strongly recommend the “best practices” of finance academics to the climate science community:
Data should be made publicly available at a reasonable cost
While climate scientists try to explain temperatures, finance professors try to explain stock prices. In the early sixties, the University of Chicago set up the Centre for Research in Security Prices to collect historical data on stock prices and other financial information. This information is made available to all academic institutions for a fee. Climate researchers should do the same. Moreover, as they use proxies for temperatures in the pre-1850 period, they should disclose how and why these proxies were chosen and how they are combined in computer algorithms. This is an important issue, as the one of the most common sources for estimating pre-1850 temperatures is tree rings. But considering that the number of trees is infinite, it seems to me that you can always find a tree that gets you the desired result. This is, I believe, the basic difference with finance: we don’t try to estimate stock prices if there is no organised stock exchange with verifiable records. This significantly reduces the potential for cherry-picking and data manipulation.
Data should be respected, theories not
The quality of a theory depends on its ability to explain the facts. So when the facts don’t fit the theory, the theory should be changed, not the facts.
For example, one of the leading Nobel Prize-winning financial models is the Capital Asset Pricing Model (CAPM). When it was first tested using data prior to 1970, it was found to be roughly consistent with the facts and became for a while the holy grail of finance. However, as time went by, anomalies were discovered, the model was rejected and alternatives were proposed. Some of these alternatives were proposed by the same researchers who provided the original empirical support for the CAPM. So there is nothing embarrassing about changing your mind after seeing new evidence.
This way of operating is quite different from the climate scientist practices revealed in an e-mail exchange of October 2009. In particular, one of the scientists says:
“The fact is we can’t account for the lack of warming at the moment and it is a travesty that we can’t”
He was referring to the fact that, since the prediction of increased global warming in 1998, global temperatures have actually declined. The e-mail was a result of the fact that Paul Hudson, the BBC’s reporter on climate change, had pointed this out. Rather than calling this a ‘travesty’ the scientists should have welcomed this as an interesting development and a call for remodelling. Perhaps we are at the beginning of a period of global cooling, as some scientists suggest. So let’s hold on to the SUV for the moment.
Don’t create institutions that decide whether an academic debate is closed
The academic finance area does not have an institution such as the IPCC that assesses periodically whether a specific theory should be accepted as absolute truth. In January 2001 the IPCC stated that “there is new and stronger evidence that most of the warming observed over the last 50 years is attributable to human activities.” All main national and international science academies subsequently endorsed this opinion. For finance academics such unanimity is unusual. Academic debates in finance rarely are declared “closed.” For example, one of the debates in finance that has gone on for as long as I can remember, and will never be settled, is whether the stock market is informationally efficient. It would be unthinkable that, once in a while, there would be an official organisation declaring the state of the Efficient Market Hypothesis, and deciding which papers are relevant and which ones are not. The danger is that such organisations would be dominated by academics who want to push their particular point of view and declare the academic debate closed.
Evidence consistent with such behaviour at the IPCC can be readily inferred from the fact that none of authors of the 2001 report questioned figure 3. Indeed, I find it most disturbing that none of the scientists (or policy makers, or other science academies and scientific societies that have endorsed the IPCC 2001 opinion) insisted on seeing the reconstructed data from 1980-2000, to check whether the proxies were relevant. It is as if I would use stock price data from 1900 to 1980 to design a trading rule, publish it in 2001 and then the referee would not ask me to check whether the rule works from 1981 to 2000! The only explanation for the lack of curiosity of scientists and policy makers must be that they liked the “hockey stick” picture which showed that warming in the 20th century was unprecedented. So, if climate scientists want to regain credibility, I recommend that they close down the IPCC. Alternatively, the IPCC should transform itself in a lobby group for man-made global warming, but should not pretend to be an objective assessor of climate change research.
Don’t become captive to a political movement or an industry
Although many of us are funded by financial institutions, we don’t refrain from criticising those who feed us. For example, there are numerous papers advocating the Efficient Market Hypothesis, which claims that active portfolio managers create no value and that the optimal investment strategy is to invest in an index fund. Others have shown that acquisitions destroy value for bidders, often blaming the success fees of investment bankers as well as the use of earnings multiples in valuation. This critique has not prevented finance professors from being endowed with chairs financed by asset management firms and investment banks. The reason, I believe, is that whatever we say or write does not have a major impact on the real world. Indeed, there are numerous successful active portfolio managers and bankers still use multiples when valuing companies.
Climate scientists, on the other hand, are being taken very seriously by politicians, environmentalists and business people. For example, alternative energy producers can only survive thanks to government subsidies, regulation and taxes on their competitors in the ‘non-alternative’ energy sector. These government policies will only be implemented if the public is convinced that global warming is a man-made serious problem. Hence, climate scientists may be more reluctant to revise their theories if so many people’s fortunes depend on the acceptance of these theories. So this should perhaps be another message: don’t take yourself too seriously so that others won’t take you too seriously either.
Theo Vermaelen is Professor of Finance at INSEAD. The views expressed here are his own.
Drucker on the ‘bounded goodness’ of corporate social responsibility
by Craig Smith, INSEAD Chaired Professor in Ethics and Social Responsibility
Courtesy of INSEAD Knowledge
Peter Drucker’s immense contribution to the thinking and practice of management extends to social responsibility in business. This work goes back over 60 years but remains relevant today — notwithstanding the impacts of globalisation and the greater interconnectedness of business and society. This article first identifies Drucker’s CSR ‘principles’ and then examines their implications for business today, with an emphasis on marketing practice. As well as revealing their significance, it also considers Drucker’s views on the limits of social responsibility, referred to here as “bounded goodness”. It examines how Drucker’s thinking informs the challenging question of “how much is enough?” in relation to corporate responsibility issues such as food marketing and obesity, availability of AIDS drugs in Africa, as well as supply chains and labour rights.
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| Peter Drucker |
Drucker consistently affirmed his belief in social responsibility in business (and other institutions). His earliest writing (The End of Economic Man, 1939 and The Future of Industrial Man, 1942) affirmed his view of the social purpose of business and, through his examination of the grounds for corporate legitimacy, the social responsibilities of management. Management, Drucker’s (1974) 800-page treatise on the tasks, responsibilities and practices of management, contained five chapters in an entire section on social impacts and social responsibilities. His later writing remained consistent with these beliefs. In some cases, he addressed social responsibility directly, in other cases more indirectly by describing his humanistic conception of management and his concern for the social role and responsibilities of business, as in his last book, Management Challenges for the 21st Century (1999).
Drucker differentiated between two types of social responsibilities: those to do with social impacts or what business does to society and those to do with social problems or what business can do for society. Social impacts go beyond the specific contribution the company exists to make, such as providing needed products and services. They are often unintended but inescapable by-products of business, as part of and serving society. Drucker advised that, once identified, social impacts are best eliminated. The principle was clear: identify and address — if not eliminate — undesirable social impacts of business activities and, if they cannot be turned into profitable business opportunities, seek a regulatory solution (industry self-regulation or government regulation) that creates an optimal trade-off for all involved. Drucker also viewed social problems as sources of opportunity. He suggested that business has responsibilities in relation to social problems, but that there are also limits to social responsibility in this regard.
In answer to the question ‘when to say no?’ – the limits of corporate responsibility – Drucker suggested demands for social responsibility in response to social problems be resisted when this would impair the performance capability of the business, exceed its competence, and when it would usurp legitimate authority (such as that of government) or would involve illegitimate authority.
For example, fast food companies certainly appear to have a responsibility to act to eliminate the negative social impacts evident in their contributions to obesity in children. In contrast, the pharmaceutical companies dealing with requests to give away life-saving drugs to all that need them are responding to what Drucker would term social problems rather than social impacts. They are not responsible for the limited healthcare budgets of developing countries that preclude purchase of drugs at developed country prices, but they might choose to act on the issue of access to essential medicines nonetheless.
Drucker’s writing richly and extensively sheds immense light on business and other institutions and their management, remaining as fresh and relevant today as it did decades ago. This is no less true of his writing on social responsibility. In some respects, his insights might be taken for granted and they are far from a complete understanding of social responsibility as it is conceived today. However, Drucker’s distinction between social impacts and social problems remains a key consideration, and his three limits on CSR in response to social problems (performance of the firm’s specific mission, competence and authority) still have validity even if they only provide a foundational understanding and don’t provide a sufficient answer to the question, ‘how much is enough?’
Energy-Friendly
How One Investment Company is Giving Clean Energy Entrepreneurs a Boost to Mitigate Climate Change
by Karen Cho
E+Co is not what you would call a typical investment company. For starters, it’s not a large company with a huge amount of capital. Second, it’s focused exclusively on energy and third, it invests in only small and growing clean energy businesses from developing countries. Read more
Human Capital: The Challenges Facing Asia
by Kevin Tan, Singapore
While the economic downturn is a key focus for many C-level executives, the need to attract and retain talent remains an important issue. This is all the more so in Asia where developing countries such as China and India are helping to drive the world’s economic recovery.
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Narayan Pant
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Narayan Pant, Affiliate Professor of Strategy and former Dean of Executive Education at INSEAD, believes that companies are already thinking about their human capital needs for when economies pick up. “So the question for many was, if you have excess people now, could you find a way to hold on to them so that you would have them available when the economy starts looking back up? I think this was an important focus for many organisations.”
At this year’s Singapore Human Capital Summit where Pant was a facilitator, participants were told that companies have to engage their employees by recognising their different needs and aspirations, and address these accordingly. “The way to engage people is to figure out what creates value for them – recognition, opportunities for personal development, opportunities for travel, work-life balance or other dimensions, in addition to compensation,” says Pant. “Understanding what dimensions of value are relevant for different groups of employees and tailoring solutions that work for different groups, is one way to keep employees engaged.”
However companies in Asia are not doing enough to recognise the diversity in employee needs and segment employees appropriately, says Pant. Encouragingly, some large companies are clearly experimenting with this, he says.
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Harish Manwani
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Pant also notes that companies are trying to attract talent by using corporate social responsibility (CSR) initiatives. Notably, Harish Manwani, Unilever’s President for Asia, Africa, Central and Eastern Europe, championed the idea of ‘doing well by doing good’ at the conference. Pant believes, however, that to be sustainable, CSR initiatives need to make a business case, otherwise they will be yet another fad of good times.
“So if it makes people feel good to be part of an organisation that seems to care, then offering employees CSR opportunities is one way to improve commitment and productivity. This could, in turn, have beneficial business effects,” explains Pant.
“Saying that CSR results in better employee engagement numbers makes less of a dollars and cents case, but it can make sense. Higher engagement results in lower turnover and better on the job performance, which builds a potential business case for CSR.”
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Sunny Verghese
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Also at the conference, Sunny Verghese, Chief Executive of commodities trading firm Olam International, said that in his view CSR initiatives are only tenable if they help sustain profitable growth. As a concerned shareholder himself, Verghese is interested in engaging in CSR initiatives that have two features – they enhance business growth and they fall in an area the company knows something about. And so Verghese says Olam does not get involved in HIV/AIDS programmes, even though HIV and AIDS affect many farmers in areas where they do business. Instead Verghese seeks to use Olam’s expertise in farming to help farmers achieve better crop returns, which in turn benefits Olam, says Pant.
At the conference, Unilever’s Manwani also argued that companies should think locally and act globally, which Pant agrees with. Manwani’s point, says Pant, is that any individual is a local customer, meaning that the act of purchasing always happens in a local context. However, companies can enjoy a competitive advantage at the local point of sale by leveraging their global reach and strength.
“Thinking about the challenge in this way could empower employees to engage with local customers in ways that create value for them while leveraging the advantage of a global organisation,” argues Pant. “Manwani perceives this to be much more sustainable than the other way, which is trying to offer global solutions to people who are local customers.”
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Asian Human Capital Award 2009 Accenture India triumphed in a ‘close fight’ for the inaugural Asian Human Capital Award, fending off 43 competing entries from seven countries across the region. Speaking to INSEAD Knowledge, Narayan Pant, who was a member of the judging panel, said: “The thing about Accenture India that caught my attention was how their mentor-mentee relationship worked. I thought it was quite powerful, and they had teeth to it.” “Both mentors and mentees got evaluated on how they did in this relationship. But the crucial aspect to that was that relationship was designed to enable the mentee, or the person that was being mentored, to achieve his or her developmental goals.” “Those developmental goals, those personal aspirations were at the centre of the mentoring relationship which to me was very powerful, so it wasn’t about how we get you to be a better cog in the organisational system, it was much more about what do you want and how can we help you get it?” |
Pant adds that, semantics aside, companies often fail to empower their client-servicing employees with the tools to deliver value to customers. Sales forces of multinational corporations often complain that they have to follow global and possibly misaligned marketing approaches for their local clients. A quick win would be to work more seriously on adapting sales tools and approaches to the local context.
“If you give a person the ability to adapt solutions to local needs, you make them feel good, you make them feel powerful, you excite and energise them.”
Asked about an assertion at the conference by Hsieh Fu Hua, the Chief Executive of the Singapore Exchange, that leadership has to be shared in companies, Pant says that companies in Asia are adopting this idea. But he notes that Asians believe the myth that the boss makes all the decisions and that all decisions are made before meetings, which are used only to rubber-stamp decisions.
However the myth is just that, says Pant, as Asia often practises ‘leadership by walking the corridors’. “The boss has actually come to a decision by walking the corridors a month before the meeting, making sure that he or she understands what everybody’s thinking.”
“So by the time he comes to the meeting, he’s already tried and tested a couple of trial balloons behind the scenes with several key stakeholder groups.”
“I think there is a great weight given to community and harmony in Asia. This co-exists almost paradoxically with an external impression of great power distance and strong hierarchical organisations. The way these are reconciled are quite unique and can be seen in leadership practices that are less visible to the casual observer.”
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Hsieh Fu Hua
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At the conference, Hsieh was asked how companies should manage the paradox of driving change while maintaining a sense of stability for employees. Hsieh replied that companies should foster evolutionary change, anchored to the values and culture that are shared by employees.
On this issue, Pant agrees that it is important for companies to manage change while fostering a sense of stability among employees. But he notes that organisations can make incremental changes for quite a while, until the need for dramatic changes (such as changing leadership teams and organisational structure) becomes over-powering. This has been described in the organisational literature as long periods of evolutionary change, punctuated by bursts of revolutionary change.
Pant adds that the current generation of managers is possibly more receptive to the idea of continuous change than previous generations who tracked their progress by the office spaces they occupied in their careers. Pant says he doesn’t think employees expect organisations to remain the same because they don’t expect environments will remain the same.
On the key lessons gleaned from the conference, Pant says the idea that companies shouldn’t treat employees as if they are all the same, is becoming popular as there is a growing emphasis on the need to segment employees carefully and create varied engagement strategies for diverse segments.
Companies also learned that leveraging global workforces meant empowering them to think local, while gaining access to the benefits of being part of a global organisation, says Pant. Gaining tangible benefits from this will require companies to get the logistics right that enable these employees around the world to work with each other.
But the biggest lesson, says Pant, is that no guru anywhere has the answers to the specific issues and challenges that Asia will face in the future. It is up to those who work in Asia to experiment, innovate and find the best solutions that work for them.
INSEAD was an academic partner of the Singapore Human Capital Summit, which was held on September 29-30, 2009.
For-Profit or Not-for-Profit? Social Enterprises Seek a Better Way
by Robert Goldsmith. Courtesy of Insead Knowledge.
Social enterprises must currently choose whether to be charitable non-profit organisations or money-making, for-profit companies. The choice is often hard to make since the legal status of each has positive points as well as drawbacks. Because of this, a leading social entrepreneur thinks it is time to create a hybrid legal status for social enterprises. Read more
¿Qué CSR, Señora?
By Amanda Coffin
Perhaps to the disappointment of some readers, the Global Latinas in the title of Lourdes Casanova’s newly-released book (INSEAD Press, 2009) include neither Mexican telenovela starlets nor Shakira, but rather a sampling of South American multinational companies.
Dr. Casanova asserts that most research on multinationals has focused on those from developed nations. What research has emerged on developing markets has looked primarily to Asian companies. Aiming to fill this void, she examines the unique challenges to building a global business in South America, and some of the correspondingly unique success stories. Read more
Health Care at $1.75. Is There a Business in Micro Health Insurance?
Courtesy of INSEAD Knowledge
by Grace Segran, Barcelona
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Micro health insurance is in its infancy but it’s expected to take off in the next couple of years, with the financial success of microfinance helping to speed up the process. Yet Johanna Mair, a former doctoral student at INSEAD (PhD 01Jul) who is now an associate professor of strategic management at IESE business school here, says microfinance and micro insurance are two very different processes.
A number of organisations are experimenting with different models, varying from subsidy to non-subsidy schemes and in delivery methods. Experimentation at this stage is extremely important, says Mair.
Grameen Health, for example, has a micro health insurance plan that costs $1.75 a year which covers six members of the family for rudimentary preventive medicine.
With some 100 million euros in funding from the Dutch government to start pilot projects in four countries in sub-Saharan Africa, PharmaAccess Foundation works specifically on the financing side of micro health insurance. They currently subsidise 90-95 per cent of private voluntary health insurance, using local partners as health care providers.
AAR, the largest and oldest HMO (health management organisation) in East Africa, works through a membership programme. As middle men accounted for some 65 per cent of its costs, the organisation became a micro insurance company so that it could come up with its own products to reach the poor.
“Yes, there is an opportunity for business but we have not found the solution or the perfect model yet,” Mair said during Net Impact’s Doing Good, Doing Well 2009 conference held here recently. “We need to address bottleneck issues, learn how to do things better, and identify the kind of model we can scale around the world.”
Micro health insurance and microfinance
Mayte Oosterveld, director community health systems at PharmAccess Foundation, says that unlike microfinance where you can lend part of a loan, you can’t sell one quarter of health insurance or treat only malaria. “We can give someone a $1 loan, but we can’t give a very small, restricted health care insurance.”
“We need to address a basic package and determine what it is that people will buy,” she says.
The difficulty for micro health insurance, she argues, is that it is a new concept for many people. “As they are paying out of their pockets, they ask: ‘Do I have to pay in advance with the risk that if I need treatment in nine months’ time that the clinic is still going to be there? Or do I keep the money in my pocket so that when a family member falls ill, then I have money to pay for treatment?’”
Educating people about micro health insurance and establishing trust with the group you work with is very important, she says. “The one day that the medication isn’t available … they are never going to buy that insurance again. Then you’ve lost them. That’s why it’s so different from microfinance.”
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Microfinance has had its success stories, but the same is not true for microinsurance, especially when there is an emphasis on serving the poor, Matthew Jowett, senior health financing specialist, with the World Health Organisation in Europe told INSEAD Knowledge. “Insurance, in particular health insurance, is a complex product to deliver, involving the assessment of individual health risks, and delivery of services either through the scheme’s own network of facilities or through contracts with a third party.”
The upshot
Oosterveld doesn’t think there is a business yet at this stage. “Everything needs to improve significantly before that can happen. The education system, doctors and nurses, delivery, pharmaceuticals.”
The Grameen Health initiative does show, however, micro health insurance schemes can virtually be self-financing, if not fully self-financing, says Jowett. “It seems that this is achieved by covering only small risks, that is, low-cost care in primary clinics, having low operating costs, for example labour, and achieving scale in terms of membership. This in itself is a major achievement – generating a profit, however, would be far more problematic.”
Most schemes targeting the poor are likely to either require subsidies, a focus on limited, perhaps smaller risks (such as only primary health care, and not hospital care), or will have to make enrolment compulsory, or semi-compulsory (for example, a scheme would need a minimum number of people in a group agreeing to join). Jowett concludes that micro health insurance does not appear to provide the same opportunities as microfinance does in harnessing the business sector to deliver on socially-oriented goals.◊
The Doing Good, Doing Well conference was held in Barcelona February 27-28, 2009.
Organised by IESE´s Responsible Business Club (an affiliate of Net Impact), the conference attracts professionals and students from around the globe.
