The objective of this study was to clarify whether the constituent selection methodology of the sustainable DJSI World Index, applying a best-in-class screening, prevents those companies with reprehensible or unethical behaviour from being selected. Unethical behaviour was defined as an action that generates negative news in the media and is considered a controversy by the Eikon database.
In principle, controversial companies are expected not to form part of the index. The average retail investor has difficulty understanding that a company involved in an environmental, labour, corruption, etc. scandal can belong to a sustainable index, regardless of the selection methodology used. An index including “controversial” companies as a reference for socially responsible investment would undoubtedly be meaningless.
Analysis of the Controversies Reported in the EIKON Database Relating to Companies Included in the DJSI World Index
Firstly, we studied the existence of controversial companies within the DJSI World Index, looking at the different industry sectors. Then, the different types of controversies and the inclusion of the controversial companies in the index were studied. Finally, it was verified whether the nationality of the controversial companies influences their inclusion in the index.
shows the percentage of companies that have committed irresponsible activities included in the DJSI World Index. In 2016, one in ten companies included in the index were involved in irresponsible activities. However, the percentage of corporations with a reprehensible action within the index has clearly declined in recent years. Between 2011 and 2016, the number of controversial companies included in the DJSI World Index has been reduced by 40%. This development may be due to a modification in the implementation of the methodology used by the index. As a result, more companies with bad reputation have been excluded from the index. The opposite development could have been expected, as in 2016 there was a marked increase in the controversies and the companies involved in socially irresponsible activities (Figure 1
It is interesting to note the unusual development that takes place in 2015, as it breaks the descending trend, which continued in 2016.
An interesting aspect to analyse is whether a similar reduction has occurred in all industry sectors of controversial companies included in the DJSI World Index. To facilitate investigations, companies were classified into three industrial sectors: goods, services and works. In the period under study, corporations classified in the goods industry sector represented 48.4% of all the companies with controversies, the services industry sector represented 49.3%, and the works industry sector the remaining 2.3%. None of the companies in this 2.3% became members of the DJSI World Index. The analysis was therefore limited to the companies in the goods and services industry sectors.
shows an important decrease in the number of manufacturing companies included in the DJSI World index that behaved irresponsibly. Specifically, from 2011 to 2016, the percentage of manufacturing companies deemed as controversial managing to enter the index fell by 45%.
Regarding companies in the service industry, as shown in Figure 4
, although the development was similar, it was not as pronounced as the goods industry sector. The percentage of controversial service industry companies in the index decreased by 35%, 10% less than manufacturing companies.
shows the development of the percentage of controversial companies that belong to the sustainable index DJSI World Index within specific industry sectors.
A selection of the four sectors with the largest number of companies with controversies throughout the period was made. These sectors are: banking, metals and mining, oil and gas and telecommunications.
By differentiating the companies according to their industry, it becomes evident that not every sector follows the previously mentioned development. Irresponsible companies in the banking and the metal and mining sectors are gradually reducing from the sustainable index, with only a slight increase in 2015 compared to 2014. The reduction in the banking and metal and mining sector is 51%, and 44%, respectably.
In the case of the oil and gas and telecommunications sectors, the situation is different. Firstly, the percentage of controversial companies included in the DJSI World Index in 2011 was much smaller than in the banking and metals and mining sectors, and well below the global value shown in Figure 2
(16.6%). However, in 2015, a strong increase in both sectors occurred, decreasing in 2016 to similar levels of 2011. It seems that the selection process used by DJSI World Index is somehow stricter with some sectors, while other sectors are handled with more flexibility. It would be interesting to analyse whether the industry diversification requirements of the index are responsible for this outcome.
Another aspect that is interesting to analyse is the type of irresponsible activities carried out by the companies included in the DJSI World Index. It is important to examine whether the selection criteria implemented by the index are influenced by some specific type of controversy and companies committing certain irresponsible activities are more likely to enter the index.
shows the percentage of controversial companies that are included in the DSJI World index within the different controversy types: community, environment, human rights, management team, product, shareholders and labour.
Foremost, it is clear that the percentages of companies included vary greatly depending on the type of controversy. However, the trend is declining, in the sense that the percentage of controversial companies admitted to the index is getting lower, regardless the kind of controversy.
Special attention must be paid to companies with human rights controversies, where the percentages are especially high. This is especially striking in 2016, when there were only eight companies in the Eikon database with human rights disputes, out of which three were included in the DJSI World index.
It is also worth mentioning the development of management team related controversies. In 2011, two out of three companies with controversial actions in this area belonged to the sustainable index. Since then, the percentage has been drastically reduced, reaching 0% in 2015. It seems reasonable to think that the index selection process has been modified to be more scrupulous, or less lax, regarding this type of irresponsible activities.
Finally, it was studied if belonging to a specific country increases the probability that controversial companies become constituents of the DJSI World Index.
shows the percentage of controversial companies that are included in the DJSI World Index, divided by country. The ten countries with the highest number of controversies during the examined period are included: Germany, Australia, Canada, China, South Korea, France, India, Japan, The United Kingdom and the United States. These 10 countries belong to the group of the 14 largest countries in the world in terms of GDP. This situation is expected, as Eikon only reports controversies from the largest companies in the world, which generally are located in high developed countries.
A simple look at Table 2
reveals that treatment by country is not homogeneous. The geographical diversification policy in the index has an impact in the selection of companies. Nevertheless, the development of every country is similar to the one described in Figure 2
. That is, regardless of the country, at present, fewer controversial companies are accepted in the index compared to past years.
The percentage of controversial companies that are included in the DJSI World Index varies greatly between countries. The countries with the highest percentage in 2016, and also throughout the whole period, are Germany and France, followed by the United Kingdom. In other words, they are European countries.
The countries with fewer controversial companies within the DJSI World Index are Asian countries: China, India, Japan and South Korea. It is also striking that the United States has such a low percentage, the lowest among the Anglo-Saxon countries.
This leads us to think that the geographic diversification policy, the need to include a minimum number of companies from each region, decisively influences in the selection of companies. This impacts on the quality of the selected companies regarding their socially responsible behaviour. As the United States have a large number of global companies, well diversified among all industry sectors, it is easy to discard controversial companies. By contrast, European countries do not have such a wide range of options.
Furthermore, it should be questioned whether the analysis of companies is equally exhaustive in all regions or whether there is a language barrier to consider. It may be possible that certain companies performing irresponsible activities are both included in the DJSI World Index and not reflected in the Eikon controversies database as they are not subject to narrow scrutiny because of language barriers. It is surprising that, within the 10 countries selected with the most controversial companies, neither Italy nor Brazil, which are the eighth and ninth biggest economies in the world, respectively, are included, while Australia, which is the fourteenth biggest economy, is included.
also shows that the geographical diversification of the DJSI World Index plays an important role when companies are selected. This figure shows the percentage of companies with controversies that are included in the DJSI World Index, according to their region of origin: Europe, Oceania, South America, North America, Asia and Africa.
The conclusions that can be extracted are in line with those obtained analysing Table 1
. It was confirmed that the percentage of companies with controversial behaviour that are included in the DJSI World Index is bigger for European countries. According to the Eikon database, in 2016 (Figure 6
), of the 371 corporations performing irresponsible activities, 63 were European companies that were included in the sustainable index. Therefore, 22.1% of the European controversial companies listed in the Eikon database joined into the DJSI World Index. The second place was for South America (18.5%), although only five controversial companies were included in the sustainable index.
It is important to mention that there are no African companies in the DJSI Index, which means the index does not include controversial African companies. Regarding Asia, which only has four companies subject to controversies that have become index constituents, it is possible that the DJSI World Index selection process is stricter with Asian companies. However, it is also possible that Eikon monitors companies in this region less exhaustively than companies in other regions. A reason may be the difficulty of analysing the news in different languages. It is possible that the DJSI World Index could include controversial Asian companies that have not been identified as such by Eikon. This could explain why there is a low percentage, only 1.6%, of controversial Asian companies included in the index.
Regarding North America, of the 281 irresponsible companies, there are 23 controversial companies included DJSI World Index. In the case of North America, compared to Europe, it can be concluded that the range of large companies among which to select the constituents of the DJSI World Index is broader. Therefore, the index can include more companies that are not involved in controversial activities, explaining the low percentage (6.2%) of North American controversial companies included in the index compared to the percentage of European companies. (22.1%)