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Concept, Design and Principal Agent Problem in the Environmental Mutual Fund Industry ABSTRACT The present paper addresses the Law and Economics of Green Investment Green Shares in the specific field of green mutual funds, and analyzes the principal agent problem that exists between the single investor and the green fund manager, suggesting regulation and optimal contracting clauses in order to reduce and minimize the conflict of interests and asymmetric information inherent to the relationship.

The first chapter introduces and establishes the concept of Green investment Green shares. The second chapter focuses on the market instruments of Green Investment, outlining mutual funds, as well as pension funds, private equity and hedge funds.

Empirical data is presented, siniz mainly with fund performance and effects of remuneration schemes and covenants. The third chapter covers the legal background of mutual funds and correlated vizzotti instruments of green investment in Europe, the UK and the USA, in both hard and soft law areas. The last chapter presents the Principal Agent Problem, with normative suggestions of new regulation and contracting possibilities in the area of Green Mutual Funds.

According to FRIEDMAN, executives of corporations should use shareholder s assets and resources foremost to increase the value of the company, and not in another ways, like, for example, to reduce pollution an example of internalization of externalities.

Looking to the present, the argument appears dniiz be out-dated, since established literature states that the interests of both shareholders and stakeholders must be considered in order to maximize the value of the firm 3, which will eventually increase the social net welfare.

On the same grounds, the concept of sustainability, seminal in the decade, is today the mainstream of vizzotto and professional discussion.

Ethics in business 4, the role of trust and the advantages of cooperation in long term relationships, are some of the philosophical foundations 5 of this new investment trend. In relation to this, the market for investor consultancy firms that consider on their evaluations Environmental, Social and Governance ESG 6 issues and of course the flow of money in this kind of investment 7 are rapidly increasing. It is the shareholders money being used to increase sustainability e.

This is an affirmative reinforced by case studies covering mutual funds, companies and industrial sectors linked with the environment 9. The environment is part of corporation s life and also the capital market.

There is a growing set of environmental legislation and regulation established both on a national and international levels, by legislators and administrative regulators 10, in areas like environmental information disclosure, legal and financial incentives for green investing, fund manager duties, regulation of green hedge funds and so on. Non-governmental organizations – NGO, and institutional investors are also actively participating in this line of business.

Issues like climate change, sustainability and good environmental practices greatly influence markets, investors and corporations behavior as well as the utilization of their resources. This means that some percentage of this can be related to ESG points i. Participating in other social and ethical issues is likely to destroy firm value. See, also, the studies that are made by the Sustainable Investment Research Platform.

The Sarbanes-Oxley is another example. From now on, it can be considered that there is an important field to be explored, as well as manifold questions which can be better answered or clarified The area of green investment is growing and affecting markets in a important way. It is a broad concept that covers an array of financial instruments and areas presenting discussions of an ambiguous 13 nature, to say the least, about its design, performance, regulation and contractual relations, which are increasing in number and in depth.

That the economic approach to human behavior and its extensions is important and relevant is not a matter of discussion, but the words of GARY BECKER confirm the foundations of this approach: In accordance with the textbook definitions, the term law here refers to statutes, judge-made law, treaties and customary law. However, not only the law itself is studied, but also the way it came into existence and, in particular, its effects.

According to him the transaction costs can be divided in 3 steps search costs, bargaining costs and enforcement costs.

The Financial Times article says that Only a decade ago, the idea of a standalone firm researching the environmental and social impact of corporate activity would have been dismissed out of hand.

Yes, one or two ethical funds did exist, but only as a tiny cog within a large machine. Today, green investment and, consequently, analysis of green issues is big business Financial Times. The concept of economic efficiency, however, is complex and widely misunderstood.

The author list at least 5concepts of efficiency: The movement has different origins, because of the intense participation of important schools of thought that gave birth to topics such as Public Choice Theory, Institutional Law and Economics and Neoinstitutional Law and Economics.


The present study will start with positive methodology and will use the instruments vizotto Law and Economics to adopt a normative method as well, bearing in mind that each approach concerns the personal viszotto 18 of the author and takes into account the existent theory.

This basic framework will be used in this thesis. The proposal here is the establishment of optimal regulation and contractual clauses in the field of green investment; the consequence of the adoption of these proposals will be dinzi reduction of uncertainty and asymmetric information; the ideal, social welfare maximization. The present research will not utilize its own econometric models or new concepts einiz measure the performance 20 of green shares the academic literature that already exists is detailed and have analyzed a wide set of investment funds, comparing ethical funds to non-ethical, for example.

The results already found, vary from source to source depending of the age on the fund, the screening style, the benchmarks used, vizztto country and region measured and so on. From here on, we can say that the flow of money in this kind of investment configures a signal that regulation and contracting schemes sooner or later, in a soft or hard way – will be necessary. The basic research questions of the present paper are the following. The first part is introductory, because the boundaries of the problem riniz be defined and explained.

The chapter ends with the establishment vizaotto the main characteristics and a concept of Green Investment and Green Shares.

The second part is mainly written in economic terms and deals with one of the most important financial intermediaries of our days, mutual funds. Following this track, a description of how they work, with an analysis and review of the literature and of empirical data, especially related to performance and contractual clauses.

Other kinds of funds private equity, hedge and pension funds that are integrated in the green investment cycle are briefly analyzed. In the third part, legislation and regulation in state and global level of mutual funds and green investment are analyzed, with focus in fund managers duties of disclosure and conduct.

The fourth part will be the merger of Economic and Legal fields. At this stage, Principal-Agent 22 problems that exist in the green mutual fund investment cycle will be addressed.

After establishing the potential sources of conflict and main characteristic and issues of these conflicts, the chapter tries to answer the final and most important research questions, i. The fifth part will conclude. Foundations of the Green Investment Area The foundations of the Green Investment are multiple, coming from different sources academic, governmental, local, global.

The main purpose of this chapter is to reconstruct and lay down the basic foundations that lead to the development of this specific area of investment. From the point of view of a given legal system, efficient is whatever avoids waste; whatever makes the legal system work better by lowering transaction costs; whatever is considered better by the consumers in the legal marketplace; whatever, in other words, does not pointlessly foreclose the development of a better organized human society; whatever legal arrangement they have that we wish to have because by having it they are better off.

First, the fund manager has to be aware of its relationship with the investors, but must also evaluate on how his investment decision influences the behavior of the green target company.

The two folded problem was a strategic contribution of the supervisor, Professor Doctor Rainer Kulms. The focus will be the Single Investor Fund Manager problem analyzed inbut the Fund Manager and Insider Agent in the Target Company Agency Problem will be briefly described point A third problem of asymmetric information deals with the green target company signaling, i.

Besides not being the central part of the thesis, the basic questions of the problem will be pointed in the section. In sequence, it presents the main characteristics of Green Shares and Green Investment, with the suggestion of a concept. Her book discussed the use of pesticides such as DDT 24 and the damages that it caused to humans and environment, what resulted in the ban of it in by the United States government.

Bruno Boessio Vizzotto

Reports about establishing economic development without considering the environment evoked a conscience about the scarcity of resources and the fact that they must be explored in a rational way, within a context of equilibrium between economic development and sustainable environment.

In the same year, the Stockholm Convention was held The convention report can be considered as a milestone to the further development of global environment protection, and a shift of a purely economic perspective to a more holistic one, as observed by LISA NELSON It stated the importance of all nations adopting policies towards sustainable development, a concept that defined in a UN General Assembly resolution Since Stockholm, other United Nations scale international meetings that held talks concerning the environment have been Nairobi inRio inwhich resulted in the Agenda and Johannesburg in.

All these international meetings evolved towards establishing the goals for this Millennium. This objective is to be periodically measured Economics Perspective Economic scholarship does not ignore the impact of environment and the affect of a modification on the existing natural resources in the market.

BibTeX records: Bruno Boessio Vizzotto

In mainstream economics, the impact of economic activity in the environment, a classic case of negative externality, was first addressed by ARTHUR PIGOU and his theory on efficient social level of activity which can be reached trough taxation of private parties.


Market agents created instruments that use the protection of the environment as an incentive for transactions e. In reality, PETER SAND 42 suggests that, after command and control and market based instruments there is a third wave of environmental regulation, one that deals with the disclosure of environmental information. CSR and SRI All this movement towards the integration of the environment into the economic cycle also captured the attention of the most important agent of the capitalist society: The notion that firms activities can have important consequences to the environment and that this can affect, in the long run, the own share value of the company, made shareholders and managers care about the sustainability not only of the environment.

From now on, companies own sustainability plays also an important role, considering that both grounds are connected. As a result, Corporate Social Responsibility and Social Responsible Investment began to increase their participation in discussions that involved the firm and its value maximization.

HEAL gives a concept related to this thesis in the context of financial markets, defining it as a program of actions “which reduce the extent of externalized costs or avoid distributional conflicts 43 “.

The kind of Corporate Social Responsibility being dealt with here is the strategic one, not the altruistic, the latter being sometimes partially disconnected from the maximization of the value of the company. In the emerging global economy, companies are more frequently judged on the basis of their environmental stewardship. Besides this, it must be asserted that CSR is not a panacea for companies or for society. Companies can adopt CSR practices, but only in an efficient way, if they want to be competitive.

In reality, managers normally treat investment in CSR as any other business, whatever logically reduce the range of the activities considered to be profitable on both social and private grounds. In order to illustrate the fact that investment in CSR has concrete effect in the value of the company, a study made by HALL and RIECK 48 shows that signaling corporate social actions present a positive effect on stock prices included in this set of companies firms producing environmentally-friendly products.

The body of literature that deals with this is rising and there are different categories of approaches and analysis of it. The author made a categorization of the literature of social responsible investment. Social Responsible investment can be considered the umbrella where some kinds of investment, like Ethical, Social and Environmental are accommodated.

But this does not mean that all investment in this area follow the same and specific factors and basics. For example, one of the main characteristic of Social Responsible Investment is that it has a screening technique. This means that companies that do not fulfill or accomplish certain factors are excluded from the portfolio of investment of a mutual fund manager.

This does not necessarily means that all kinds of SRI will choose the same target companies. For example, an ethical investment can avoid investment in companies that produce tobacco and guns; on the other hand, a green investor could invest in one of these companies, if it adopts sustainable practices and has a long term view of the business.

It will depend mainly of the nature of the fund, the investment strategy of it and also of the investor behavior 1. The absence of a clear cut concept of green investment, and also the lack of stable data relating returns and profits demand studies in the area, in order to develop the field and reduce the already mentioned uncertainty at least in the acceptable level for financial markets or to some specific financial instrument, like, for example, mutual funds.

In the beginning of the 90 s general SRI and Green investment were more strictly linked, but as the area advanced, there are now different points of view between them, such as investment criteria, screening technique and so on.

Usually, the main targets of green investment are renewable energy companies, waste management companies, companies with technology in water efficiency and energy efficiency. Green investment has some different patterns from other SRI investments.

Project finance represents the supply side of the market, while green investment represents the demand side. Environmental reporting is part of the institutional framework that facilitates the work of the financial market Established the foundations of Green Investment, it s possible to go further and try to develop a concept of it.

In this sense, Green Investment can be characterized as an investment in other words, the participation in the stocks of these firms, what from now on we refer as Green Shares in companies within a specific sector that is closely linked with the environment 56 or in companies that adopt environmental oriented practices It also includes funds and other financial instruments that invest in this kind of area.