Does Money Talk? Market Discipline Through Selloffs and Boycotts

Nickolay Gantchev is Associate Professor at the Southern Methodist University Cox School of Business; Mariassunta Giannetti is Professor of Finance at the Stockholm School of Economics; and Rachel Li is Assistant Professor at the University of Alabama Culverhouse College of Business. This post is based on their recent paper. Related research from the Program on Corporate Governance includes Socially Responsible Firms by Alan Ferrell, Hao Liang, and Luc Renneboog (discussed on the Forum here).

Market discipline is viewed by policy makers as essential to achieve a more environmentally and socially sustainable economy. For instance, almost half of the respondents to a recent institutional investor survey consider environmental, social, and governance factors in their investment decision-making (See This suggests that investors have ethical and social standards and may be willing to vote with their wallets and spurn firms that fall short of their expectations on ethical norms and environmental and social (E&S) principles. Similarly, customers are concerned with more than just product quality or prices and may be willing to pay a cost if firms meet their E&S preferences.

However, little is known about whether small investors and customers can impose market discipline with their product purchases and trading of firms’ shares. This is an important question because market discipline may or may not be effective for several reasons. First, for market discipline to be effective, expectations on the combined impact of investors’ and customers’ actions must be large enough to affect firm valuations and trigger changes in corporate behavior.

In addition, even if firm valuations were temporarily affected, managers who are rewarded for long-term profitability may not necessarily have incentives to improve corporate E&S policies. Instead, managers could rely on the fact that investors tend to have limited attention or memory and may quickly go back to demand a firm’s stock following a negative shock to its reputation on E&S policies. Customers may also be quick to forget and go back to purchasing the firm’s products. Thus, even a temporary backlash may not result in changes in firm policies, potentially limiting the effects of market discipline.

While it is very important to understand whether and to what extent market discipline can be effective in improving firms’ E&S policies, evidence is scarce. Existing work simply highlights that large blockholders can engage with companies’ management and pressure for changes in corporate E&S policies, but it is silent on the effects of small investors and customers.

The lack of evidence on the effectiveness of market discipline largely reflects difficulties in capturing changes in investors’ and customers’ discontent with firms’ E&S policies. In our new paper, Does Money Talk? Market Discipline through Selloffs and Boycotts, we overcome this obstacle using a novel dataset, which monitors violations of internal policies and international standards for listed companies around the world. In particular, we use company-specific media coverage of potential risks and violations of internal or external sustainability standards to isolate environmental and social risks from broader firm governance risk and focus on the former to capture a firm’s E&S vulnerability.

We then explore how investors with different social preferences, measured using either the cultural attitudes towards E&S issues in their countries of origin or their investment portfolios’ sustainability ratings, react to E&S risks. We find that E&S conscious investors decrease their shareholdings in firms experiencing heightened E&S risks. Similarly, we measure customers’ social preferences using the cultural attitudes towards E&S issues in their countries of origin. We find that the sales of firms facing heightened E&S risks decrease in E&S conscious countries. As a consequence of the actions of E&S conscious investors and customers, firms’ stock returns drop following negative realizations of E&S risks. The price decreases are concentrated in firms with ex ante more E&S conscious investors and customers, indicating that the market expects these firms can get stronger punishments from violating environmental and social standards.

Importantly, we show that investors’ divestitures and customers’ backlash not only affect stock prices, but also companies’ E&S policies. The effect of negative realizations of E&S risk on stock prices acts as an early warning. For fear of magnifying the negative effects on corporate valuations, firms take initiative to repair their reputations and avoid possibly worse consequences in the future. Following negative realizations of E&S risk, firms with more E&S conscious investors and customers improve their E&S policies, regardless of their initial E&S rating. Our results are driven by industries with higher dispersion in E&S policies, in which firms are better able to choose alternative E&S practices.

Our paper provides important insights for the current debate on whether regulatory agencies should impose uniform disclosure standards regarding E&S issues. We show that market discipline can play a powerful role in improving firms’ E&S policies as long as investors and customers are able to evaluate firms’ E&S practices. Thus, mandated standards of disclosure increasing transparency of E&S policies may enhance the effectiveness of market discipline and serve as a powerful instrument to incentivize firms to adopt more sustainable policies.

The complete paper is available for download here.

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