Does Socially Responsible Investing Change Firm Behavior?

Daniele Macciocchi is Assistant Professor of Accounting at University of Miami Herbert Business School. This post is based on a recent paper by Mr. Macciocchi; Davidson Heath, Assistant Professor of Finance at the University of Utah Eccles School of Business; Roni Michaely, professor of Finance and Entrepreneurship at The University of Hong Kong; and Matthew Ringgenberg, Associate Professor of Finance at the University of Utah Eccles School of Business. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance by Lucian A. Bebchuk and Roberto Tallarita (discussed on the Forum here); Companies Should Maximize Shareholder Welfare Not Market Value by Oliver Hart and Luigi Zingales (discussed on the Forum here); and Reconciling Fiduciary Duty and Social Conscience: The Law and Economics of ESG Investing by a Trustee by Max M. Schanzenbach and Robert H. Sitkoff (discussed on the Forum here).

Over the last decade, investors have shown a growing appetite for socially responsible investing (SRI). SRI funds, who advertise that they care about environmental and social issues in addition to maximizing returns, have more than doubled their assets under management. This trend is consistent with the proposals of some academics (e.g. Bérnabou and Tirole (2010) and Hart and Zingales (2017)) that corporations should seek to maximize shareholder welfare and that SRI funds should play a role in addressing environmental and social issues. Whether this approach can increase social welfare is an issue of heated debate in the literature (see, for example, Bebchuk and Tallarita, 2021).

One important aspect of this debate is how effective SRI funds are at bringing about environmental and social change. SRI funds have an official mandate in their prospectus to promote and implement socially responsible objectives. Further, these funds often advertise themselves as having environmental and social goals and in many cases the fund’s name alludes to these goals. As a result, investors in these funds expect them to improve corporate conduct (Levine, 2021). On the other hand, it may be costly for funds to change corporate behavior. First, monitoring corporate conduct is, itself, costly. Second, investing in accordance with environmental and social goals may actually cause the fund to earn lower returns by constraining the fund’s investment universe. These opposing forces make it unclear, ex-ante, what SRI funds actually do. There are several possibilities: (1) SRI funds might choose firms with better environmental and social conduct; (2) SRI funds might actively work to improve the environmental and social conduct of the companies in their portfolio; or (3) SRI funds might greenwash. Put differently, they might advertise and promote themselves as SRI but de facto do nothing (or close to nothing). Most SRI funds claim they both select ‘good’ firms and push firms to consider environmental and social goals more favorably; however, to date, there is little empirical evidence on this.

Our paper, Does Socially Responsible Investing Change Firm Behavior? contributes to this debate by examining these three possibilities. That is, we examine whether SRI funds choose firms with good environmental and social conduct or whether they cause their portfolio firms to improve environmental and social conduct.

We examine comprehensive micro-level data on the environmental and social conduct of U.S. firms from 2010 to 2019. Specifically, we examine firms’ pollution using detailed data from the Environmental Protection Agency. We also examine employee welfare using data on employee satisfaction from Glassdoor, Inc. and data on workplace accidents from the Department of Labor. Finally, we examine gender and ethnic diversity on the board of directors, and customer satisfaction using data from the Consumer Financial Protection Bureau. Across a variety of tests, we find consistent evidence that SRI funds do select companies with better environmental and social conduct. On average, SRI funds hold firms that pollute significantly less and that invest more in pollution abatements. Furthermore, SRI funds hold firms that have higher employee satisfaction (e.g., better corporate culture, better career opportunities and compensation benefits), and fewer workplace accidents. Finally, firms in SRI funds’ portfolios have greater gender and ethnic diversity on the board of directors. In sum, SRI funds offer their investors a portfolio of firms with higher environmental and social standards.

However, we find that SRI funds do not improve the environmental or social conduct of their portfolio firms. We develop a new research design that allows us to examine plausibly random variation in SRI fund ownership. We find that changes in SRI fund ownership are followed by zero improvements in their portfolio firms’ environmental or social conduct. In additional tests, we verify that these zero findings are not due to statistical issues, insufficiently long horizon, or fund ownership stake. SRI fund investment reliably has no effect on the conduct of their portfolio firms.

Why do we find no effect? In further tests, we do find that SRI funds, on average, vote more in favor of shareholder proposals on environmental and social issues than non-SRI funds. Thus, it appears that these funds are trying to affect firms’ behavior. But to date, their attempts have little effect. It can also be argued that they are not trying hard enough (see the counter example of Engine #1 involvement in affecting Exxon’s environmental behavior; even with a very small equity share, it is possible to have an impact if there is a will). It is possible that SRI funds primarily try to achieve their objective through portfolio selection rather than changing firm behavior—this is consistent with incentives: investors are happy when their dollars are invested in green companies, and firm managers do not have to drastically change their corporate policy. Moreover, investing in green companies tends to attract investor flows, which boost fund managers’ compensation. Overall, our results suggest that SRI funds, on average, invest in companies with better environmental and social behavior, but they do not cause companies to behave better. Additional regulatory scrutiny, or a different model of stakeholder capitalism, may be required if investors want to change corporate conduct.

The complete paper is available for download here.

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