Dirty Air and Green Investments: The Impact of Pollution Information on Portfolio Allocations

Raymond Fisman is a Slater Family Professor in Behavioral Economics at Boston University. This post is based on a recent paper by Professor Fisman, Professor Pulak Ghosh, Professor Arkodipta Sarkar, and Professor Jian Zhang. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance (discussed on the Forum here) and Does Enlightened Shareholder Value Add Value? (discussed on the Forum here) both by Lucian A. Bebchuk and Roberto Tallarita; How Much Do Investors Care about Social Responsibility? (discussed on the Forum here) by Scott Hirst, Kobi Kastiel, and Tamar Kricheli-Katz; and Companies Should Maximize Shareholder Welfare Not Market Value (discussed on the Forum here) by Oliver Hart and Luigi Zingales.

Globally, investment in so-called ESG (environmental, social, governance) funds has grown exponentially in recent years, far outstripping the rate of growth of assets under management more generally.  Much of the growth and attention has focused on the “E” in ESG, with sustainable investment seen as one mechanism for disciplining firms that generate negative environmental externalities.

There are many potential drivers of this increase – it may reflect return expectations resulting from anticipated climate regulation, a proliferation of ESG funds that service a latent demand for socially responsible investment, or a shift in investor preferences resulting from greater salience and attention to environmental concerns. Yet distinguishing amongst these various explanations is a challenge. For example, the signing of the Paris Agreement on climate change potentially affected all three factors – it gave greater visibility to environmental issues and thus may have impacted investor preferences, signaled to asset management firms a potential market, and also imposed (in theory) binding constraints on companies’ carbon footprints.

In our paper, “Dirty Air and Green Investments: The Impact of Pollution Information on Portfolio Allocations,” we are able to isolate a potential role for investor preferences in driving green investment, by studying the introduction of continuous air quality monitoring stations (CAAQMSs) across India over the past two decades. These stations provide nearby residents with accurate, real-time information on local pollution via, for example, commonly-used smartphone apps and government-sponsored billboards. As a result, pollution becomes more salient for investors close to monitoring stations when they appear, leaving the pollution perceptions of other (more distant) investors unchanged.

We combine information on the CAAQMS rollout with detailed, geocoded data on the portfolios of Indian retail investors. Our data, which include all trades executed on the National Stock Exchange during the years 2004-2020, allows us to explore how investments in “brown” industries like oil and mining shift when pollution thus becomes more salient for investors exposed to CAAQMS information. Specifically, we posit that access to pollution information will make investors more sensitive to air quality by making environmental concerns more salient.

Our main finding is that the appearance of a monitoring station leads to an immediate increase in the sensitivity of investment in brown stocks to air quality. To provide a sense of magnitude, a two standard deviation worsening of air quality (i.e., from moderately good to moderately bad) leads to a 1 percentage point reduction in the fraction of assets held in brown companies by investors within a 20-kilometer radius of the new monitoring station. We observe no such relationship for these investors before the station appears, nor do we observe any such shift for “control” investors located further from the station (40-60 kilometers away – far enough that the pollution readings have little relevance).

To link these patterns more directly to pollution salience, we examine shifts in portfolio allocations around changes in particularly salient shifts in air quality. Specifically, we look at air quality “alert” days when the air quality transitions from Moderate (yellow) to Poor (amber), a change that also triggers government warnings about the health risks posed to the broader population. Using a “regression discontinuity” approach around this air quality cutoff, we show that there is a discrete drop in the share of brown stocks held by investors when air quality shifts from Moderate to Poor.

In a final set of results, we explore heterogeneity in investors’ responses to exposure to air quality information. Given that air quality information from monitoring stations was delivered primarily via a smartphone app, it is interesting to note that we find a bigger effect of monitoring stations among investors who trade via their mobile devices. And in line with greater environmental concern amongst the young and for women, we also observe a bigger impact for younger as well as female investors.

Our findings suggest that investors’ environmental concerns (and possibly social concerns more broadly) may play at least some role in dictating their portfolio allocation decisions. Potentially, we are picking up shifts in behavior that extend well beyond investment behavior, so that highlighting environmental problems may indeed be one step toward their solution. Yet we conclude with two important caveats. First, the effect size we document suggests that making environmental problems salient may ‘nudge’ investors toward brown divestment, but it will hardly be our salvation, given the modest impact on portfolios (a 1 percentage point shift for a relatively substantial change in pollution). Second, we do not confront a broader concern over ESG investment, which is that divestment – rather than actively pushing for change at heavy polluters – may be at best irrelevant and possibly counterproductive. Awareness of social problems may make investors care about them, but addressing environmental and other concerns surely will require broader collective efforts.

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