Values and Finance: A Study of Socially Responsible Investing

Princeton University, Princeton NJ

Investigators

Abstract

The proposal will study the economics of socially responsible investing (SRI). Socially responsible investors are motivated not only by returns but also trade off concerns about values (e.g. ethics or concern for the environment) associated with their investments. As a result, these investors discriminate against (support) the shares of companies they deem irresponsible responsible) as a means of encouraging firms to change policies. SRI has been met in the market place by manager-initiated programs, broadly known as corporate social responsibility (CSR), designed to maximize not only shareholder value but also the welfare of other stakeholders (e.g. workers and neighbors). SRI can be thought of as a market-driven initiative to provide firms with incentives to internalize externalities. There is little research on the demand for SRI, the supply of CSR and efficacy of SRI in influencing stock prices and bringing about changes in firm policies. The proposal is comprised of three papers. The first paper measures the importance of political values on the demand for SRI using data on the political contributions and stock holdings of US mutual fund and hedge fund managers. The idea is that Democratic values are more pro-SRI than Republicans values. As such, the main hypothesis is that managers who donate to Democrats (presumably sharing Democratic values) under-weight (relative to non-donors or Republican donors) stocks that are deemed socially irresponsible (e.g. tobacco, guns and defense, natural resources). This study also examines whether these values imply that Democratic managers are more long-termist with their socially responsible stocks. The second paper examines the asset pricing implications of SRI using an international crosssection of stocks with commercially available scores for their corporate social responsibility. The PI will test three hypotheses. First, do institutional investors tilt towards socially responsible stocks or do they just avoid irresponsible ones? Second, if there is indeed a tilt, do socially responsible companies receive a higher stock price? And third, if SRI investors are more long-termist, then are these firm's stock prices more stable in the sense of being less sensitive to poor performance? The third paper examines the determinants of CSR activities through the lens of three distinct economic channels. The first is that CSR is a firm's attempt, like investor relations, to improve its cost of capital. The key prediction is that firms (particularly equity dependent ones) which suffer a decrease in stock price or exit of institutional investors respond with an increase in CSR activities. The second is that SRI influences CSR behavior through a media and agency channel---managers want to avoid the bad press of corporate social irresponsibility. The key prediction here is that firms with more lax corporate governance (or greater agency issues) are more likely to be socially responsible and this effect ought to be larger for firms that are in the media spotlight. The third is that manager political values themselves matter. This hypothesis, akin to money managers, is that Democratic CEOs are more likely to support CSR. The merit of the proposal largely rests on two grounds. First, SRI is growing in importance around the world. Critics worry that governments are using the SRI-CSR nexus as a means to avoid the regulation needed to deal with difficult environmental and social concerns. CSR is also a dramatic change from the paradigm of maximizing shareholder value. Such concerns require a careful analysis. Second, SRI provides a rich context with which to conduct novel economic analysis on an important topic in economics: the effect of social norms and values on markets.