Since institutional investors own the bulk of the world's equity capital, it is important to understand how they affect the behavior of the companies they invest in. A study of over 3,000 firms across 41 countries by Hannes Wagner (Professor of Finance, Bocconi University) and colleagues shows that they can be a force for good. The study, available online before press (DOI: 10.1016/j.jfineco.2018.08.013) in the Journal of Financial Economics, shows that investors have a positive and causal effect on firms' environmental and social (E&S) performance. Investors, in turn, are motivated both by financial considerations and by social attitudes, to promote these two pillars of corporate social responsibility.
These surprising findings matter because they demonstrate that mainstream institutional investors care about E&S issues, and actively push firms to improve their E&S performance. While one might expect activist investors, such as environmental and social impact funds, to push for such changes, the study instead finds that a broad range of mainstream investors do this.
In particular, the effect is driven by institutional investors from countries with social norms that deem strong E&S performance valuable. These are mostly European countries--they fill the first 17 positions in a country ranking of attitudes towards E&S issues, produced by the authors. Only pension funds, with their long investment horizons, have a positive effect on E&S regardless of their country of origin.
Institutional investors from countries above the median in the E&S ranking improve their companies' environmental performance by 7.4% and social performance by 5.2%.
"We show that the color of money matters", Prof. Wagner says, "and this 'color of money' effect is unlikely to be without conflict". To see this, compare a Dutch mutual fund investing in a US firm with a US mutual fund investing in a Dutch firm. The Dutch fund, and others like it, will successfully push the US firm towards better environmental and social performance--but likely against resistance of US executives. The rationale for this is that the Dutch fund caters to the social norms of its Dutch constituents. Instead, the US fund will not exert any such pressure on the Dutch firm, since US social norms towards environmental and social issues are relatively weak.
"Interestingly", Prof. Wagner says, "we find that institutional investors don't influence the E&S performance by buying shares of good companies and selling those of bad ones, but by engaging with firms they already own. Furthermore, their engagement is private and they turn to public pressure only occasionally, to increase leverage in private negotiations".
The authors single out the financial motivations of investors by using the shock of the global financial crisis as an experiment. Firms with greater institutional ownership pushed harder for improved E&S performance after recognizing the value of E&S during the crisis (companies with high E&S scores proved to be more resilient and performed better in the wake of the financial bust).
The paper also helps inform the recent debate about regulatory changes to deter foreign ownership. The finding that foreign investors, specifically European investors, have a positive effect on corporate social responsibility casts a doubt on the opportunity of such regulations.
Alexander Dyck, Karl Lins, Lukas Roth, Hannes Wagner, Do Institutional Investors Drive Corporate Social Responsibility? International Evidence, forthcoming in the Journal of Financial Economics, DOI: 10.1016/j.jfineco.2018.08.013