Does Socially Responsible Investing Work?
Values-driven versus profit-seeking social investors.
BY Jeroen Derwall, Kees Koedijk, Jenke Ter Horsta | July 20, 2010
Socially responsible investing (SRI) has undergone a tremendous development ever since it emerged as a faith-based initiative in the eighteenth century. SRI nowadays attracts the attention of governments, universities, foundations, public pension funds, and mainstream asset managers. Consequently, SRI extended from a religious investment to a broader concept, reflecting a wider range of investment criteria and objectives that meet the needs of different interest groups. These developments have caused confusion about what SRI nowadays constitutes and which purposes it serves.
SRI is typically understood as a “values-driven” investment approach, in which the decision to integrate corporate social responsibility (CSR) criteria into investment decisions is grounded in social and personal values instead of financial considerations.12 This view implies that investors accept a loss of financial performance in exchange for nonfinancial utility derived from the SRI attribute of their investment. But according to the latest wave within the SRI movement, SRI can be seen as a “profit-seeking” approach that accommodates investors in their pursuit of traditional financial goals. The U.S. Social Investment Forum (SIF (2005, p. 2)), for example, defines SRI as “an investment process that considers the social and environmental consequences of investments, both positive and negative, within the context of rigorous financial analysis.”
Understanding which views are borne out in reality is crucial for research that focuses on the implications of SRI for financial markets. On the theory side, researchers have shown that investors who pursue nonfinancial goals affect asset prices and returns differently compared to the traditional wealth-maximizing investor (e.g., Heinkel, Kraus, and Zechner (2001), Fama and French (2007), Statman, Fisher and Anginer (2008), and Hong and Kacperczyk (2009)). The “shunned-stock hypothesis” says that socially controversial stocks have superior returns because they are shunned by values-driven investors who push their prices below those of responsible stocks, all else equal. In contrast, the “errors-in-expectations hypothesis” predicts that socially responsible stocks have higher risk-adjusted returns because the market is slow to recognize the positive impact that strong CSR practices have on companies’ expected future cash flows (e.g., Edmans (2009), Pantzalis and Park (2009)).
On the empirical side, an overwhelming body of research has tested these different predictions. Some evidence points out that socially controversial stocks have earned anomalously positive returns, but other evidence suggests that stocks of companies with high scores on environmental and social responsibility issues outperform companies with low scores. However, studies also conclude that SRI mutual funds neither outperform nor underperform their conventional peers, even after expenses.
In the debate about SRI performance, surprisingly little attention is given to the fact that SRI has over time been shaped by various movements. Much of the confusion emerges from researchers’ implicit assumption that socially responsible investors form a homogeneous group, so that only one SRI doctrine can hold. The main contributions of this paper to the SRI literature are that we suggest that a breakdown of the SRI movement by values-versus-profit orientation solves the puzzling evidence that both controversial stocks and socially responsible stocks have produced anomalously positive returns. From a synthesis and reinterpretation of the SRI literature, we derive that the empirical evidence on SRI performance accords with an SRI movement that consists of both values-driven and profit- seeking investors. We base this insight on a common thread that runs through studies that investigate different motivations among socially responsible investors and their effects on firms’ ownership structure, money flows, and stock prices. Finally, we examine empirically the economic consequences of the suggested segmented SRI market by testing the errors-in- expectations as well as the shunned-stock hypothesis over time. That is, although it is important to acknowledge that motives among socially responsible investors differ, economic logic teaches us that not all views of SRI can co-exist in the long-run. Values-driven motives among investors are arguably pervasive, whereas errors in expectations ultimately disappear as investors learn about the sources of firms’ future cash flow. Read the full paper here.