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The study of socially responsible investing

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There seems to be a buzz about corporate social responsibility–the idea of a company or organization benefiting society and not just maximizing profits. Associate Professor Abhishek Varma in the College of Business, along with two colleagues from other institutions, conducted an empirical study to explore the incentives behind institutional investors making socially responsible financial investments.

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Abhishek Varma

“Our research is not about saving the planet or a means to do social good,” said Varma. “It’s about economic incentives and risk management.” Companies are ranked on the basis of their environmental and social characteristics, which may be valuable for investors looking to assess a company’s environmental and social wellbeing, he explained.

When Varma and his team conducted their research, they weren’t just interested in a niche industry like mutual funds, they were interested in the entire realm of professionally managed assets. They looked at a database for all institutional funds that report their holdings quarterly. And specifically they looked at a general preference for investing in companies that have high environmental social ratings. “What we found was something very interesting,” he said. “It seemed like institutional investors don’t necessarily care about a company having a good rating on an environmental or social parameter. But, they do care if the company has a poor rating.”

“For example, a company that is performing poorly on environmental and social characteristics is probably going to attract regulatory attention later–they could attract legal consequences, poor publicity, etc.,” said Varma. As a result, investors may want to avoid companies with a higher probability of a negative event.

Varma cited Volkswagen and BP as recent examples of companies that have seen negative consequences because of EPA (Environmental Protection Agency) violations. “As a result, these company’s stocks have dipped, and BP has paid out $50 billion in damages,” he said. “That’s a lot of money to pay out in damages.”

Some industries may not have a negative environmental or social rating, but may be considered harmful to society such as tobacco, alcohol, gambling, or nuclear energy. These controversial products may not pose event risks, but are less likely to be owned by some investors due to their controversial nature. “People might argue that nuclear energy is dangerous, and some may argue that it is efficient,” said Varma. “There is a lot of difference in opinion in that regard.”

As an example of economic incentives for institutional ownership of controversial stocks, Varma also noted that firearm stocks have had a bumpy ride. While the Federal Assault Weapons Ban (FAWB) Act was in place from January 2001-August 2004, institutional holding (after controlling for various factors) for the average firearm stocks was about 9.69 percent lower than other stocks. In September 2004, once the FAWB Act expired, the institutional holdings increased 6.63 percent. In December 2012, firearm stocks’ institutional holdings decreased by 9.02 percent after the Sandy Hook school shooting. “Most investment managers don’t want to invest in a company that will suffer those adverse consequences–as is reflected in their ownership patterns,” he added.

When it comes to an individual’s personal investing, a fund family like Fidelity might offer a socially responsible mutual fund. “You might pick this company because it’s a good financial decision, or you can get a non-monetary benefit from investing in something like this because it feeds into your values,” he said. However, their research found that alignment of institutional portfolios with socially responsible investing is most likely driven by risk management and economic motives rather than social values.

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