New research shows that funds with a good track record of social responsibility have attracted more assets. But that is a historical effect; additional fund flows do not lead to further improvements in social responsibility.
There clearly has been a dramatic increase in investor interest in sustainable investing, as evidenced by the fact that by 2020, according to the US SIF Trends Report, there was in excess of $17 trillion in U.S. sustainable investment strategies, topping $40 trillion globally.1
Davidson Heath, Daniele Macciocchi, Roni Michaely and Matthew Ringgenberg contribute to the sustainable investment literature with their May 2021 study, “Does Socially Responsible Investing Change Firm Behavior?” They assembled a novel set of outcome variables designed to measure whether socially responsible investing (SRI) affects different firm stakeholders. Their outcome variables assessed the relation between SRI and firm customers, employees and society in general. In particular, they examined nine different measures of employee satisfaction using data from Glassdoor, three measures of customer satisfaction using data from the Consumer Financial Protection Bureau, two measures of workplace safety using data from the Occupational Safety and Health Administration (OSHA), two measures of diversity on boards of directors using data from BoardEx and Institutional Shareholder Services, and eight different measures of pollution using data from the Environmental Protection Agency. Their data sample covered U.S. open-end mutual funds for the period 2011-2018.
Following is a summary of their findings:
- SRI funds choose to invest in stocks with better environmental and social responsibility. For example, SRI fund ownership is strongly related to lower pollution and an increase in investments in pollution abatement technologies at the firm level.
- Employees at firms with more ownership by SRI funds rated their firm better in nearly every category, including career opportunities, compensation benefits, corporate culture and overall job satisfaction. Using OSHA data, SRI fund ownership was associated with fewer workplace injuries as measured by hospitalizations and amputations.
- Firms with greater SRI ownership have significantly more women on their board of directors and slightly more non-Caucasian board members.
- Greater SRI fund ownership is associated with fewer customer complaints and better relief for complaints, and relief that occurs in a timelier manner.
- SRI fund ownership does not lead to further improvements in environmental or social responsibility – following an exogenous increase in SRI capital allocated to a stock, there was no change in air, land or water pollution, nor any change in workplace safety, employee satisfaction, or gender or racial diversity on corporate boards.
Their findings led Heath, Macciocchi, Michaely and Ringgenberg to conclude that while SRI funds are not engaged in greenwashing (conveying a false impression or providing misleading information about how a company's products are more environmentally sound): “Our results suggest there is a relation between SRI fund ownership and firm behavior, but it is largely driven by selection effects, not treatment effects.” The findings are inconsistent with SRI funds improving the environmental behavior of their portfolio firms. They added: “It is possible that SRI is successful at changing corporate behavior at longer horizons; our results show it is not successful in changing corporate behavior at short- and medium-term horizons measured in months and years.” Finally, they added this caveat: “It is also possible that SRI funds indirectly cause firms to behave differently via the threat of entry or exit. For example, a firm could dramatically reduce its pollution in order to attract capital from SRI funds.”
This is a statement of importance, not just a caveat, because the academic research, including the 2019 study, “Foundations of ESG Investing: How ESG Affects Equity Valuation, Risk, and Performance,” has found that companies that adhere to positive environmental, social and governance principles have lower costs of capital, higher valuations, are less vulnerable to systemic risks and are more profitable. The evidence that a focus on sustainable investment principles leads to lower costs of capital provides companies with the incentive to improve their ESG scores – or they will be at a competitive disadvantage. In addition, research including the 2021 study, “Do High Ability Managers Choose ESG Projects that Create Shareholder Value? Evidence from Employee Opinions,” has demonstrated that improving ESG scores has also been found to improve employee satisfaction. Further, research including the 2020 study, “Environmental Impact Investing,” has found that environmental stringency of green investors pushes companies to reduce their greenhouse gas emissions by raising their cost of capital.
There is mounting evidence that the sustainable investing preferences of investors are having a favorable impact on the behavior of companies, providing them with the incentive to improve their sustainability ratings lest they be at a competitive disadvantage in terms of their cost of capital and ability to attract and retain talent.
Larry Swedroe is the chief research officer for Buckingham Strategic Wealth and Buckingham Strategic Partners.
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1Depending on how you identify ESG assets, those numbers are considerably less.
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New research shows that funds with a good track record of social responsibility have attracted more assets. But that is a historical effect; additional fund flows do not lead to further improvements in social responsibility.