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Beyond Returns: Investigating the Social and Environmental Impact of Sustainable Investing

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Beyond returns: Investigating the Social and Environmental
Impact of Sustainable Investing
Julian F. Kölbel1,2, Florian Heeb2, Falko Paetzold2, Timo Busch2,3
1MIT Sloan, Cambridge MA, USA
2University of Zurich, Department of Banking and Finance, Center for Sustainable
Finance and Private Wealth (CSP), Plattenstrasse 32, 8032 Zürich, Switzerland
3University of Hamburg, School of Business, Economics and Social Science,
Von-Melle-Park 9, 20146 Hamburg, Germany
This version: November 2018
Abstract
While many studies have examined the financial performance of sustainable investing (SI),
little is known about the social and environmental impact of SI. We address this research gap
in a multi-disciplinary literature review. We begin by developing a definition of investment
impact, and a framework that clarifies the relationship between an investor’s impact on a
company and a company’s impact on the real world. Focusing on investor impact, the literature
review brings together evidence on three mechanisms: shareholder engagement impact, capital
allocation impact, and indirect impacts. We find direct evidence that investors can affect
companies through shareholder engagement, especially when the costs of demanded reforms
are low, investors wield influence, and companies have prior experience with engagement. We
find only indirect evidence for the capital allocation impact, yet studies indicate that this impact
is more likely when SI investors hold a large market share, deviate strongly from the market
portfolio, and focus on assets that are hard to substitute. The capital allocation impact is also
more likely when companies depend on external financing for growth, and when the cost of
conforming with the expectations of SI investors is low. Indirect effects, where investors rely
on intermediaries to influence companies, have little support in the literature. Our results
suggest that investors can increase their impact by expanding engagement efforts, by focusing
on widely shared priority issues, making sure these issues are assessed consistently, and by
targeting markets where external capital is a limiting factor.
JEL Classification: A13, G11, G12, Q51, Q56
Keywords: Sustainable Investment; Impact; Causality; Literature Review; Sustainability
Acknowledgments:
We gratefully acknowledge financial support from the Luc Hoffman Institute. We thank James Gifford,
Jonathan Krakow, Vincent Wolf, Alex Barkawi, Britta Rendlen, Emilio Marti, Raj Thamoteram,
Tillmann Lang, Julia Meyer, David Wood, and Florian Berg for valuable input and discussions. We
would also like to thank participants of the Luc Hoffmann Institute workshop “Shareholder Activism
for Sustainability” on May 28, 2018, and of the Yale Initiative on Sustainable Finance Symposium 2018.
Electronic copy available at: https://ssrn.com/abstract=3289544
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Introduction
Sustainable investing (SI) was originally devised as a tool to improve the world. Historically,
when it was still called ‘responsible investing’, the Quakers divested from businesses
associated with slavery, and colleges divested from companies to protest the South African
apartheid regime (Molthan, 2003). Also today, many investors are attracted to SI by altruistic
motives (Hartzmark and Sussman, 2017; Riedl and Smeets, 2017), expecting that SI will
allow them to make a positive contribution. In line with this desire from investors,
policymakers discuss SI as a mechanism to help realize the UN’s sustainable development
goals (Betti, Consolandi, and Eccles, 2018), as well as to hold back climate change (IPCC,
2014).
Over the last decades, the SI industry has increasingly adopted the so-called ‘business
case’, which emphasizes the financial performance of SI, rather than its social and
environmental contributions (Richardson, 2009). SI has also grown rapidly over the last
decades; some studies estimate that one in four dollars globally is in SI (GSIA, 2016).
Academic research on SI has overwhelmingly embraced the logic of the business case. Over
2000 studies examine the financial outcomes of SI (Friede, Busch, and Bassen, 2015), yet
only a few studies investigate the environmental and social outcomes of SI (see e.g. Rivoli,
2003).
This results in a problematic research gap: while SI is assumed to be a tool to improve
the world, its impact on environmental and social outcomes is unclear. It is unknown, for
instance, whether the enormous growth of SI has contributed in a meaningful way to a
reduction of global greenhouse gas emissions. This knowledge gap has an important ethical
dimension because important goals ought to be pursued with effective means (Singer, 2015).
SI has both the potential to greatly facilitate the achievement of global development goals, as
well as to divert substantial human and financial resources from other, more effective means.
Thus, before investors and policymakers rely on SI as a means to address some of the world’s
greatest challenges, there is an urgent need to investigate the impact of SI.
An important reason for the existence of this research gap is that the issue of
investment impact cuts across disparate disciplines. Relevant studies can be found in
financial economics (Hong and Kacperczyk, 2009), business ethics (Rivoli, 2003), legal
scholarship (Richardson, 2009), and industrial ecology (Koellner et al., 2008). At this point,
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there is no scholarship that investigates investment impact holistically and brings together the
existing evidence that is available on the topic of investment impact.
This review article takes stock of what is currently known about the investment
impact of SI. First, we provide a definition and a framework for investment impact, in order
to clarify the concept and to set the scope of the literature review. We highlight that
investment impact consists of two complementary components, namely investor impact – the
impact of investors on companies and company impact – the impact of companies on the
outcomes that are ultimately desired (Brest and Born, 2013). Focusing on investor impact, we
identify mechanisms through which investor impact can be achieved and review a wide range
of literature that deals with these mechanisms. In doing so, we assess the level of empirical
evidence for these mechanisms and identify the key determinants on which the mechanisms
depend. In the discussion, we draw out the implications of our findings for the current
practice of SI and highlight opportunities to increase the investment impact of SI.
Conceptual Framework
The literature review in this article is focused on investor impact, by which we mean the
impact that investors have on companies. To explain this concept and show how it relates to
the general idea of impact, we begin by developing a conceptual framework that reflects
investment impact as a whole. The framework was developed on the basis of established
concepts from development finance. However, it was adapted and refined in consultation
with practitioners from the SI field. The goal of the framework is to bring conceptual clarity
to the idea of investment impact while also reflecting all the components and mechanisms
that are deemed relevant by practitioners.
The framework illustrated in Figure 1 reflects three key theoretical assumptions about
investment impact. First, impact is defined in terms of the change in social and environmental
parameters. Second, investors affect these social and environmental parameters through
companies they interact with. Third, there are different mechanisms to achieve investment
impact. In the following, we elaborate on these assumptions. The framework is illustrated in
Figure 1.
Definitions
The notion of impact has originally been developed in development finance. The world bank
characterizes impact as “(…) causal effects of a program on an outcome of interest” (Gertler
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et al., 2011). There is a rich literature concerned with impact evaluation, mostly with
applications to development finance and foreign aid (Bamberger, Rugh, and Mabry, 2012). In
this literature, impact is consistently described as having three defining characteristics: (1) it
describes a change against a baseline, (2) it relates to a clearly defined parameter, and (3) it
implies causality. Applying these characteristics to the case of SI, we define investment
impact as “change in a specific social or environmental parameter that is caused by the
actions of an investor”.
We apply the idea of investment impact to sustainable investing (SI), which we define
broadly as “any form of investing that considers environmental, social, and governance
(ESG) information as part of the investment process”. This definition is the lowest common
denominator between the definitions provided by various industry associations (USSIF,
EUROSIF, SSF, EFAMA, PRI) and also consistent with the view of the European Parliament
(European Parliament, 2013).
Figure 1: Framework outlining the components and mechanisms of investment impact
The components of investment impact
Investors affect the real world through the companies they interact with. To reflect this in our
framework, we follow Brest & Born (2013) and split investment impact into two
components. Company impact describes the impact of a company on the natural and social
environment. Investor impact describes the impact of the investor on the company.
Investment impact describes the additional company impact that is due to the activities of an
investor. By altering a company’s impact, an investor can ultimately influence social or
environmental parameters.
Investor
Investment
Approach
Company
Scaling Activities
Change in Activities
World
Change in Relevant
Parameter
Indirect Impacts
Company Impact
Investor Impact
Intermediary
Operations
Products & Services
Capital Allocation
Shareholder
Engagement
Investment Impact
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Consider for example a company that manufactures solar panels and achieves a
certain amount of carbon emission savings with each solar panel sold. The company’s carbon
reductions are equal to the number of solar panels sold times the carbon emission savings per
panel – this is the company impact. Investors can increase this company impact by helping
the company to scale and sell more solar panels. Assume an investor provides capital that
enables the company to double its output – this is the investor impact. The overall investment
impact in this example is the change that the investor caused in the company’s impact on
global carbon emissions.
This example makes clear that investor impact and company impact are
complementary. When a company has zero company impact, investors cannot have an impact
through that company. Likewise, when the investor impact is zero, investors cannot have
impact on the company, regardless of how impactful the company’s activities may be.
Investment impact results only when both investor impact and company impact are present.
The mechanisms for achieving investment impact
Having clarified the components of investment impact, we turn to the mechanisms behind
investment impact. These mechanisms describe how concrete actions by investors and
companies are connected and ultimately result in investment impact. Figure 1 shows the
identified mechanisms for investor impact and company impact as arrows.
Investor impact can be achieved through three primary impact mechanisms: (1)
shareholder engagement impact refers to influencing a company through various
communication mechanisms that are open to investors, such as dialogue and shareholder
votes. (2) capital allocation impact refers to supporting a company by providing capital - or
inhibiting a company by denying the provision of capital. (3) indirect impacts refer to a range
of impacts that investors can have on a company through intermediaries that are not direct
agents of the investor, for example the company’s stakeholders, rating agencies, or other
investors.
Through these mechanisms, investors can achieve two different types of changes in
company activities. Investors can either cause a company to scale its activities, for example
by enabling the company to grow. Alternatively, investors can cause a company to change its
activities, for example by influencing the company to adopt a new technology. Whether such
a changing or scaling of activities propagates into a real-world impact depends in turn on the
impact of these activities - the company impact.
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Company impact can be achieved through two primary mechanisms: (1) directly
through the company’s operations, i.e., its emissions, its employees, and its resource
consumption, and (2) indirectly through the products and services the company provides or
purchases.
We acknowledge two limitations of this theoretical framework. First, investors could
have impact not only through companies, but also through other investable entities such as
countries, or real estate projects. While the impact mechanisms may be similar for these
cases, we did not consider these cases explicitly in the literature review, and our conclusions
do not necessarily apply. Second, investors may also have impact while bypassing companies
or other investable entities altogether, for example through direct engagement with
regulators. While this could be an effective measure to have impact, we exclude these types
of direct impacts, because actions such as lobbying are not uniquely available to investors.
Methodology
Scope of the literature review
The literature review is focused on investor impact, based on three considerations. First,
investor impact immediately speaks to the investment activities of sustainable investors and
has the most direct implications for sustainable investors. Second, the literature on company
impacts is very broad, as company impacts differ enormously for each industry and context.
As a result, a thorough review of the literature dealing with company impact would be
beyond the scope of this paper. Third, rating agencies are already developing measures for
company impact, whereas the concept of investor impact is still widely ignored in practice.
The aim of the literature review is to identify and to bring together the available stock
of scientific knowledge on each of the three mechanisms of investor impact. We then analyze
these stocks of knowledge in two specific ways. First, we assess the empirical evidence om
each of the mechanisms. Second, we identify the key determinants on which the effectiveness
of the mechanisms depends.
We conduct a multi-disciplinary literature review, given that the concept of investor
impact cuts across disparate literature streams. For each mechanism, we searched academic
databases for suitable keywords. We extended this range by also searching for central
concepts and keywords contained within identified articles. For example, the concept of
“stock price elasticity” was identified as an important theoretical basis for the capital
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allocation impact, directing our search towards a large body of literature dealing with stock
price elasticity. This approach ensured that we could identify all articles that are important for
the various mechanisms, even if they use different terms to describe the mechanisms, or deal
only with essential aspects of the mechanisms in our framework.
Using this approach, we identified a total of 51 relevant articles from a range of
different disciplines. The capital allocation impact is dealt with mostly in the financial
economics literature, specifically asset pricing and corporate finance. The shareholder
engagement impact is dealt with mostly in the corporate governance literature, as well as in
management science. The indirect effects are dealt with primarily in business ethics,
management science, and sociology.
Literature Review
Shareholder engagement impact
Shareholder engagement refers to actions undertaken by shareholders with the intention of
changing a company’s activities. This includes the right to vote on shareholder proposals
during annual general meetings, discussions during informal meetings with management, as
well as criticizing corporate practices in news outlets.
The impact of shareholder engagement is relatively straightforward to trace. An
investor requests a company to implement a certain change, and the investee either follows
through or not. There are four empirical studies that analyze the extent to which companies
comply with shareholder engagement requests (Barko, Cremers, and Renneboog, 2017;
Dimson, Karakaş, and Li, 2015, 2018; Hoepner et al., 2016).
Dimson et al. (2015), analyzing a dataset of over 2152 shareholder engagement
requests between 1999 and 2009, report that 18% were successful in the sense that the
request was implemented by the company. Hoepner et al. (2016) report a success rate of 28%
in a dataset of 682 engagements between 2005 and 2014. Expanding on these results, Barko
et al. (2017) report a success rate of 60% in a sample of 847 engagements between 2005 and
2014. Dimson et al. (2018) report a success rate of 42% in a sample of 1,671 engagements
between 2007 and 2017. Together, these studies provide strong evidence that shareholder
engagement is an effective mechanism through which investors can change company
activities.
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The success probability of any particular shareholder engagement depends on a host
of determinants related to characteristics of the engagement request, the engaged company,
the engaging investor, and the specific process of engagement (Goranova and Ryan, 2014).
The studies reviewed above highlight three specific determinants that have an important
influence on the average rate of success.
The first determinant is the cost of the reform that is associated with complying with
the engagement request. A consistent finding of the reviewed studies is that requests in the
environmental domain tend to have lower success rates compared to requests in the social
domain, and requests in the corporate governance domain have the highest rate of success.
Dimson et al. (2015) attribute this to the fact that reforms in the environmental domain are
likely to be more costly than in the governance domain. More explicitly, Barko et al. (2017)
show that material requests that require some form of reorganization have lower success rates
compared to less material requests. Taken together, these findings indicate that the chances of
success decrease with the costs of the requested reform.
The second determinant is investor influence. There is evidence that engagement
requests are more likely to succeed, when the engaging shareholder holds a larger share of the
targeted company (Dimson et al., 2015, 2018). However, investor influence increases not
only with the size of the holdings. Dimson et al., (2018) find that a group of engaging
investors has more influence when the engagement is spearheaded by an investor that is from
the same country as the engaged company, suggesting that linguistic and cultural aspects may
play a role as well. Additionally, the chances of success rise when asset managers that are
large and internationally renowned are part of the group of engaging investors.
The third determinant is the company’s level of ESG experience. The success rate of
engagement is higher with companies that have previously complied with engagement
requests (Barko et al., 2017; Dimson et al., 2015). Furthermore, companies that have high
ESG ratings prior to the engagement are more likely to comply with engagement requests
(Barko et al., 2017).
Taken together, these studies provide strong evidence that shareholder engagement
exerts a significant influence on companies. The impact of shareholder engagement depends
on the cost of the requested reform, on the investor’s influence, and on the company’s level of
ESG experience.
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Capital allocation impact
The capital allocation impact describes the mechanism where, by allocating capital towards
certain sustainable activities, investors increase the amount of these sustainable activities.
This mechanism is relevant whenever sustainable investors exclude non-sustainable
companies from their portfolios or concentrate their investments in sustainable companies.
While the impact of capital allocation may seem intuitive at first sight, it touches upon a
rather fundamental question, namely to what extent the decisions of investors influence the
course of the real economy.
We were not able to find studies that relate the capital allocation decisions of
sustainable investors to corporate investment activities or operational practices. Hence, direct
empirical evidence for the capital allocation impact is lacking. However, several strands of
literature cover central aspects of capital allocation impact and indicate determinants on
which it depends. We structure the review of the literature along the questions: 1) How do
investment decisions of sustainable investors influence asset prices? 2) How do changes in
asset prices influence companies’ activities?
The effect of investment decisions on asset prices
Two empirical studies, which investigate sustainability preferences in stock markets, come to
opposing conclusions regarding the effect on share prices. Hong and Kacperczyk (2009)
examine the effect of investors excluding “sin stocks”, such as tobacco, alcohol, and
gambling from their portfolio. They show that sin stocks have depressed share prices and
exhibit outperformance of 2.5% per year, relative to comparable stocks. This result implies
that the moral aversions of investors against sin companies have decreased stock prices of
these companies. At the same time, a related study focusing on the effects of divestment in
the context of the South Africa boycotts in the 1980s, concludes that the divestments had no
discernible effects on asset prices (Teoh, Welch, and Wazzan, 1996).
Recent studies on green bonds, i.e., bonds that are issued to finance projects with
environmental benefits, show that the sustainability preferences of investors can influence
bond prices. Baker et al. (2018) find that at issue, yields of green bonds are on average 0.06%
below the yields of comparable bonds. They present supporting evidence that the observed
differences are caused by non-financial preferences of investors. Similarly, Zerbib (2019)
show that sustainability preferences of investors result in a negative yield premium of 0.02%
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for green bonds. Also, Hachenberg and Schiereck (2018) confirm that green bonds are traded
with a negative yield premium.
Taken together, these studies provide evidence that non-financial preferences of
investors can affect asset prices. However, the results differ substantially in terms of effect
size and do not reveal the determinants of the effect size. To understand these determinants
better, we review additional strands of literature within financial economics.
One insightful perspective comes from a theoretical literature that considers the
consequences of investor tastes in equilibrium models. Following the efficent market
hypothesis, i.e., assuming full rationality and information of all market participants as well as
the absence of transaction costs, prices should purely be defined by fundamentals (Fama,
1970). However, several studies show that the existence of non-financial tastes can distort
asset prices, in otherwise efficient markets. Based on standard asset pricing models, Fama
and French (2007) argue that taste-neutral investors require a premium for balancing out the
portfolio choices of investors sharing a particular taste because it forces the neutral investors
to deviate from the market portfolio
1
. The impact of sustainable investors’ tastes on asset
prices has been explicitly modeled in three papers (Beltratti, 2005; Heinkel, Kraus, and
Zechner, 2001; Luo and Balvers, 2017).
In accordance with the predictions of Fama and French (2007), all three models show
that there are two main determinants on the effect of sustainability tastes on asset prices.
First, the total effect size, as well as marginal effect size per additional dollar increases with
the fraction of wealth commanded by sustainable investors. Hence the effect of an individual
investor’s decisions depends on how many others invest according to the same non-financial
preferences. Second, the effect is weaker when a company or industry is easily substitutable
1
Fama and French (2007) also show that disagreement among investors on the probability
distributions of future payoffs leads basically to the same price distortions as non-financial tastes of
investors. The only difference is that the effects of taste on asset prices are persistent, while the effects
of disagreement eventually disappear once the actual development of cash flows is revealed. Hence,
the model suggests, for example, that investors, who believe that oil stocks are overpriced given
regulatory efforts to limit global warming have the same effect on prices as investors who think oil
stocks are ethically unacceptable – until it becomes evident whether oil stocks are indeed overpriced.
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from a portfolio diversification perspective, e.g., if its returns are strongly correlated with
business cycles.
Another perspective is provided by empirical studies of stock price elasticity. These
studies confirm that non-fundamentally driven changes in demand can influence stock prices.
A large set of studies make use of the fact that, due to passive investors, the inclusion or
exclusion of companies to or from popular indexes triggers substantial investments in or
divestments from these firms. Several studies focus on the S&P 500 index (e.g., Beneish and
Wahley, 1996; Lynch and Mendenhall, 1997; Shleifer, 1986; Wurgler and Zhuravskaya,
2002). Kaul, Mehrotra, and Morck (2000) make use of a rule change of the TSE 300 index;
Chang, Hong, and Liskovich (2015) focus on additions to the Russel 2000 index, applying a
regression discontinuity approach. These studies find that the observed sudden changes in
demand do affect stock prices and that, hence, demand curves for stock slope down. Studies
that make use of order-books (Ahern, 2014), announcements of equity issues (Loderer,
Cooney, and Van Drunen, 1991) or auction repurchases (Bagwell, 1992) come to similar
conclusions as the literature on index inclusions.
There is no consensus on how steep demand curves for stocks are, i.e., how strongly
changes in demand affect share prices. A useful measure for the steepness of demand curves
in stock markets is the price elasticity of demand.
2
Highly negative elasticity values indicate
little influence of changes in demand, whereas less negative values indicate a stronger
influence of demand on prices. The results by Loderer et al. (1991), Kaul et al. (2000),
Wurgler and Zhuravskaya (2002) as well as Ahern (2014) indicate elasticities of around -5 to
-10. The studies by Bagwell (1992), Chang et al. (2015) and Shleifer (1986) indicate lower
elasticities between -1 and -1.5. While these studies do not agree on how strongly share
prices react to changes in demand, price elasticities are higher than, for example, those of
food and non-alcoholic beverages, which range from -0.3 to -0.8 (Andreyeva, Long, and
Brownell, 2010).
2
Price elasticity of demand is defined here as (%ΔQ / % ΔP), where Q is the quantity of the
demanded good and P it’s price. As for stocks, supply curves are vertical, Q can be interpreted as
excess demand (Wurgler and Zhuravskaya, 2002). Hence, a price elasticity of -10 implies that a 1%
increase in prices leads to an 10% decrease in demand. Vice versa, an increase in demand by 10%
would be associated with a 1% increase in prices. The elasticity of flat demand curve would be
negative infinity; and changes in demand would not affect prices.
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Only a few studies investigate demand effects in private markets, such as markets for
private equity and venture capital. Gompers and Lerner (2000) show that a doubling of
inflows of capital increases the valuation of new investments of venture capital funds
between 7% and 21%. This would correspond to an elasticity of -5 to -14. Diller and Kaserer
(2009) confirm that demand effects influence private equity funds’ return.
Both Wurgler and Zhuravskaya (2002) and Ahern (2014) find that stocks with low
substitutability show a lower price elasticity. This implies that prices for stocks that are not
easily replaceable with similar assets react stronger to changes in demand. This is in line with
the findings derived from equilibrium models, as reported above.
The effect of changes in asset prices on corporate activities
Even if the preferences of sustainable investors succeed to alter asset prices, this may not
necessarily translate into changes in corporate activities. So far, there is no empirical
evidence that the capital allocation decisions of sustainable investors have affected corporate
activities. However, the reviewed literature identifies two general channels how companies
can be affected by changing asset prices: Changes in costs of capital can influence how fast
companies are able to scale their activities, while managerial incentives can cause companies
to change their activities.
The first channel operates via the cost of capital. As stock markets define the cost of
equity capital, they may affect corporate investment activity, as postulated by Fischer and
Merton, (1984). An increase in stock market valuation caused by investor’s taste may make it
more attractive for a company to raise equity capital to implement investment options. Vice
versa, depressed share prices may force companies to reduce investment opportunities.
However, as pointed out by Beltratti (2005), companies shunned on stock markets may shift
towards debt financing if sustainability preferences are not shared by debt investors as well.
Accordingly, Hong and Kacperczyk (2009) show that sin companies seem to rely more on
debt financing, possibly evading the effect.
Empirical work shows that reduced costs of capital do not necessarily translate in
increased corporate investment and growth. Baker et al. (2003) show that the sensitivity of
investment activity to non-fundamental movements in stock prices is only high for firms that
depend on external capital. According to Kaplan and Zingales (1997) many publicly traded
companies do not depend on external capital. Especially large, established companies often
have sufficiently large cash flows to cover investments. In contrast, a series of empirical
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studies show that small firms, young firms, firms operating in less mature financial markets
with weak institutions as well as firms with less tangible assets are more likely to be
restricted in their investment activity by the cost of external financing (Almeida and
Campello, 2007; Beck et al., 2006; Beck, Demirguc-Kunt, and Maksimovic, 2008; Bloom et
al., 2010; Rajan and Zingales, 1996). Especially in developing countries, many small and
medium-sized companies are completely lacking access to external financing (Beck, 2007;
Beck and Demirguc-Kunt, 2006). The finding that many small firms are restricted by the cost
of capital or even access to capital is consistent with the finding that most small companies
use retained earnings, insider finance, and trade credit to finance their investments (Berger
and Udell, 1998; Carpenter and Petersen, 2002). Financing constraints seem to have a
particularly strong inhibiting effect on entrepreneurial activities. Evans and Jovanovic (1989),
as well as Holtz-Eakin, Joulfaian, and Rosen (1994) show that wealthy individuals are much
more likely to become successful entrepreneurs. Hence, the likelihood that changes in asset
prices influence the growth of a company increases with the degree to which a company is
restricted by external financing conditions.
The second channel operates via managerial incentives. Edmans et al. (2012) argue
that when managerial incentives are tied to stock market value, managers will be sensitive to
shifts in the share price of their corporation – regardless of the reliance on external financing.
Thus, if SI leads to a shift in asset prices, conforming to the expectations of sustainable
investors can be profitable (Gollier and Pouget, 2014). The key criterion for this to hold is
that the cost of reform is lower than the expected gain in market valuation. Based on their
equilibrium model, Heinkel et al. (2001) provide a numerical example in which at least 20%
of the market need to apply a common screen, to create the incentives to implement reforms
that cost a company 5% of its annual cash flow.
Summary
While there is evidence that the preferences of sustainable investors can influence asset
prices, so far there is no direct evidence that these changes have altered corporate activities.
However, based on the reviewed literature we can identify a number of factors that make
capital allocation impact more or less likely.
The effect of investor decisions on asset prices increases with the market share of
investors with common non-financial preferences as well as the degree to which the
portfolios of these investors deviate from the market portfolio. It decreases with the
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substitutability of affected assets. Considering these factors, the outperformance of sin stocks
reported by Hong and Kacperczyk (2009) may represent an upper bound for the effect
sustainable investors can have on stock prices
3
.
The cost of reform determines whether changes in asset prices provide managerial
incentives to change corporate practices or whether those changes mainly affect the
company’s growth by altering its cost of capital. The likelihood of whether a company’s
growth is influenced by changes in the cost of capital decreases with the size, age, the
tangibility of its assets, as well as the maturity of financial markets it is operating in. For
companies that do not have access to capital markets, such as many small and medium-sized
firms in developing countries, the questions of capital allocation impact is reduced to whether
a company has viable investment options that could be realized with external capital.
Whereas the reviewed studies agree on the direction in which the identified factors
influence the capital allocation effect, the results differ substantially regarding the magnitude
of influence. Thus, while we can say that the capital allocation impact of a given investment
decision depends on the identified determinants, the literature to date does not allow a
quantification of the capital allocation impact.
Indirect Impacts
Next to the impacts of shareholder engagement and capital allocation, investors may also
influence companies indirectly through intermediaries. We identified four different indirect
impact mechanisms: stigmatization impact, endorsement impact, benchmarking impact, and
demonstration impact.
Stigmatization impact
Investors can stigmatize a company by divesting the company’s assets or categorically
excluding it from their portfolio. Apart from a capital allocation impact that this might have,
3
The aversion against sin stocks is arguably one of the most widely shared non-
financial preferences among investors. At the same time the returns of sin stocks are largely
independent of business cycles, and thus sin stocks are not easily substitutable in a diversified
portfolio.
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the action can also impact other relevant stakeholders of the company. For example, people
might be deterred from working at a company that is excluded by investors. Literature on this
stigmatization impact, however, is thin. In a detailed assessment of the carbon divestment
movement, Ansar, Caldecott, and Tilbury (2013) postulate that one of its most important
impacts might be the stigmatization of the fossil fuel industry. For the anti-apartheid
divestment campaign, there is anecdotal evidence that it helped to lift the issue of Apartheit
on the political agenda. Desmond Tutu, South African archbishop and an important figure in
the struggle against the Apartheid regime commented that the disinvestment campaign in the
US added punch to their political struggle (Knight, 1990). However, we were not able to find
studies that analyze to what extent exclusion decisions by sustainable investors have lead to
stigmatization.
Endorsement impact
Investors can endorse companies for their social or environmental performance by including
them in their portfolio or sustainability index. Such an endorsement may help to increase the
visibility and reputation of a company, indirectly helping the company to gain customers or
motivate employees. We were not able to identify studies that analyze to what extent
company reputation was improved as a consequence of investor endorsement. There are two
studies, however, that investigate whether companies that were included in a sustainability
index decided subsequently to communicate this inclusion to stakeholders (Carlos and Lewis,
2018; Searcy and Elkhawas, 2012). The fact that companies communicate index inclusion
suggests that such an inclusion helps to improve reputation, yet the studies do not investigate
the magnitude of this impact. They show, however, that nearly half of the companies that
were included in the Dow Jones Sustainability Index chose not to communicate their
inclusion publicly. Carlos and Lewis (2018) find that companies are more likely to remain
silent about their index membership, when they have a strong reputation for ESG
performance already. Thus, one important determinant of the endorsement effect seems to be
a company’s prior ESG reputation.
Benchmarking impact
SI is feeding a growing industry of ESG rating agencies. These rating agencies develop
standards, create ESG benchmarks, and request increasing amounts of data from companies.
The growth of this industry is likely to encourage companies to report on their practices, in
order to satisfy the increasing data demands. Measuring and reporting may then also induce
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16
companies to improve their performance, for example because companies are benchmarked
against peers.
The literature provides no direct evidence that investors have impact via their support
of ESG rating agencies. However, a number of studies have investigated the impact of
standards and ratings on social and environmental performance. Regarding standards, there is
one study that concludes that the introduction of the voluntary ISO 14000 standard for
environmental management has led firms to improve their environmental outcomes (Melnyk,
Sroufe, and Calantone, 2003). Another study, however, concludes the adoption of this
standard had no discernible effect on environmental outcomes (Hertin et al., 2008).
Studying ESG benchmarks specifically, Chatterji and Toffel (2010) provide evidence
that companies improve environmental performance in response to receiving a low rank in an
environmental benchmark. They find this especially to be the case when the cost of reform is
low, and when the industry operates in a highly regulated industry. A problem with this effect,
however, is that there are remarkable differences between ESG benchmarks compiled by
different agencies (Chatterji et al., 2016). Due to these differences, the authors conclude that
“SRI ratings will have a limited impact on driving rated firms toward any particular shared
behaviors”. One important determinant of the effectiveness of the benchmarking impact is
thus the consistency of ESG benchmarks.
Demonstration impact
One investor engaging in SI may encourage other investors to do the same so that the original
investor has an indirect effect through those additional investors. While exactly this
“mainstreaming” of SI was a key goal of industry associations such as the Principles for
Responsible Investing (PRI), we found no research documenting such a demonstration effect
in the context of SI.
Summary
In summary, there is no direct empirical evidence for any of the considered indirect impacts.
This is not surprising, given that indirect impacts are difficult to measure. By definition, they
involve an additional intermediary, so that both the investor’s impact on that intermediary as
well as the impact of the intermediary on the company need to be considered. As a result,
indirect impacts could be relevant, but they are inherently uncertain and hard to measure.
We find no concrete evidence for the stigmatization impact and the demonstration
impact. Parts of the endorsement impact and the benchmarking impact have been studied, and
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17
these studies revealed two determinants. Endorsement impacts are likely to be more relevant
for companies with low ESG reputations. Benchmarking impacts are likely to be more
relevant, when different ESG benchmarks are consistent.
Discussion
Academic literature has shown enormous interest in SI, most prominently under the theme of
‘doing good by doing well’. However, this literature has almost exclusively focused on the
‘doing well’ part, and hardly investigated the ‘doing good’ part so far. This is problematic
because the central motivation to study the financial performance of SI is the assumption that
it has a positive impact. If SI did not have at least some social and environmental benefits, its
financial performance would be quite irrelevant from a scholarly point of view. The
assumption that SI has positive impact, however, should not be taken for granted – it needs to
be examined.
This article begins to examine the impact of SI and makes three central contributions
in doing so. First, the article provides a conceptual basis to evaluate the social and
environmental impacts of SI going forward. Second, the article provides a comparison of
different impact mechanisms based on available literature. Third, the article identifies critical
research gaps that need to be closed in order to work towards a quantification of investment
impact. Furthermore, the results of this article have important implications for practitioners,
in particular for data providers and fund managers. In the following, we discuss these points
in detail.
A basis for the evaluation of investment impact
As a first contribution, this article provides a basis for evaluating investment impact going
forward. It provides a definition and a framework of investment impact, specifying what is
meant with ‘doing good’ in the context of SI. The definition is parsimonious and flexible.
And yet, it introduces key requirements that are suited to constrain the excessive use of the
term ‘impact’, notably that merely analyzing company impact does not provide a measure of
investment impact.
In addition to the definition, this article puts forward a framework that clarifies the
key steps and mechanisms that comprise investment impact. This framework may serve to
structure the discussion about investment impact beyond this article. The article has shown
that the concept of investment impact cuts across a wide variety of disciplines. This means
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that in order to fully understand investment impacts, financial economists, management
scholars, sociologists, and ecologists will need to collaborate and complement each other.
The framework could support this multi-disciplinary effort by highlighting where different
disciplines can contribute to the overall understanding of investment impact.
Assessment and comparison of investor impact mechanisms
As a second contribution, the article provides a comprehensive assessment and comparison of
the identified investor impact mechanisms, based on the current academic literature. In
particular, the article compares the level of empirical evidence supporting the mechanisms
and identifies the key determinants on which the different impact mechanisms depend. These
key results are summarized in Table 1.
Shareholder engagement emerges from the literature review as a relatively certain
way to achieve impact. Several studies provide direct evidence that investors have impact on
company activities through shareholder engagement. The studies also identify three key
determinants. The investor impact of shareholder engagement increases with the influence of
the engaging investor and the ESG experience of the engaged company. The investor impact
decreases with the cost of the requested reforms. Shareholder engagement is therefore suited
as a mechanism that reliably results in impacts, which investors could quantify and
communicate.
The capital allocation impact emerges from the literature review as a somewhat
uncertain way to achieve impact since the literature provides no direct evidence that SI
influences company activities through capital allocation. However, its individual parts have
been analyzed in detail and are relatively well understood. As a result, there are clear
indications regarding the determinants on which capital allocation impacts depend. The
capital allocation impact increases with the share of sustainable investors having the same
sustainability preferences, the extent to which these preferences results in deviations from the
market portfolio, and the company’s dependency on external capital. The capital allocation
impact diminishes with the substitutability of the assets that are under- or overweighted as
well as with the cost of reform. Given the lack of direct quantitative evidence, the capital
allocation effect could range between substantial and negligible, depending on these
determinants.
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Table 1: Comparison of impact mechanisms
Mechanism
Key Determinants
Direct Impacts
Shareholder
Engagement
Impact
1. Investor influence (+)
2. Company’s level of ESG experience (+)
3. Cost of requested reform (-)
Capital
Allocation
Impact
1. Market share of SI investors (+)
2. Deviation from market portfolio (+)
3. Substitutability (-)
4. Cost of reform (-)
5. Dependence on external capital (+)
Indirect Impacts
Stigmatization
Impact
Endorsement
Impact
1. ESG reputation prior to endorsement (-)
Benchmarking
Impact
1. Consistency of ESG benchmarks (+)
Demonstration
Impact
Finally, indirect impacts emerge as very uncertain from the literature review. By
definition, indirect impacts are routed through an additional intermediary, which prolongs the
causal chain between an investors action and its effect on a company. While there is
anecdotal evidence for indirect impacts, none of these impacts has been analyzed
comprehensively, in the sense that the action of an investor was related to company activities.
There is no empirical evidence for the stigmatization and the demonstration impact. There is
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partial evidence for the endorsement and the benchmarking impact. Endorsements are likely
to be more valuable when the endorsed company has a low ESG reputation. Benchmarking is
likely to be more effective when different ESG benchmarks are consistent, i.e. they identify
the same laggards and leaders. It’s important to note that the evidence on these indirect
impacts is only partial, there may be additional determinants that have not been identified yet.
Research gaps
As a third contribution, this article identifies critical research gaps that inhibit SI funds from
monitoring and increasing their investment impact. Regarding shareholder engagement, an
important practical research question is how to report the impact of engagement activities. A
handful of empirical studies have shown that it is feasible to quantify impact. A next step
could be to formulate reporting guidelines to ensure that these impacts are comparable across
different cases and regions and can be reported in a standardized and understandable format.
Regarding capital allocation impact, there is currently no empirical study that relates
capital allocation decisions by sustainable investors to corporate investment decisions. Hong
& Kacperczyk (2009) point out that while their study demonstrates an effect on the share
prices of tobacco companies, it does not investigate the effects on the activities of tobacco
companies. Studies that relate SI activities not only to asset prices but also investigate the
response of affected companies in terms of management and investment decisions would
advance the understanding of investor impact decisively because it would provide direct
evidence of investor impact through capital allocation.
Regarding indirect impact, there is a need for studies that investigate the entire causal
chain of indirect impacts. Existing studies document indirect impacts only partially. Due to
their complexity, indirect impacts are suited for qualitative research methods. Comprehensive
case studies that carefully trace indirect impact mechanisms could provide important
guidance when indirect impacts matter and in which way they could be pursued most
fruitfully.
Implications
Our results have important practical implications for the SI industry. First, it suggests that
data providers have an important role in developing impact measures that reflect company
impact and investment impact. Second, the article points out concrete ways in which
investors and fund managers could evolve the current practice of SI towards greater
investment impact.
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The key data providers of the SI industry are the so-called environmental, social, and
governance (ESG) rating agencies. ESG rating agencies, such as MSCI, Sustainalytics, or ISS
have developed comprehensive datasets that reflect companies’ sustainability performance
across a wide spectrum. Portfolios of SI funds tend to overweight companies with good ESG
ratings and underweight companies with poor ESG ratings. SI funds are also benchmarked
regarding their portfolio-weighted ESG ratings, such as the Morning Star Sustainability
rating. As a result, ESG ratings play an important role in guiding SI decisions.
Recently, several ESG data providers have begun to develop impact metrics that relate
company performance to wider outcomes such as the United Nations’ Sustainable
Development Goals (see e.g. Vörösmarty et al., 2018). These efforts are a very important step
to guide SI towards greater impact. And yet, these metrics are incomplete as long as they are
focused only on company impact and do not reflect investor impact.
At the portfolio level, metrics that exclusively consider company impacts result in
misleading assessments of a fund’s overall investment impact. Such metrics do not
distinguish between funds that have a major investor impact, and funds that have negligible
investor impact. As a result, a fund that successfully induces emission intensive companies to
improve their practices may appear to have less impact than a fund that simply has exposure
to companies that already have these practices in place. As a result, metrics based only on
company impact cannot indicate a fund’s overall investment impact.
Therefore, ESG data providers should complement their assessments of company
impacts with an assessment of investor impact. This article provides an initial overview of the
relevant mechanisms and determinants that would be relevant for such an investor impact
assessment. While estimating investor impact will require investment in novel
methodologies, developing these methodologies may be attractive due to their scalability:
company impacts require different methodologies for each industry, investor impacts apply
generally to any investment.
For investors and fund managers, the article points to a number of concrete ways in
which the impact of current approaches to SI could be increased. While SI is a diverse
industry and any investment has some impact in principle, the bulk of SI assets is currently
invested in ways that promise relatively modest and perhaps even negligible investment
impact. In the US, only 10% of SI assets are associated with shareholder engagement (USSIF,
2018), meaning that the most reliable impact mechanism is only rarely used. Also, the capital
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allocation impact may not be very relevant in practice. Frequently, SI funds focus on the
stocks and bonds of large established companies that are least sensitive to capital allocation
impacts. In addition, while the overall market share of SI assets is growing, it is diluted by
disagreement about which companies are the most and least sustainable (Chatterji et al.,
2016). Thus, the current practice of SI offers a number of ways to increase impact.
First, fund managers could expand shareholder engagement activities. A number of
studies identify shareholder engagement as a reliable mechanism to achieve investment
impact. Shareholder engagement is also quite flexible, as it can be combined with most
existing investment approaches. SI funds and service providers already practicing shareholder
engagement could exploit the fact that the impacts of shareholder engagement are measurable
and communicate their actual investment impacts more prominently.
Second, investors could enhance capital allocation impacts by considering the
determinants identified in this article. Regarding market share, sustainable investors could
coordinate and focus on a few, widely shared priority issues and make sure that they are
consistently assessed. The most promising priority issues would be practices that have major
company impact, but which can be implemented by companies at low or even negative costs.
Finally, SI funds might focus on companies and markets where external capital is a limiting
factor, such as small-cap growth stocks in emerging markets.
Third, investors who are convinced that they can have indirect impacts could attempt
to demonstrate these effects. While indirect effects have currently little scientific support, SI
funds could provide examples and proxies that make these effects more tangible. For
instance, investors could measure media attention in response to an exclusion announcement.
Fund managers who launch an innovative product could track the uptake of their innovation
by others to support their demonstration impact. Data providers, finally, could also attempt to
show how their work with companies leads to operational improvements, and share these
findings with the investors that pay for their services.
Finally, the SI industry could profit from adopting a common definition of investment
impact. This article provides a succinct definition, along with a framework that might aid the
practitioner debate around impact. The basic idea that investment impact refers to the
contribution that investors make towards a company’s real-world impact is straightforward. A
clear understanding of investment impact would help to distinguish it from other objectives
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associated with SI, such as risk management or value alignment, and provide essential
support to SI funds that indeed achieve investment impact.
Limitations
We acknowledge three limitations. First, the presented recommendations are based on
qualitative observations. While the literature review allowed us to identify mechanisms and
determinants, we cannot judge the relative importance of some determinants in comparison to
others. Such a quantitative comparison would, however, be an interesting future research
project.
Second, the academic literature is biased towards publicly listed corporations and
stock markets, due to data availability. Accordingly, also this literature review is somewhat
biased towards public stock markets. There are potentially further relevant impact
mechanisms in specific financial markets, such as corporate debt, private equity, bank
lending, and real estate, which are not reflected in this article.
Third, this review article was limited to investor impact, even though company impact
is an equally important component of investment impact. It is challenging to review company
impacts, given that company impacts are very industry specific. Nevertheless, a thorough
review of company impacts would provide a helpful complement to this article.
Conclusion
Increasingly, SI is thought of as a tool to achieve environmental or social outcomes, such as
the United Nation’s sustainable development goals. However, to date there is very little
research that investigates the impacts of SI, creating a wide research gap around a rather
fundamental issue. This article begins to close this research gap by way of a multi-
disciplinary literature review. It makes three specific contributions.
First, the article provides a definition of investment impact, along with a framework
that identifies the central components and mechanisms of investment impact. The framework
highlights that investor impact and company impact are separate but complementary
components of investment impact. For mechanisms of investor impact, the framework
distinguishes shareholder engagement impact, capital allocation impact, and indirect impacts.
Second, the article conducts a systematic literature review of the investor impact
mechanisms. It brings together the available evidence for three impact mechanisms and
identifies for each mechanism the key determinants that increase or decrease investor impact.
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Shareholder engagement emerges as the only impact mechanism that is directly supported in
the literature. There is no direct evidence for the capital allocation impact, but the literature
clearly identifies the determinants on which it depends. Indirect effects have little support in
the literature so far.
Third, the article derives key implications for data providers and SI funds. Data
providers could play an important role in stimulating the impact of SI by providing measures
that reflect both company and investor impact. Investors who want to have impact could
expand shareholder engagement activities and increase their capital allocation impact, for
example by screening for specific corporate practices with low reform costs in unison with a
large coalition of investors, or by focusing on small and medium-sized companies that have
positive company impact but lack access to external capital.
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Electronic copy available at: https://ssrn.com/abstract=3289544
... Julian F. Kölbel et al. stellten in zwei Untersuchungen ebenso fest, dass durch aktives Engagement der soziale und ökologische Impact von Unternehmen maßgeblich stärker ist als die reine Kapitalallokationswirkung von Investitionen (vgl. Kölbel et al. 2018;2020 3, 3/25, 8/36, 9/14). Asset Manager:innen nehmen durch Stimmrechtsausübung auf den Hauptversammlun gen sowie direkter und indirekter Kommunikation mit den Emittent:innen einen wesentlichen Einfluss auf die Unternehmensführungen (vgl. ...
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... Hartzmark and Sussman (2019) show substantial net inflows (outflows) into high-sustainability (low-sustainability) US mutual funds when there is a sudden increase in the transparency of the funds' sustainability ratings, suggesting that environmental performance is a positive fund attribute. Kölbel et al. (2018) find direct evidence that investors can affect companies' environmental performance through shareholder engagement, especially when the costs of demanded reforms are low. Given such a relationship, a number of studies address the question of how financial development in particular equity markets affects CO 2 emissions. ...
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... , includes a set of variables in the extended Kaya formula outlined in Figure 1 and related to CO 2 emissions in the literature (see the discussion in the next section about data). Specifically, we consider the target CO 2 intensity , * as a linear function of those variables in the following expression 6 : ...
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