Sustainable investing, social preferences and ESG commitment
This thesis examines sustainable investment and social preferences of investors and fund managers. The first chapter examines individuals’ social preferences and the potential drivers behind such preferences. Although abundant evidence exists in psychological and sociological studies that show people demonstrate other-regarding behaviors. It is unclear how and whether this is manifested in the economic life of agents. In the first chapter of this thesis, I examine the response of philanthropic flows in the UK and the US to exogenous shocks that potentially motivate or disincentivize giving. I find humanitarian crises, such as an earthquake taking place far from the population being studied, are unlikely to induce strong social preference changes. Whereas there is some evidence that shocks related to environmental protection may result in more charitable donations. In addition, I show that the preference for “fair play” may also manifest in the form of demanding effectiveness and a good reputation from non-profit organizations as individuals reduce donations to scandalous charities. I also show that the extent to which economic agents act altruistically and make donations could depend on the financial benefits of doing so. In Chapter 3, I illustrate that social preferences do not drive sustainable investing (SI) by examining the response of SI flows to the exogenous shocks in Chapter 2 that trigger changes in donation flow. The research design of this analysis is grounded in the theory that considers a philanthropy-conventional investment bundle as an alternative to SI, given their common social preference and risk-return motives. While environmental shocks trigger altruism, as evidenced by a significant effect on granular US and UK charity flows, there is no response in SI. Adverse shocks to charities’ reputation and tax shield benefits also do not affect SI. In addition, the thesis addresses alternative explanations: risk-return effects and institutional and informational differences between SI and philanthropy. Chapter 3 contributes to the increasing body of literature on SI by presenting new evidence on a commonly-assumed argument that, compared to conventional investors, SI investors make decisions based on a different utility function modified by their social preferences. Chapter 4 of this thesis examines differences in portfolio choices between sustainable investing (SI) mutual funds and conventional mutual funds. In line with existing literature, I show preliminary evidence that SI and conventional funds share similar financial characteristics, although labeled differently. Additionally, anecdotal evidence suggests SI funds do not underweight firms that incurred well-publicized ESG scandals. To empirically examine the ESG commitment of SI funds, I employ a difference-in-differences approach to compare portfolio holding changes of SI and conventional funds after ESG controversies. I control for financial interests in rebalancing by categorizing controversies into positive, negative, and insignificant cumulative abnormal returns (CAR). I find that both SI and conventional funds hold their portfolios unchanged when there are clear market reactions to controversies (positive and negative CAR). Conventional and SI funds act in opposite directions when the market disagrees on the stock price implications of ESG controversies, with SI being buyers of controversial firms. I suggest this is because SI funds are motivated by the fact that controversies lead to an increase in ESG ratings. The novelty of this work lies firstly in using the percentage of shares (stake) in companies as an objective measure of portfolio-level ESG commitment of SI funds, as opposed to most existing literature that uses noisy and subjective fund-level ESG ratings. The research design also addresses endogeneity in portfolio decision making by SI/Conventional mutual funds by using firm level “ESG compliance” measured by an objective measure - the number of recent ESG controversies. The findings have important implications for the theoretical underpinnings for SI investing. While most theoretical models assume SI has a distinct taste for ESG, I do not find such empirical evidence regarding ESG controversies. The findings in this thesis suggest that SI fund investors and policy makers should not rely on ratings when evaluating SI fund commitment to ESG using portfolio level ESG ratings.