The UN, as part of the Sustainable Development Goals project, argues that although it is widely accepted that “open markets and private enterprise are critical for sustainable development”, governments must be willing to establish “good governance and a conducive operating environment” to allow private enterprise to be “integral partners in… environmental sustainability”. But, this directive leaves open to interpretation how policy makers should engage private enterprise in sustainable development, and what role financial markets have in dictating a firm’s preposition to engage in this type of reform. This paper addresses the response of individual investors to more sustainable behavior by firms, in an effort to inform future policy. It defines investors by type, lays out possible investor responses to Thomas Reuters’ metric of environmental corporate social responsibility (CSR), and then uses empirical methods to measure whether investors reward or penalize socially responsible behavior. As current investor philosophy states that a firm’s ability to undertake action is ultimately delivered by the mandate of its investors, the reaction of investor owners is a critical aspect of designing meaningful and economically-perpetuating environmental policy.
Results/Conclusions
This paper uses two methods to estimate the effect of environmental CSR on stock market returns: a within firm fixed effect model and a portfolio method. Results from the FE model are mixed by region and environmental measure. In North America, there is a small but statistically significant reduction in total stock return (TSR) per one unit increase in resource and emission scores (-.029 and -0.38% points respectively), but no effect for environmental innovation. Likewise, the model predicts that a one unit increase in resource efficiency score reduces TSR by 0.06% points per annum in Asia Pacific. Scores in Europe were generally null.
In the portfolio model, firms are added to a passive portfolio of high environmental CSR performing firms. Versus the broader market, this portfolio underperforms in North America on all measures (the resource portfolio underperformed by 2.7% points). There is no loss of TSR in Asia Pacific from investing in the high CSR model and mixed results in Europe. Since we see different results by measure and by region, this suggests that different policy responses may be effective depending upon whether ethical investors are happy to receive slightly lower returns. These policy options are addressed in the paper.