Do Institutional Investors Drive Corporate Social Responsibility? International Evidence

University of Toronto – Rotman School of Management

University of Utah – Department of Finance

Lukas Roth

University of Alberta – Department of Finance and Statistical Analysis

Hannes F. Wagner

Bocconi University – Department of Finance; Bocconi University – IGIER – Innocenzo Gasparini Institute for Economic Research

December 27, 2015

Abstract:

We examine whether institutional investors affect a firm’s commitment to corporate social responsibility (CSR) for a large sample of firms from 41 countries over the period 2004 through 2013. We focus on environmental and social aspects of CSR, while controlling for firms’ governance levels. We find that institutional ownership is positively associated with firm-level environmental and social commitments. Further, the “color of money” matters. Domestic institutional investors and non-U.S. foreign investors account for these positive associations, while U.S. institutional investors’ holdings are not related to environmental and social scores. Similarly, higher scores are associated with long-term investors such as pension funds but not with hedge funds. Evidence from a quasi-natural experiment shows that institutional ownership causes improvements in environmental scores. Overall, our results suggest that institutional investors, in aggregate, use their ownership stakes to promote good CSR practices around the world.

Do Institutional Investors Drive Corporate Social Responsibility? International Evidence – Introduction

In signing on to these principles, you are publicly committing yourselves to adopt and live up to them. And you are expressing your intent to channel finance in ways that encourage companies and other assets to demonstrate corporate responsibility and sustainability. In short, you have given a vote of confidence to corporate responsibility – not as a luxury, not as an afterthought, not as a goal to be achieved someday, but as an essential practice today.

~ Ban Ki Moon, UN Secretary General Speech at the NYSE announcing the UN Principles for Responsible Investment, and pledges of investors with $2 trillion in AUM to commit to the initiative, April 26, 2006

Many institutional investors tout their attempts to influence publicly traded firms’ environmental and social commitments, also known as corporate social responsibility (CSR) practices. For example, as of 2015, investors with over $59 trillion in assets under management around the world have pledged to follow the UN Principles for Responsible Investment, requiring among other things that they incorporate environmental, social, and governance issues into their investment analysis and decision making and that they are active owners individually and collectively regarding these goals. An important premise behind the push for environmental and social issues to be integrated into the investing process is that these issues may pose substantial risks to individual firms and the ongoing health of economies and society at large. Such concerns may cause institutional investors, who own and will continue to own a large fraction of world equities, to compel managers to lessen these risks.

While statements by institutional investors may generate press coverage, there are also strong arguments for why these investors, in aggregate, might not drive firms to improve their environmental and social (E&S) commitments. Even if investors perceive benefits of E&S commitments, it is difficult to share the costs of active engagement, and the resulting free rider problem limits actual engagement. Investors may also be engaging in cheap talk and not follow pledges with actions. If investors perceive firms’ E&S commitments as potentially reducing risk-adjusted financial return, then investment managers—who are typically judged on financial returns only—as well as the institutional owners themselves—who have fiduciary duties to focus on financial returns—would be justified in just paying lip service. Further, where disagreement amongst a firm’s institutional investors exists regarding the importance of E&S, managers will be less likely to respond to those investors pushing for E&S changes.

To our knowledge, there exists no large-sample work that tests whether institutional investors influence E&S commitments of firms around the world. We use recently available E&S data from Thomson Reuters alongside institutional ownership data from Factset to address this question. Our sample includes 3,277 non-U.S. firms from 41 countries over the period 2004 through 2013. Thomson Reuters provides E&S data through its ASSET4 platform. They collect firm-level measures of E&S commitments from annual reports, corporate sustainability reports, NGOs (non-governmental organizations), and news sources, and package this information so that institutional investors can easily view a firm’s performance for specific E&S items or categories. From these data we construct aggregate environmental and social scores for each firm-year, and we segment these scores into those that are input based (e.g., policies and procedures) and output based (e.g., tons of pollutants). We also take advantage of proprietary summary scores for E&S produced by Thomson Reuters that are made readily available to all investors that use their platform.