The Good, The Bad, and The Ugly: A Theory of Profitable and Effective Socially Responsible Investments

Transcription

1 The Good, The Bad, and The Ugly: A Theory of Profitable and Effective Socially Responsible Investments Christian Gollier and Sebastien POUGET Toulouse School of Economics Chaire FDIR ( Séminaire Fourgeaud, Direction générale du Trésor, February 13 th, 2013

2 Motivation People and institutions choose socially responsible investments for extra-financial reasons but also for economic reasons The long-term business case for socially responsible investments (SRI) may appear unclear due to lack of consensus concerning financial performance Some studies (e.g., Derwall, Guenster, Bauer, and Koedijk, 2005) suggest that SRI can deliver positive abnormal returns for investors Others (e.g., Hong and Kacperczyk, 2009) suggest that SRI screens are damageable for investment performance in line with the theoretical analysis of Heinkel, Kraus, and Zechner (2001) 2

3 What we do Provide some theoretical underpinnings for SRI industry Financial performance? Change within companies? Analyze the practical implications for SRI industry What type of funds? With which strategy? 3

4 Our approach Set up an asset pricing model for socially responsible assets Study the link between financial markets and corporate decisions via shareholders voting decisions Propose a business model for SRI funds that associates financial performance and changes in corporate behavior Within the SRI industry, engagement strategies and private equity funds can display abnormal returns at equilibrium The washing machine investment strategy 4

5 Profitable SRI? Proposing a model in which SRI investors outperform traditional ones is challenging Consider that CSR pays at the company level, i.e., virtuous firms display higher earnings than vicious firms If one considers that financial markets are informationally efficient Both SRI and traditional investors overweight virtuous firms These funds display identical performances If one considers that financial markets are inefficient Both SRI and traditional investors try and collect information to spot the firms that are mispriced Again, these funds display identical performances 5

6 Profitable SRI There are at least three reasons why SRI might outperform traditional investment funds SRI may be better at spotting the most promising companies because of expertise in extra-financial analysis SRI may be better at anticipating new trends in corporate social responsibility and benefit from the subsequent enthusiasm SRI may implement the washing machine strategy we characterize in this paper 6

7 Literature Other pricing models for socially responsible assets include Heinkel, Kraus, and Zechner (2001) and Barnea, Heinkel, and Kraus (2005) These are models in which investors use negative screens only A model in which SRI do not exclude assets a priori is Barnea, Heinkel, and Kraus (2009) This model deals with the impact of fiscal policy on CSR expenses No explicit link with corporate decision making 7

8 Date 1 Date 2 Date 3 Model Financial market Shareholders meeting Firm s results 8

9 Date 3 Model Firm s results Standard strategy: financial return r = l N(Er,σ 2 ) no externalities Responsible strategy: financial return r - c positive externality e > c 9

10 Date 2 Model Shareholders meeting Strategy choice: standard vs. responsible Vote: simple majority One share = One vote 10

11 Date 1 Model Financial market An initial owner sells his shares 11

12 Date 1 Model Financial market An initial owner sells his shares Socially responsible investors: The Good value r, c and e proportion π 12

13 Date 1 Model Financial market An initial owner sells his shares Socially responsible investors: The Good value r, c and e proportion π Traditional investors: The Bad value r, and c only 13

14 Date 1 Model Financial market An initial owner sells his shares Socially responsible investors: The Good value r, c and e proportion π Traditional investors: The Bad value r, and c only Trading at price P 14

15 Rational expectations equilibrium Corporate strategy? Shareholders vote? Investors demand? Investors holdings? Share price? 15

16 Standard strategy Corporate strategy Standard Standard Strategy chosen if Shareholders vote Investors demand Er - P As 2 p <1/2 Identical Investors holdings Share price P = Er - As 2 16

17 Responsible strategy Corporate strategy Responsible Shareholders vote Investors demand Investors holdings Share price 17

18 Responsible strategy Shareholders vote Corporate strategy Responsible Investors demand Traditional Er - c - P As 2 Responsible Er + e- c - P As 2 Investors holdings Share price 18

19 Responsible strategy Shareholders vote Corporate strategy Responsible Investors demand Traditional Er - c - P As 2 Responsible Er + e- c - P As 2 Investors holdings Share price P = Er + pe-c- As 2 19

20 Responsible strategy Responsible hold more than traditional Shareholders vote Investors holdings Corporate strategy Investors demand Share price Responsible Traditional Er - c - P As 2 Responsible Er + e- c - P As 2 P = Er + pe-c- As 2 20

21 Responsible strategy Responsible strategy chosen if p > 1/2 1+ x with x = 1- p ( )e As 2 Responsible hold more than traditional Shareholders vote Investors holdings Corporate strategy Investors demand Share price Responsible Traditional Er - c - P As 2 Responsible Er + e- c - P As 2 P = Er + pe-c- As 2 21

22 Results so far The responsible strategy is adopted when π > (1/2)/(1+x) Responsible company offers a lower risk-adjusted return than the standard company In line with Hong and Kacperczyk (2009) SRI funds risk adjusted performance is lower than the one of traditional funds but row returns can be higher Helps explaining why empirical results on SRI funds financial performance is unclear see, for example, Bauer, Koedjik, Otten (2005), and Aminc and Le Sourd (2008) Responsible companies market cap is higher than the one of standard companies when πe > c Helps explaining why event studies on CSR are unclear see, for example, Krüger (2009) 22

23 Value creation thanks to engagement When π < (1/2)/(1+x) and πe > c, responsible investors do not hold a majority of shares (the standard strategy is adopted) and the firm is undervalued (with respect to the situation in which the responsible strategy would be chosen) Potential for value creation (both financial and social) 23

24 Date 0 Date 1 Date 2 Date 3 Intervention of a raider Takeover Financial market Shareholders meeting Firm s results 24

25 Date 1 Date 0 Intervention of a raider Takeover Raider makes a take-it or leave-it offer to the initial owner The Ugly Financial market Raider sells back her shares to investors 25

26 Raider s strategy At date 0, raider offers a price Er-Aσ 2 at which the initial owner accepts to sell his shares At date 1, raider could be tempted to sell back all his shares at a price of Er+πe-c-Aσ 2 (which is greater than Er-Aσ 2 ) This strategy is not feasible because, if he sells back all his shares, responsible investors do not have a majority The raider has to keep a part α of the shares such that the responsible strategy is adopted 26

27 Raider s commitment for CSR This strategy is not credible unless the raider votes, at the shareholders meeting, in favor of the responsible strategy If he focuses on financial returns only, he will always favor the standard strategy Hence, a traditional raider cannot intervene and restructure the firm Only a socially responsible raider can at the same time change the strategy of the firm and benefit financially from this change 27

28 An example of raiders commitment On 10/2007, KKR and TPG, two private equity funds, took over TXU (for $45 billion) whose energy mix is mainly based on coal KKR and TPG committed to not build 8 additional coal-firing plants The credibility of this commitment is secured by EDF (Environmental Defense Fund) One of EDF representatives seats on the newly created TXU Sustainable Energy Advisory Board 28

29 Relation with empirical evidence Empirical evidence suggests that responsible companies are more valued on financial markets: Hong and Kacperczyk (2009) on sin stocks Bauer and Hann (2010) on green companies and credit spreads Bauer, Derwall, Hann (2009) on employee relationships and spreads Chava (2011) on green companies and bank loans Dimson, Karakas and Li (2012) show that investment strategies based on engagement on environmental and social issues can generate a 4% positive abnormal return 29

30 Conclusion To benefit from the washing machine strategy, SRI should: Invest in non responsible firms and turn them into responsible Have a long-term orientation Have a credible orientation towards social responsibility Strategy can be implemented Alone by SRI private equity or hedge funds In group by SRI mutual funds or pension funds Two remarks: Investing in non responsible firms raises a reputation issue for SRI It is crucial to check the actual level of social responsibility 30