Do Institutional Investors Drive Corporate Social Responsibility?

Executives of firms face increasing pressure to look beyond profits and to consider their firms' environmental and social impacts. Additionally, firm-level measurement of these impacts has evolved such that investors and other outsiders can easily track firms' E&S performance on the main investment platforms. Yet, whether improved E&S performance is beneficial to the average shareholder remains controversial.

In a recent working paper, we assess whether the environmental and social (E&S) performance of firms worldwide is driven by investors. Across 41 countries, we find that institutional ownership is positively associated with firm-level E&S performance, with multiple tests suggesting a causal relation. These surprising findings matter because they demonstrate that mainstream institutional investors care about E&S issues, and actively push firms to improve their E&S performance. While one might expect activist investors, such as environmental and social impact funds, to push for such changes, we instead find that a broad range of mainstream investors do this.

Next, if money is all the same, and institutional investors are interested only in financial returns, then the cultural origin and social norms of investors should not matter. Instead, we find that cultural origin matters-foreign institutional investors domiciled in countries with social norms supportive of strong E&S commitments are the ones that impact firms' E&S performance. This result suggests that a society's social norms flow through the channel of portfolio investment into firms and provides new evidence on the way in which culture makes its way into economic decision making.

To see the effect we document, compare a Dutch mutual fund investing in a US firm with a US mutual fund investing in a Dutch firm. We find that the Dutch fund, and others like it, will successfully push the US firm towards better environmental and social performance. The US fund instead will not exert any such pressure on the Dutch firm. The rationale for this is that institutional investors cater to the social norms of their constituents. US social norms towards environmental and social issues are relatively weak. When instead social norms towards E&S issues are strong, such as in the Netherlands and throughout Europe, the foreign investor transplants (Dutch) social norms into (US) firms.

From a CEO and firm management standpoint, the success of foreign investors transplanting their social norms into the firms they own adds an additional dimension to the importance of institutional investors. This 'color of money' effect is unlikely to be without conflict-executives of firms from low-social-norm countries would have both social norm and fiduciary duty incentives to push back. Our results help inform the debate about increasing investor power by, for example, giving investors enhanced access to the proxy. To the extent that domestic social norms place less value on E&S performance, calls for enhanced investor power are likely to be challenged by management and domestic regulators.
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