Does SRI represent altruism at the expense of financial performance or is it social hypocrisy hidden behind a popular label?

eco

Socially responsible investment is nowadays more and more coveted by investors. In the United States, 1 out of 8 dollars is invested in SRI and in France it represents more than 5 billion dollars in 2014. At comparable profitability, investors seem to favour socially responsible investment. Does SRI represent altruism at the expense of financial performance or is it social hypocrisy hidden behind a popular label?

However, it can be seen that companies that opt for ethics often have lower returns. The idea in this article is to understand how the social rating of a security can affect its financial performance?

 financial performance

According to classical financial theory, the stock market is the place par excellence of financial rationality. Investors selfishly seeking to maximize their own wealth. However, ethical consideration has a real value in terms of utility for investors and influences their choice. By analysing the link between financial performance and the social rating of the securities traded on the market: there is a correlation that is very real.

Why do these ethical considerations interfere with their choice?

The ancient literature shows that investors have real concerns such as the satisfaction of contributing to the public good, the search for recognition or social status so that altruism or selfishness, we can ask ourselves the question.

In addition, socially responsible firms have a lower cost of capital than non-socially responsible firms. However, the market expects a lower expectation of profitability for SR(1) firms so SR prices will move in a downward trend. It is therefore necessary to impose a profitability bonus for unethical companies. For this to happen, it is also necessary that there are a sufficient number of SR investors, otherwise it will have no impact.

To better understand the impact of ethics on company performance, studies have been conducted on the subject.

Two trends emerge. The first is that ethical investors impose constraints on themselves that go beyond simply maximizing financial performance in their portfolios. If the number of ethical investors is large, SR stocks will be under strong pressure, which will drive up prices, so they will be more expensive to buy and there will be less profitability. The second is that investors take into account the change in society that produces ethical standards.

From these studies, two hypotheses were then identified: mixed profitability and financial profitability.

These two hypotheses are based on a model, that of the mathematicians FAMA and FRENCH. The model of the latter is well adapted to represent a world where investors have purely selfish motivations, motivations to maximize their final wealth for a given risk. The model is summarized as follows:

However, if some so-called social investors have specific ethical expectations and accept a financial sacrifice, the model must be modified.

This is the model of mixed rationality. The mixed rationality hypothesis emphasizes investor altruism. It consists in saying that the agent does not compartmentalize his utility function according to his domains. It can be summarized as follows:

with the addition of neither social rating and Em,t the ethical cost of the market per ethical rating point

Faced with the growing ethical sensitivity of stakeholders, there is the possibility of affecting the current or future profitability of companies. Investors therefore assess and take into account this new risk. There is then a risk premium for unethical firms: this is the financial rationality model.

With ei NME and the risk premium factor.

Faced with these two models, the results of studies comparing ethical and unethical funds by inserting the social rating and risk premium into the classic FAMA and FRENCH model have shown:

for study number one, that the sensitivity of the social score to performance affects all companies regardless of their score. There is a difference of 0.9% not significant in the 3 study.
For study number two, based on Pearson’s correlation coefficient to stock market indices of ethical and unethical companies, the result was that ethical factors are less correlated to the market than other factors.
And finally, for study number three on the explanatory capacity of each of the empirical models on profitability, that the ethical note contribute significantly to the explanation of the residues of the risk premium model. But the NME factor as it has been constructed does not capture the full richness of ethical rating.

With ei NME and the risk premium factor.

Faced with these two models, the results of studies comparing ethical and unethical funds by inserting the social rating and risk premium into the classic FAMA and FRENCH model have shown:

for study number one, that the sensitivity of the social score to performance affects all companies regardless of their score. There is a difference of 0.9% not significant in the 3 study.
For study number two, based on Pearson’s correlation coefficient to stock market indices of ethical and unethical companies, the result was that ethical factors are less correlated to the market than other factors.
And finally, for study number three on the explanatory capacity of each of the empirical models on profitability, that the ethical note contribute significantly to the explanation of the residues of the risk premium model. But the NME factor as it has been constructed does not capture the full richness of ethical rating.
Conclusion for mixed rationality, the ethical note explains the performance differentials and for financial rationality: The social bonus does not intervene individually in investors’ decisions. In summary, ethical factors in the market are less correlated to the market than other (unethical) factors.

There is an underperformance of ethical securities that is due more to a financial sacrifice accepted by socially responsible investors to hold ethical securities than to a risk premium required by investors with purely financial rationality to hold securities with high social risk.

However, the results remain insignificant (sample of 50 companies for a 61-month comparison). However, they have an explanatory power. In addition, the gap between ethical and unethical funds is narrowing, so investors are paying less for their commitment.

Marylin BAKOULA

Marylin BAKOULA


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