Methods that influence individuals’ and organisations’ behaviour by utilising market forces are defined as market-based instruments. Market signals can incentivise such actors to pursue their own self-interest whilst also contributing to the benefit of society, such as environmentally friendly practices (Stavins, 2003). One such instrument is socially responsible investment (SRI). SRI is the explicit investment in a firm acting in a perceived socially responsible manner by the investor, whilst also seeking to make a financial return on public markets (Baker and Nofsinger, 2012). SRI has gone from niche to mainstream (Cowton, 1999; Revelli, 2015): The Forum for Sustainable and Responsible Investment[1] (2017) estimates that $8.72 trillion US-domiciled assets involved SRI at the beginning of 2016; an average annual growth rate of 13.25% since 1995. While SRI encompasses environmental, societal and governance (ESG) factors, this essay will concentrate on its impact on the environment. ESG indicators can be used to evaluate the non-financial practices of firms, formulate investment decisions and create SRI funds (Bassen and Kovacs, 2008). SRI is unique when compared to other traditional market-based instruments: it is borne and maintained by the capital markets and it is underpinned by a combination of ESG metrics, ethical values, and macroeconomic factors; these synergies make SRI a fascinating instrument to explore (Garriga and Melé, 2004).

This essay begins by delineating how the perceptions of the role of firms and investors inform debates surrounding SRI. It will be shown that the literature indicates SRI provides no financial advantage or disadvantage compared to conventional investments. Succeeding this, the reliability and accuracy of ESG data and the motivations of investors will be challenged. Thereafter, it will be shown that there are substantial gaps in the literature vis-à-vis environmental performance because of the fixation on profits. ESG funds and indices will be analysed because it is very easy to justify as SRI compared to individual investors (Wagemans et al., 2013). Crisis and non-crisis financial periods, as well as macroeconomic factors and the role of the state, will not be discussed due to academic constraints.

The SRI mechanism for improving the environment is threefold: mobilising capital via ESG-integrated exclusion/inclusion investments/divestments via positive and negative screenings incentivising firms to adopt environmentally friendly practices to receive more capital, shareholder activism to push for environmentally friendly practices, and as changing the environmental behaviour of firms as a marketing tool via ‘greenwashing’ (Sparkes, 2002). The theoretical debates surrounding the concept of SRI fixate on the perception of the fundamental roles of investors and corporations, reflected in the schism between neoliberal economic and finance theories and stakeholder theory. SRI restructures how companies should be valued and how capital markets should invest by taking in to account non-financial factors (their environmental practices). Inherently, the assumptions of the purpose of a firm are fundamental to the analysis of SRI (Jensen, 2001). The most prominent discussion was sparked by Friedman (1970), who rejected the notion of corporate social responsibility because it imposes restrictions on profit maximisation, thus creating inefficiencies and costs in a capitalist economy. Indeed, “the social responsibility of business is to maximise profits,” not the wider implications of their practices or investments – that is for charities and governments to rectify, not for businesses to establish (p.173). Baumol and Blackman (1991) echo this sentiment, proposing that the inefficiencies that would arise for the firm concentrating on creating social value, in a competitive market, would reduce said firm’s competitiveness and will lose market share to rivals undermining its intentions.

In contrast, stakeholder theory questions the purpose of the firm and the responsibility of managers have to stakeholders (Freeman et al., 2004). This position is summarised by Porter and Kramer (2011), who posit that corporations create shared values, not just profits, and therefore, must incorporate wider society’s values into their decision-making. This perspective has achieved growing traction since the 1980s but rapidly increased in the aftermath of the 2007/8 global financial crisis (Belly and Junkus, 2013). Moreover, Mackey et al. (2007) propose that profit and value maximisation are not mutually exclusive: investing in improving the environment will increase the value of the firm in the long-run, even if financial losses are made in the short-run. SRI is underpinned by these core tenants of stakeholder theory and seeks to maximise societal value, not just profit (Baker and Nofsinger, 2012). Therefore, the perception of the role of a corporation – profit or value maximisation ­– establishes an analytical lens to view and approach the effectiveness of SRI.

SRI is premised on its ability to be at least as financially profitable as conventional investments to succeed. Markowitz’s (1952) portfolio theory – that the most efficient portfolio is a diversified one – alludes to the inefficiencies and lower financial yields highlighted by Friedman and Baumal and Blackman, as the screening constraints prevent investing in profitable ‘sin’ stocks. However, Diltz (1995) proposed that markets are sufficiently efficient to mitigate against such diversification costs. Nevertheless, Hamilton et al. (1993) and Derwall et al. (2011) argue that the efficient market hypothesis renders any advantage or disadvantage of SRI a moot point: there are no mispriced assets in a competitive stock market in the long-run: stocks are correctly priced for their environmental impacts. Empirical studies widely differ in their conclusions because of the heterogeneity of SRI funds, such as size and investment horizon inter alia, as well as data comparison methods and analytical themes by academics (Revelli and Viviani, 2015; Chegut et al., 2011). Revelli and Viviana (2015) proclaim that previous meta-analyses either lacked sophistication (such as Margolis, 2009) and/or had a small sample size (for example, Rathner (2013) used 25 studies). Further, they assert that differences in the literature arise out of ex-ante portfolio constructions to generate a desired result, or different portfolio methods are utilised compared to fund managers due to lack of financing. The major meta-analyses are summarised in Table 1 below, and predominately indicate the SRI is positively correlated, or at least, non-negative, to corporate and stock financial performance. Friede et al.’s (2015) second-order meta-analysis of 60 review studies and 551 primary meta-analysis – over 2200 primary and secondary studies – from 1978 to 2014 identified that approximately 90% of papers significantly illustrated a positive relationship between ESG and financial performance. The nonnegative nature of SRI to financial performance means it can successfully be incorporated into investment strategies, further evidenced by its aforementioned meteoric rise. As Blancard and Monjon (2012) conclude, using online search engines and archive collections of academic journals for keywords related to SRI, academics suffer from the streetlight effect due to the numerous available datasets and that “maybe too much attention has been paid” to SRI’s financial performance and not its theoretical foundations.

Table 1 – Summary of the major meta-analyses of SRI’s financial performance

Author(s) Number of Studies Time Period Geographical Region Conclusion Frooman (1997) 27 (event studies) 1969-1996 US Corporate socially irresponsible behaviour has a substantial statistically significant negative impact on shareholder wealth. In contrast, there is insufficient evidence to suggest socially responsible behaviour in and of itself improves shareholder value. Orlitzky et al. (2003) 52 1972-1997 US Environmental responsibility is significantly positively correlated with corporate financial performance. Margolis et al. (2009) 192 1972-2007 America and Europe Small positive effect of corporate social responsibility on corporate finance performance, which gets smaller the newer the paper. Weighted averages could not be calculated because the studies lacked sophistication and difficulties in quantifying sample sizes. Rathner (2013) 25 1991-2000 US 75% of performance comparisons could not find any significant difference. Consideration of survivorship bias has a significant increase/decrease on the probability of outperformance/under performance. No general conclusions can be drawn from the results. Revelli and Viviana (2015) 85 (and 190 experiments) 1972-2012 International SRI encompasses no financial costs or benefits. Synthetic portfolios may result in selecting best-performing or worst-performing stocks by academics, to promote or discard a ‘green effect’. The age of the paper was statistically insignificant to the results. Friede et al. (2015) 60 (review) and 551 (primary) 1978-2014 International Secondary and primary meta-analyses. ESG relationship with financial performance has been positive and stable over time, even across asset classes and geographical regions. Approximately 90% of the papers were significantly positive. The outperformance of the market is likely in North America and Emerging Markets.

The increase in SRI assets implies this instrument is improving the environment by mobilising capital towards environmentally friendly firms. However, the SRI strategy to improve the environment is only as useful as the ESG metrics utilised (Riedl and Smeets, 2017). Despite the perceived institutionalisation of ESG data, for example, the UN Principles for Responsible Investment and integration with Bloomberg Terminals (Park and Ravenel, 2013) there is no central authority which calculates and allocates ESG scores; ESG metrics are provided by over 100 private intermediaries, such as Thomson Reuters, and are not verified by a third party (Avetisyan and Hockerts, 2016). ESG figures are not universal or standardised, and are computed by secondary data collection from companies, media and non-governmental organisations (NGO) reports, as well as company feedback (Avetisyan and Ferrary, 2013; Huber et al., 2017). Hypothetically, ESG data should be similar, but as Eccles et al.’s (2018) survey of 582 institutional investors affirms, 60% attest that the lack of standardised ESG data is the biggest barrier to using SRI irrespective of geographies and asset types. While surveys potentially include various biases – response, selection and attribution – they provide insights into the decision-making process. Their survey echoes Zadeh and Serafeim’s (2017), whose survey of 413 senior investment professionals considered the lack of standardisation and comparability as significant impediments to utilising ESG data.

They further found that a clear majority (82%) of the investors were motivated by financial returns (ibid.). Wagemans et al. (2013) distinguished between passive (screening) and active (shareholder advocacy) SRI strategies, with the latter only available for institutional investors. Indeed, NGOs are typically highly engaged with the companies they are working with, in contrast, institutional investors are less inclined to push for environmentally friendly practices unless there are financial incentives to do so. Indeed, Fernando et al. (2017) profess that institutional investors favour environmental practices when they mitigate against environmental risks, such as oil spillages thus creating long-term value by hedging against lawsuits and bad press, over green initiatives in and of themselves. Levine and Emerson (2011) contend that less-engaged institutional investors will simply create financial SRI products that appear to create value but do none of the work; the intended impact of SRI is at risk of becoming an “afterthought to use for external reporting and marketing…just nice stories with pictures” (pp.13-17). This is reinforced by an interview with an SRI director by Sandberg et al. (2009): “[SRI] is whatever the client wants it to be” (p.528). SRI could provide false optimism for improving the environment depending on the intentions of the investor.

The literature is parochially constrained by its fixation on the profitability ESG-integrated investment strategies and has distracted large swathes of academics from analysing SRI’s underlying rationale. It has changed SRI from a justification of embedding social values and investments to a financial instrument to sell to ‘Generation SRI’ (The Economist, 2017). Revelli (2016) proposes that this top-down approach which positions financial returns top needs to be reversed for SRI to make an environmental impact. This is supported by Groot and Nijhof’s (2015) review of SRI research priorities in the past 25 years: financial performance trumps all other kinds of research. Furthermore, there is a lack of analysis of the reliability and accuracy of the ESG figures, nor is there a sizeable debate about the virtues of information competition and an information monopoly. With the former, one can draw parallels with credit rating agencies manipulating scores of bonds prior to the global financial crisis 2007/8 out of fear of losing out to rivals, while the latter requires a universal and standardised metric and could be subject to regulatory capture and internal groupthink (White, 2010). As Levine and Emerson (2011) question, would a clean-energy investment which destroyed a habitat be considered sustainable? The ranking, societal conformation of environmental values and protentional dilution of environmental goals from financialization have drawn limited discussion in the literature (Revelli and Vivianai, 2015). These gaps are incredibly important because SRI is premised upon ESGs being reflective of environmental practices; SRI is flawed if the data is a poor signal of environmental performance.

In conclusion, the study of SRI is necessarily multi-disciplinarily, incorporating insights, debates and conflicts from a plethora of academic perspectives. This essay has delineated the major debates and themes within the SRI-associated literature, as well as its gaps. There is a divide between the theoretical success of SRI rooted in the perception of the purpose of firms and investors. Indeed, the contemporary literature not only rejects neoliberal economic and finance theories’ assumption that firms are solely profit-maximisers, but also that SRI cannot be financially competitive. However, the literature is abundant with analysis of the financial performance of SRI that it appears to have lost track of the fundamental of SRI: improving environment and society. There has been limited discussion on the reliability and accuracy of ESG data, especially relevant when the data is computed with secondary evidence. It further implies SRI is just another financial product or as a marketing tool, not about the impact on the environment and society. Moreover, the motivations of investors are considered crucial to the success of SRI and imply financially motivated SRI investors need financial incentives. The promise of SRI is built-upon truthfulness of ESG data as a gauge to the environmental performance of firms and further research should be dedicated to determining the effects, possibilities, and wider ramifications of standardisation.

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[1] SIF reports are used widely in the literature for the total value of ESG funds; this figure is compared to $40.3trillion total asset market (ibid., p.13)