DP14351 A theory of socially responsible investment

Author(s):	Martin Oehmke, Marcus M. Opp
Publication Date:	January 2020
Keyword(s):	capital allocation, ESG, social ratings, Socially responsible investing, SPI, sustainable investment
JEL(s):	G23, G31
Programme Areas:	Financial Economics
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=14351

We characterize necessary conditions for socially responsible investors to impact firm behavior in a setting in which firm production generates social costs and is subject to financing constraints. Impact requires a broad mandate, in that socially responsible investors need to internalize social costs irrespective of whether they are investors in a given firm. Impact is optimally achieved by enabling a scale increase for clean production. Socially responsible and financial investors are complementary: jointly they can achieve higher welfare than either investor type alone. When socially responsible capital is scarce, it should be allocated based on a social profitability index (SPI). This micro-founded ESG metric captures not only a firm's social status quo but also the counterfactual social costs produced in the absence of socially responsible investors.