VoxEU Column Industrial organisation

The effects of market discipline on environmentally and socially sustainable corporate policies

There is growing consensus that as well as maximising shareholder value, listed companies should also take into account their shareholders’ environmental and social concerns. This column aims to shed light on whether market discipline can influence corporate behaviour. The findings indicate that through their sales and purchases, investors and customers can effectively impose their social preferences on firms, suggesting that market discipline indeed works.

Corporate environmental and social (E&S) policies are attracting increasing attention from academics and policymakers alike. There is growing consensus that listed companies should not only aim to maximise shareholder value, as traditional corporate finance theories imply, but also take into account their shareholders’ environmental and social concerns (Hart and Zingales 2017). 

Even if shareholders care about more than just returns, it is an empirical question whether small investors and customers can influence corporate policies. Existing evidence is limited to cases of large institutional blockholders engaging with management to obtain changes in E&S policies (e.g. Dyck et al. 2019, Dimson et al. 2018, Krueger et al. 2019, Chen et al. 2019). Evidence on whether and how small investors’ and customers’ discontent affects corporate E&S policies is scarce. Such evidence is needed to evaluate whether market discipline is a realistic way to achieve a more environmentally and socially sustainable economy.

The effectiveness of market discipline is debatable. Policymakers that favour market discipline argue that investors and customers alike are concerned with more than just stock returns and product quality or prices; they have ethical and social standards and may be willing to pay a cost if firms meet their preferences.1 As a consequence, small investors and customers are expected to vote with their wallets and spurn firms that fall short of their expectations on ethical norms and E&S principles.

Others argue that market discipline may not be very effective if the combined impact of investors’ and customers’ actions is not large enough to affect firm valuations. In addition, even if firm valuations are temporarily affected, managers who are rewarded for long-term profitability may not necessarily have incentives to improve corporate E&S policies (Davies and Van Wesep 2018). Instead, managers could rely on the fact that investors who tend to have limited attention or memory may quickly go back to demanding a firm’s stock following a negative shock to its reputation on E&S policies. Customers may also be quick to go back to purchasing the firm’s products. Thus, even a temporary backlash may not result in changes in firm policies, potentially limiting the effects of market discipline.

In our recent paper (Gantchev et al. 2019), we aim to shed light on whether market discipline can really influence corporate behaviour. We overcome the challenge of measuring changes in investors’ and customers’ behaviour using a novel dataset, which aims to monitor environmental, social, and governance (ESG) business conduct risks and company-specific violations of internal policies and international standards for listed companies around the world. The data provider screens daily over 80,000 media, stakeholder, and third-party sources, including print and online media, NGOs, government bodies, regulators, think tanks, newsletters, social media (e.g. Twitter), blogs, and others. We capture heightened ESG risks by increased company-specific media coverage of potential violations of internal or external ESG standards. Importantly, we are also able to isolate E&S risks from broader firm governance risk and to focus on the former.

We then explore how investors and customers with different social preferences, measured using either the cultural attitudes towards E&S issues in their countries of origin or their investment portfolios’ sustainability ratings, react to E&S risks. We find that E&S-conscious investors – institutional investors from countries with cultures that value environmental and social behaviours or investors that hold portfolios with high sustainability ratings – decrease their shareholdings in firms experiencing heightened E&S risks. Similarly, the sales of firms facing heightened E&S risks decrease in countries that are friendlier to E&S issues. As a consequence of the actions of E&S-conscious investors and consumers, firms’ stock returns drop following negative realisations of E&S risks.

We also show that ownership by non-E&S conscious investors increases, partially offsetting the sales of their E&S conscious counterparts. This fact, together with evidence that following other negative firm news, E&S-conscious investors do not sell and E&S-conscious customers do not reduce their purchases, confirms that negative E&S risk captures changes in investors’ and customers’ discontent rather than expectations of deteriorating firm fundamentals. 

We show not only that investors’ trading and customers’ purchases affect stock prices, but also that companies subsequently improve their E&S policies. Importantly, the effects we document are due to small investors’ divestitures and consumers’ boycotts rather than to blockholder engagement. Overall, our results indicate that through their sales and purchases, investors and customers can effectively impose their social preferences on firms, suggesting that market discipline indeed works.

Our work offers important policy implications. Market discipline works as long as investors and customers are able to evaluate firms’ E&S policies. Thus, better disclosure may enhance market discipline. Yet, despite strong pressure from institutional investors, regulatory agencies have been reluctant to impose uniform disclosure standards regarding E&S issues.  While the media and private data providers, driven by increased interest in E&S issues, have stepped in to provide information on firms’ long-term sustainability policies, mandated standards of disclosure may enhance market discipline and become a powerful instrument in incentivising firms to adopt E&S friendly policies.


Chen, T, D Hui, and C Lin (2019), “Institutional shareholders and corporate social responsibility”, Journal of Financial Economics, forthcoming.

Davies, S W and E D Van Wesep (2018), “The unintended consequences of divestment”, Journal of Financial Economics 128: 558–575. 

Dimson, E, O Karakaş and X Li (2018), “Coordinated Engagements”, working paper.

Dyck, A, K V Lins, L Roth, and H F Wagner (2019), “Do institutional investors drive corporate social responsibility? International evidence”, Journal of Financial Economics 131: 693–714.

Gantchev, N , M Giannetti and R Li (2019), “Does Money Talk? Market Discipline Through Selloffs and Boycotts”, CEPR Discussion Paper No. DP14098.

Hart, O and L Zingales (2017), “Companies Should Maximize Shareholder Welfare Not Market Value”, Journal of Law, Finance, and Accounting 2: 247–274.

Krueger, P, Z Sautner, and L T Starks, (2019), “The Importance of Climate Risks for Institutional Investors”, Review of Financial Studies, forthcoming.


[1]  For instance, in a 2018 investor survey, 43% of respondents incorporate ESG factors in their decision making, up from 22% in 2013. See the survey at

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